Is It Fair To Release Startup Funding In Tranches?

Many entrepreneurs resent investors who want to release funds in tranches, based on the milestones they achieve. They think of these as unfair hurdles, and believe that this reflects an investor’s lack of trust in the founder. They believe that if a funder has faith in the entrepreneur, he should go ahead and write the cheque for the entire amount upfront, so that they have at least 12 to 18 months of runway, and don’t have to waste time and energy in trying to prove that they deserve the second tranche.

However, I think a milestone-based disbursement of funds in tranches is actually very valuable because it provides a reality check about six months after the initial funding.

Are you on track? Have you been able to achieve the goals you said you were? This staged funding makes you much more answerable and accountable.

The good thing about having an investor looking over your shoulder is that he can provide an objective 30,000-foot view, and explain to you what you’re doing right, and where you’re going wrong. Just like entrepreneurs want investors to trust them, why can’t the entrepreneur also trust that the investor will be willing to release funds if they perform as promised?

And even if he doesn’t achieve 100% success in meeting the milestones, most investors are understanding and will not be unreasonable. After all, six months is more than enough for a founder to be able to get the investor to trust him. And if he’s not been able to do that, then this reflects poorly on him, rather than on the investor.

Yes, founders are worried that the investor may change his mind after six months, and renege on his commitment. However, this kind of milestone-based release of tranches actually makes sure interests are aligned. After all, investors want our entrepreneurs to succeed, and we will not pull the plug unless there is good cause to do so !

Yes, there are other ways of achieving the same end – for example, by putting the second tranche in an escrow account. And it’s also possible that in the future, we’ll have blockchain-based smart contracts where the funds get released automatically once the milestones have been reached.

[This post by Dr. Aniruddha Malpani first appeared on LinkedIn and has been reproduced with permission.]