Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist
Mentors are great. There’s no reason not to give someone a small success fee if they truly help you raise money (random email introductions to a VC they met once at a cocktail party don’t count). Sometimes it will make sense to compensate mentors with options as long as you have some control over the vesting of the options based on your satisfaction with the mentor’s performance as an ongoing adviser.
Investment bankers are rarely seen in early stage financings but can be the ones running the show on behalf of the company for later rounds that raise $50 million or more of capital. We are always per- plexed when we receive a funding inquiry from an investment bank- er representing an early stage company.
Don’t be shy about insisting that your lawyer cap their fee at a modest number or even that the lawyer will only get paid out of the proceeds of a deal. There’s no reason, if you are a solid entrepreneur with a good business, that even a top- tier law firm won’t take your unpaid deal to its executive committee as a flier to be paid on closing.
At the same time that you don’t want an inexperienced lawyer creating unnecessary tension in the negotiation, don’t let a VC talk you out of using your lawyer of choice just because that lawyer isn’t from a nationally known firm or the lawyer rubs the VC the wrong way. This is your lawyer, not your VC’s lawyer. That said, to do this well, you need to be close enough to the communication to make sure your lawyer is being reasonable and communicating clearly and in a friendly manner.
Be careful of too many cooks in the kitchen. In the past few years, the idea of a party round, where many investors make relatively small investments at the early stage, has become popular. It isn’t unusual to see a $2 million seed round with 10 VCs and 20 angel investors in the round. While it might seem nice to have all these fancy names in a press release, the entrepreneurs get very little attention from any of the investors since their investments were all tiny relative to what the VCs normally invest. As companies raise their next round, they real ize they have the worst of all possible worlds, which is having a lot of VCs as investors, but none who are committed in a meaningful way.
It’s essential to make sure that you are targeting the types of firms that invest in your stage of company. One of the most common mistakes entrepreneurs make is focusing on firms that are irrelevant for them at their current stage. Try to avoid the common mistake of putting energy into raising money from a firm that doesn’t invest in companies at your stage of growth.
A micro VC fund is a small venture firm that often has only one general partner. Many of these folks started out as angel investors, which we will talk about in the next section, and, after some success, created a fund to invest other people’s money alongside their own. Sizes of these funds can vary but are usually less than $15 million in total capital per fund. These firms almost exclusively invest at the seed and early stage, often alongside other micro VC firms, angel investors, and friends and family investors.
Seed stage funds are generally bigger than a micro VC and can scale up to $150 million per fund. Seed funds focus on being the first institutional money into a company and rarely invest in later rounds past a Series A. Seed stage firms often provide your first non- company board member, so be thoughtful as this relationship goes well beyond just the investment
Next up are the early stage funds. These are the funds that are generally 300 million in size and invest in seed stage and Series A companies but occasionally lead a Series B round. These firms also often continue to invest later in the life of a com- pany, often taking their pro rata in subsequent rounds
Mid stage funds are those that generally invest in Series B and later rounds. The funds are often called growth investors, as their first investment in a company is at a point where a company is clearly working, but now needs capital to accelerate, or continue, its growth. These funds usually range from 1 billion in size.
Late stage funds enter the picture when the company is now a suc- cessful stand-alone business, typically doing its last financing before a prospective initial public offering (IPO). These include specific late stage VC funds, but also can be hedge funds, crossover inves- tors that invest primarily in the public markets, funds associated with large banks, or sovereign wealth funds.
Change the terms of stock owned by the VC;
Tags: #funding
This pay-to-play provision is pretty good for you as an entrepreneur, at least as it’s described here. Conversion to common is no big deal in the grand scheme of things. What you want to avoid is a pay-to-play scenario where your VC has the right to force a recapitalization of the company (e.g., a financing at a $0 pre-money valuation, or something suitably low) if fellow investors don’t play into a new round.
VCS will want to minimize their risk of future dilution as much as possible by making the option pool as large as possible up front. When you have this negotiation, you should come armed with an option budget. List out all of the hires you plan on making between today and your next anticipated financing date and the approximate option grant you think it will take to land each one of them. You should be prepared to have an option pool with more options than your budget calls for, but not necessarily by a huge margin. The option budget will be critical in this conversation with your potential investor.
When a VC says, “I’ll invest 20 million,” the VC usually means the post-money valu- ation, meaning the pre-money the VC is offering you is $15 million.
The best VCS will give you, either proactively or reactively, a list of all the entrepreneurs they’ve worked with in the past and ask you to pick a few for reference checks. The best reference checks are from companies that went through hard times, maybe swapped out a founder for another CEO, or even failed, because you will learn from them how the VC handled messy and adversarial situations.
The best way to find the perfect VC is to ask your friends and oth- er entrepreneurs. They can give you unfiltered data about which VCs they’ve enjoyed working with and who have helped them build their businesses. It’s also the most efficient approach, since an in- troduction to a VC from an entrepreneur who knows both you and the VC is always more effective than sending a cold email to vcname@vcfirm.com.
“Less is more” when it comes to an investor presentation. There are only a few key things most VCs look at to understand and get excited about a deal: the problem you are solving, the size of the opportunity, the strength of the team, the level of competition or competitive advantage that you have, your plan of attack, and current status. Summary financials, use of proceeds, and milestones are also important. Most good investor presentations can be done in 10 slides or fewer.
“Do. Or Do Not. There Is No Try.”
One successful negotiating tactic is to ask VCs up front, before the term sheet shows up, what the three most important terms are in a financing for them. You should know and be prepared to articulate your top three wants as well. This conversation can set the stage for how you think about negotiating down the road, and it can be helpful to you when you are in the heat of a negotiation. If the VCs are pounding hard on a point that is not one of their stated top three, it’s much easier to call them out on that fact and note that they are getting most or all of their main points.
The Bully (aka UAW Negotiator)
The Nice Gay (aka Used-Car Salesman)
The Wimp (aka George McFly)
Smooth, Steady, and Smart (aka Diane Lockhart from The Good Fight)
You should never make an offer first. There’s no reason to, unless you have another concrete one on the table. Why run the risk of aiming too low?
The Technocrat (aka Pocket Protector Person)