This is part of my ongoing series “Pitching a VC“.
There’s a great meme developing this morning on the need to simplify funding terms and documents. The meme was kicked off by Chris Dixon with this post saying that term sheets need to be simplified and align investor / founder interests. That prompted Fred Wilson’s blog post appealing to the industry to make these simplified term sheets standard. Last to weigh in was Brad Feld whose blog post argues that the only 2 terms that should be negotiated are amount raised & valuation.
I totally agree but want to cover a different issue. If you’ve read any of my blog posts before you’ll probably recognize that I’m from this school of thought where founders & investors need to be more aligned and I’ve been very cynical of historic VC practices.
2006 was the last time I went out to raise venture capital. I had multiple term sheets to do my Series A financing. Many had the typical investor-friendly terms where entrepreneurs would get screwed and not even understand how they got screwed until many years later. This was pre Venture Hacks so not a lot of help on terms on the Net. The best series was done by Brad Feld on his blog here. But it was my second company so I had already learned all of the lessons the hard way.
There was one firm that offered me an entrepreneur friendly “vanilla” term sheet and that was True Ventures, which is why I believe they are attracting great early-stage entrepreneurs. They said they believed in aligning investor and entrepreneur incentives. I told another potential investor that I was accepting True’s term sheet. They immediately agreed to match True’s terms. I thought to myself, “OK, you were willing to F me when you thought I didn’t understand these terms and now you’re going to be friendly? I wonder what will happen 3 years from now when we hit our next contentious issue?”
I believe that there is a new breed of VC emerging including True Ventures, Founder’s Fund, Union Square Ventures, Foundry Group and several others that have this founder / investor alignment ethos. I have this mentality, too.
One very important item from Chris’s original post that wasn’t picked up by Fred or Brad is founder vesting. Chris writes that early-stage deals should have:
Founder vesting w/ acceleration on change of control. I talk about this in detail here. If your lawyer tries to talk you out of founder vesting (as some seem to be doing lately), I suggest you get a new lawyer.
I totally agree. Unfortunately I’ve lost two deals in the past 18 months over this issue. I don’t think that entrepreneurs properly understand the issue. Having spent way more time on the entrepreneur side of the table I believe I am a good arbiter of the issue. I sum it up here (but read Chris’s link above)
- I’m putting millions of dollars in your company. My thesis is YOU. I need some protection that you’re not fully or mostly vested where you could simply walk away with a large stake in the company, screwing not just me but the entire employee base of the company. I’m not Sequoia. I’m not looking to bring in a new team to replace you. If you leave my thesis is largely out the door.
- Without proper vesting you also place a risk on all other co-founders. In my first company there was no vesting in the seed round. One of the co-founders walked within the first year. He walked with 1/3rd of the company. It was naive and stupid on my part. I didn’t understand the issue back then.
- I do believe in protecting the founder. The most common way is to grant acceleration on change of control. That means if the company is purchased all of your shares become fully vested. Usually it is done as a “double trigger” meaning if your company is bought AND you’re asked to leave the company. Chris described the “single trigger” scenario. I regularly bring this up with founders as I want them to be protected.
- You can also cement rights for yourself in the case where you’re fired without cause to protect some or all of your shares. In my experience this issue is likely to be a source of negotiation.
- If you have founder vesting and protection on change of control + protection against losing your shares of you’re fired then we’re completely aligned. I’m protected against your walking (as are your co-founders protecting each other). You’re protected against my asking you to go or a company buying you and taking away your value.
I tried to argue my views on vesting to a company I tried to invest in 2 years ago. It was an A round deal but the founder was already 75% vested. They had brought in a new CEO who was 66% vested. They eventually took money from non-traditional VC based in the UK. Founder vesting was one of the emotional hot buttons for them. When the markets turned sour and they didn’t hit their objectives the non-standard investor decided not to follow its investment. They now own 100% of worthless stock.
I more recently lost another deal where this was a major issue. So I’m trying to reconcile it all in my head. I believe the trade I described above is not only fair but protects everybody’s interests. If you feel differently, please weigh in with comments.
(Cross-posted @ Both Sides of the Table)