This week, with the support of our Head of Legal, Risk & Compliance, Eline Murat, we’re focusing on the second round of funding and its implications for both investors and entrepreneurs. You may wonder why we’re shining the spotlight on the second round rather than the first. To clarify, let’s start by distinguishing the two rounds before exploring the specifics of what happens when a company seeks a follow-up investment.

The First Round of Funding

When a startup first launches—often with little or no revenue—the founder needs to secure capital to bring the business to life. This initial capital typically comes from friends, family, business angels, or venture capital firms. It’s a critical milestone because it determines whether the entrepreneur’s vision can be transformed into a tangible project.

The Second Round of Funding

After a few months or even years, a startup often needs additional funding to:

Continue scaling;
Sustain operations;
Or, in some cases, rescue the company from financial difficulties.

This second round is typically more complex than the first. It may involve a new valuation of the company—known as the pre-money valuation—and can bring new investors on board. Before diving into different potential scenarios, let’s explore why the pre-money valuation plays such a central role.

Pre-Money Valuation

The pre-money valuation sets the value of the company before the new funds are injected. It’s determined by examining the company’s future growth prospects, projected profits, and the market value of its assets. This valuation dictates how the capital (and ownership) is divided and can change drastically between funding rounds. Whether the valuation rises or falls will influence decisions around both investing and reinvesting.

Three Potential Scenarios in the Second Round

The Best-Case Scenario
The company is thriving, and additional capital is needed to fuel its continued growth. Valuation has gone up, motivating existing investors to reinvest and attracting new ones eager to join a promising venture.
The Base Scenario
The company has shown steady (though perhaps inconsistent) progress and seeks new funding to keep growing. The valuation may not have increased significantly, but initial investors or a venture capital firm are often willing to reinvest. However, if the startup needs a larger amount of capital, new investors may be required. This can lead to a re-evaluation of both valuation and investment terms.
The Worst-Case Scenario
The startup has underperformed, and its valuation has dropped. Existing shareholders may be disheartened, making it difficult to encourage additional investment from them. New backers may still see potential, but they often demand certain protections—such as liquidation preferences (being first in line to recoup their investment if the company is sold or liquidated while still solvent).

The Issue of Dilution: Why Existing Investors Often Reinvest

If you already hold shares in the company, you typically have a preferential right of subscription to participate in any subsequent capital increase. This right gives you priority to invest in the new round but does not force you to do so. Be aware, however, that not exercising this right will result in dilution. Essentially, when new investors come in, your ownership stake in the company decreases.

Example : Imagine a company has 100 shares, each held by a separate shareholder (so each person holds 1%). If the company issues 100 more shares to 100 new investors, there are now 200 total shares held by 200 shareholders. Consequently, each shareholder’s stake is reduced to 0.5%. The original investors are thus “diluted.”

A cautious investor often avoids allocating their entire available budget in the first round, saving some capital to reinvest later. By doing so, they can maintain their stake in the company—avoiding excessive dilution and preserving influence.

Conclusion

Most startups raise multiple rounds of funding—second, third, or even fourth—to support their ongoing development. With each round, new investors can enter the picture, leading to dilution for existing shareholders and adjustments to the investment terms. At Spreds, we stay in close contact with the companies that raise funds through our platform so we can:

Monitor their progress;
Ensure our investors have the opportunity to reinvest on the same terms as new participants.

If the company’s terms or structure change substantially, we’ll invite you to a general assembly of noteholders. There, you can decide whether you’d like to reinvest and maintain your stake in the business—continuing to support the startup’s journey while protecting your own interests.