Comments Posts

Comments of the week: Legal fees, financial projections, and fit

Nivi · January 25th, 2010

We’re determined to have the best comment section of any blog the universe. Comments that are really worth reading.

One of the tactics we use to improve comments is tweeting about the good ones. Another tactic is highlighting good comments on this blog. Here are three comments from last week that really rocked (among many other excellent ones).

Mark Suster from GRP Partners writes:

My biggest recommendation for startups: Make sure you negotiate a fixed-fee arrangement with your lawyers on fund-raising events.

– Most people will tell you this can’t be done. We’ve done it every time.
– Simply tell your lawyer that this is a “vanilla” standard funding with no big, non-standard items.
– Make sure to also talk with 2-3 lawyers and let them know politely that it’s competitive.
– Also make it clear that whomever you choose for the funding will likely get your work in the future as your company progresses.
– Finally, tell your lawyer that if any “non standard” items pop up in the fund raising then you’ll accept these are change items that they can carve out of the standard arrangement.
– This way you get a mostly “fixed fee” agreement. Most importantly it sets everybody’s expectations up front how much the transaction will cost. By doing this lawyers will be less tempted to allow “billing creep” in your arrangement.

This works like a charm.

George Kassabgi from Keas says:

“The pertinence of forward looking sales projections depends on the stage of the business. If you raise capital from investors who pretend not to understand this, you will be setup for financial incongruity.

“Consider 5 distinct business stages:

1. Incubation
2. Build Product
3. Early-Adopter Success
4. Repeatable Sales
5. Scale the business

“In (1,2) sales projections are useless, the time to prepare them is wasted effort. In (3) sales projections are presumptuous; you have yet to comprehend WHY and HOW the buyer will commit. In (4) sales projections become essential to internal planning.

“Raising capital between stages 3,4, a 1-year plan is valuable, surfacing the right questions/equations within the business, and with potential investors. A 3-5 year plan is chimerical until stage 5 and the shift preceding it.”

Jae Chung from goBalto comments:

“It’s been exactly one month since I implemented Sean’s suggestions regarding assessing our before ‘product market fit’ strategy using survey.io. I can say that we’ve now clearly identified what the core value of our site is and have done a complete redesign focusing on what people love and ended up discarding all of the distractions. Our traffic has actually been growing (presumably due to word of mouth) and we are now on a clear path to monetization. We are hovering at the 30-40% “very disappointed” and continue to refine the functionality addressing our core mission.

“In summary, I am a believer in Sean’s suggestions and even reread Steven Blank’s “4 steps to epiphany” to focus all of our company’s efforts on customer development and minimize mission drift.

“Thanks again guys!”

Please keep the awesome comments coming. We read every single one.

How to moderate (and write) comments

Nivi · December 10th, 2008

The number and quality of comments on Venture Hacks is steadily increasing. This is most awesome; we really like comments. Thanks for commenting and please keep ’em coming. We read and moderate every one.

So prospective contributors don’t have to comment into a black hole, we’ve adapted these moderation guidelines from Edward Tufte‘s epic thread on Moderating internet forums:

  1. Accept comments with good spelling, grammar, and formatting; that advance the quality of the discussion; and are civil. Focus on the quality of the discussion for the reader—whether a comment agrees or disagrees with us is irrelevant (of course).
  2. Silently and lightly correct minor spelling errors, punctuation errors, or poor formatting in otherwise good comments.
  3. Let the quality of the posts and existing comments serve as a standard for new comments.
  4. Don’t accept partially meritorious comments if the overall effect of the comment is to lower the quality of the discussion.
  5. Quickly make final decisions about whether we’re going to accept a comment.
  6. Delete accepted comments if we later decide they don’t advance the quality of the discussion.
  7. Try to follow these guidelines when we write posts on Venture Hacks or comment on other sites.
  8. Thank commenters and highlight good comments.

What do you think? Are we missing anything?

Related: Edward Tufte’s Moderating internet forums.

Reactions to Recommended

Nivi · March 26th, 2008

Every article about Recommended described the feature better than our launch post. Here’s a few snippets we particularly liked.

tc.jpgFrom Mark Hendrickson‘s article in TechCrunch:

“Entrepreneurs and venture capitalists can use the sub-site, simply called Recommended, to track who and what others think highly of, and to indicate their own affinities as well.

“It’s structured much like Twitter—users set up profiles and subscribe to each other, then review recommendations made by others and make recommendations of their own.

“The overall idea behind Recommended is to lubricate the process by which members of the startup community network and determine who and what is popular.”

eric.pngFrom Eric Eldon‘s article in Venture Beat:

“While the service is very much a work in progress, the simplicity of the connections—and the fact that you’re connecting with influential people—makes this a promising service.”

carleenhawn.jpgFrom Carleen Hawn‘s article in FoundRead:

“It is really straightforward, simple and stupid. It’s like RSS for deal flow,” Nivi told us this morning… “All startup deal flow is done by email and phone now—a push model. This is like a pull model,” Nivi explained.

“Founders no longer need to spend weeks or days lining up reference calls for potential investors: just hand over the URL of your Venture Hacks profile…”

ashkan.jpgFrom Ashkan Karbasfrooshan‘s article in HipMojo:

“I asked Nivi about the service and in typical elevator pitch fashion, he replied “it’s match.com for investors and entrepreneurs”.

“While I am not sure if we need one more social network to join or profile to create… the financing matchmaking process remains full of friction and inefficiency…”

bijan.jpgFinally, from Bijan Sabet‘s (Spark Capital) tumblelog:

“I’m now alive in the world that [Venture Hacks] created. Very cool site.”

Browse Recommended or request an invite while we’re in private beta: Recommended.

Comments: Startup founders speak

Nivi · February 28th, 2008

Here are the latest great comments from our readers—please keep ’em coming!

rob_serious.pngRob Lord, founder of Songbird (Sequoia Capital), has some ideas for VC Wear t-shirts:

“Mo’ money, mo’ board seats.
“409a a-okay!
“Some of my best friends are EIRs.
“Venture debt is a non-starter.”

829918_a630614298.jpgJonathan Boutelle, founder of SlideShare, suggests using SlideShare to share decks privately:

“One safe way to share a PowerPoint deck with potential investors: upload it to SlideShare as private. Share it only with the investor. After 48 hours (or whenever they’ve had time to check out the presentation) simply remove it from slideshare.

“You could also share via a “secret” URL: but that URL could potentially be forwarded to other parties so it’s not a good way to share files with people you don’t trust (which seems to be the challenge we’re speaking of here). Still, you could take the file down after 48 hours, and this approach wouldn’t require the other party to have a login on slideshare. So it might be the more practical option.”

headshot_nabeel_hyatt.jpg Nabeel Hyatt, founder of Conduit Labs (Charles River Ventures), says you shouldn’t send your deck to investors:

“Not worth it. Not because your deck has some amazing information, it probably is pretty high level and isn’t as unique as you wish it was, but because it kills the point of the presentation. What if Steve Jobs posted his Keynote presentation the day before Macworld and then gave his presentation the next day — how much harder would it be for him to get any sense of drama, intrigue, and frankly keep people awake?

“You should send them *something* to entice their interest, but whatever it is, expect it to be widely circulated, and think of it as just a teaser to get the meeting. You should be the main event, not your PDF.”

ted_rheingold.jpg Ted Rheingold, founder of Dogster (Michael Parekh), has some ideas for protecting your deck:

“Don’t forget to convert it to PDF or another read-only format to avoid any funny stuff once it has left your hands.

“And make sure the date is the day or month you sent it, as it then stands as a point-in-time snapshot which is likely out-of-date by the next quarter (in case the slides end up floating around inboxes month later)

“I like the idea of posting the recipients name on each page so it’s clear who leaked it if they do want to pass along.

“I also thinking striping out any slides you think reveal too much is a good compromise. (Ask a trusted person to be the judge of what is too revealing, company founders tend to over value their own IP)”

wsgrwebpicthumbnail.jpgYokum Taku, a partner at Wilson Sonsini, disagrees with us on capping legal fees:

“The statement “Most caps include the fees for both sides” is not accurate. Term sheets typically only say that the company will pay reasonable legal fees of investors’ counsel, capped at $X. (I also disagree with $10K – $20K as a reasonable cap to propose with straight face for investor counsel.) Of course, you can try to discuss a fee cap with company counsel, but almost all competent counsel will not agree to a cap. However, most experienced counsel can provide estimates based on actual data from previous similar transactions. Companies often have neglected corporate cleanup that needs to be fixed in connection with a financing (similar to not going to the dentist for years and paying the price later). In addition, there are always things that occur in financings that are difficult to predict (such as arguments among founders). Finally, capping company counsel fees is a disincentive to provide services after the cap is exceeded.”

dsc_0001.JPG Farbood Nivi, founder of Grockit (Benchmark Capital), thinks raising a good chunk of money is not a bad thing:

“There is an argument that says too much money can cause one to take the foot off the gas.

“I can’t say it’s a false statement. I can say it doesn’t make sense to me or apply in Grockit’s situation. Raising the Series A we did, as opposed to a few hundred K seed round, has given us an engine with a lot more horsepower. That knowledge, if anything, should keep your foot feeling like lead. That said, keep in mind, a more powerful car requires more adept steering, braking and maintenance.

“Money well spent buys time (far more precious than money), quality (translate: scalability and user satisfaction), people (translate: your company), access, resources. Do you need any of these?

“Money is to a business what oxygen is to a human…

“All founders are desperate. The question is what for.

“I would rather be able to pursue my desperate need to create the ass-kickinest app I can over my desperate need to generate revenue for it.

“Money allows you to reduce revenue based desperation and replace it with product building desperation.”

Like we says, keep the comments coming—we’ll highlight the best ones in the next ‘comment’ post.

Comments: Convertible debt

Nivi · May 29th, 2007

Our comments are now threaded! Click the “Reply” link beneath any comment to leave a response. Here’s an example of a threaded comment.

As usual, we’ve received many mind-expanding comments—here are some of the very best. The very lucky winner of a mug for great contributions in the field of venture hacking is indicated with a subtle ball of fire.

Dead simple equity agreements

Yokum Taku, a lawyer at Wilson Sonsini, mentions his experience with simple equity agreements that have some of the advantages of debt financing:

“I’ve done early angel preferred stock financings where the angel Series A only had a liquidation preference and there was a contractual provision that forced to company to give the angel Series A all other investor rights that would eventually be given to the “real” Series B (adjusted for price-related terms). The Series B may have issues with giving the Series A the same level of rights, so the Series B may condition the Series B financing on the Series A rights being something they can live with.”

A caveat: this is not the same as an equity financing with “standard” or “vanilla” terms. Yokum is talking about preferred stock with no rights other than a liquidation preference. So-called “standard” terms are almost always in the investor’s favor.

The benefits of convertible debt

Eric Deeds, a lawyer at DLA Piper, discusses the benefits of convertible debt:

“First, don’t underestimate the benefit of simplicity, convertible debt is a lot cheaper and quicker to put in place than an equity structure, even with dumbed down seed / angel terms. Also, if you’re raising the money $50-100k at a time, you don’t really have one person to negotiate terms with, so the fewer terms the better.

“Regarding valuation vs. no valuation, don’t forget one benefit angels are getting either way is access to the company. The door is typically shut at Series A. I don’t think it makes sense as an angel to push too hard to put a price on the company at the seed round. For one thing, its possible (and not entirely uncommon) to overpay, which is awkward for the company and the angels. A risk premium to the Series A in the 10-40% range should be adequate compensation.

“I think complex discount / cap structures can be more trouble than they’re worth. As noted, at the extreme you are pricing the company, they complicate and increase the cost of putting the round in place, and based on some experience, VCs just seem to hate paying more for a Series A share than the seed investors. Warrant coverage provides the same risk premium with a lot less friction.”

Raising debt from friends and family

Jonathan Treiber from OnCard Marketing recounts his experience with raising debt from friends and family:

vh-100.png

“We just did a convertible debt offering for our seed round and raised about $125k about 6 months ago. It was easy and painless. The investors were mostly friends and family and did not really want to bother negotiating a term sheet for an equity round. In fact, we didn’t spend nearly $10k for our debt deal, since there were boilerplate agreements without any negotiating. Our attorney just sent us the agreements, explained the mechanics to us, and we went around collecting checks and getting the docs signed…

“The terms were straight-forward and we didn’t have to make any real concessions. We did the deal with a 10% coupon (equal to a 10% conversion discount if security held for 12 months) which is paid in stock at the Series A. Based on what I’m hearing, we got a pretty good deal. However, we lost a few other potential investors who wanted better terms with a real conversion discount at 40%. In the end, we probably left about $200-$300k on the table by sticking to our original terms. The bottom line for us was that non-friends/family wanted better terms to protect their investment. Friends and family were happy with the basic terms to help us out and participate in any upside. We call this type of capital “love capital” and it’s probably some of the cheapest around. Definitely look for it if it’s available.”

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Comments: Convertible debt and vesting

Nivi · May 4th, 2007

As usual, there were many mind-expanding comments this week—here are some of the very best.

The very lucky winner of this week’s mug for great contributions in the field of venture hacking is indicated with a subtle ball of fire.

Vesting

“Anonymous” discusses his experience with getting vested for time served and how his investors “poked out” two of the company’s co-founders:

“In my first institutional round we successfully got founder vesting put in… with a year’s worth of credit and a monthly vesting rather than an annual cliff. The company was at about 16 months old. At the time, we thought we were losers and just got ripped off but in hindsight that was a genius move. When the lead VC moved to poke out two of our 3 co-founders, that vesting took away some of the sting. Having the [credit] makes them think twice about having to spend the cash to move you out. In the end, we ended up with about 12% of the company fully diluted per founder. That’s pretty damn good, especially when we were at a $650M valuation when we got poked out.

If you are EBITDA negative, you need to expect to see [vesting] in the deal. I would highly encourage you to try and fight for the value you’ve created as much as possible and look down the road at ways in which you can preserve as much of that value as possible. If you are close to break even or EBITDA positive, this should be a non-issue.”

Yokum Taku, a lawyer, mentions that co-founders can negotiate their vesting agreements before they raise financing—this provides extra leverage in the Series A negotiation:

vh-100.png

“Negotiation microhack on vesting:

When the company is newly incorporated and founders shares are being issued (well before the VC Series A financing), consider hard-wiring some of the suggestions (vesting for time served, various acceleration provisions, etc.) into the Founders Restricted Stock Purchase Agreements.

Obviously, all of the provisions of the Founders Restricted Stock Purchase Agreements can (and will be) superceded by the Series A documents, but there’s a possibility that if you lead with something that is not outrageous in terms of vesting and acceleration, it might survive the Series A financing.

One ploy involves a response to the VCs along the lines of “Well – those vesting (and lack of acceleration) provisions are different from what the [fill in number greater than two] founders originally agreed upon. It took us several screaming matches to agree on upon these terms when we issued founders stock and there was a certain level of distrust during these arguments. I don’t know if I have the stomach to go back to [fill in name of potentially unstable founder least savvy about VC terms] to explain why we want to change what we agreed upon. He doesn’t really want to take your money in the first place, and it’ll push him over the edge. He/she’ll think that I’m trying to screw him/her over and may blow up the deal.

Typical legal disclaimers apply to this comment.”

Convertible Debt

“ds” says that high valuation seed financings can cause problems:

“I like [convertible debt] for the reason that it preserves upside for the angels that are taking the first layer of risk. I have seen a fair number of deals where price-insensitive angels put some $ into a company on a fairly high valuation.

Later, in the first institutional round, the VC takes a clinical look at the business and puts a different (lower) valuation on it. In that case, no one is happy…the entrepreneur feels he has done a lot of work and is moving backwards, the angel feels like he has taken risk and gotten stuffed, and the VC feels (to the extent that they feel) like they are dealing with unsophisticated operators.

[Convertible debt] is a neat structure to avoid this problem.”

Yokum Taku, a lawyer, considers whether convertible debt goes in the pre-money or post-money:

“One corollary to the Option Pool Shuffle is “What’s in the fully-diluted shares outstanding if you have convertible notes or warrants outstanding?” The issue is whether shares issuable upon conversion of a convertible bridge note or warrants issued in connection with the bridge should be considered part of the pre-money fully-diluted shares outstanding in calculating price per share of the Series A. Remember, more fully-diluted shares outstanding drives the Series A price per share down, resulting in more dilution to the founders.

Given that many companies are doing convertible note bridge financings as their seed round, this seems to come up relatively often.

VCs will take the position that all of the shares issuable upon the conversion of the bridge note and any warrants granted will be part of the denominator for calculating the price per share of the Series A.

At first glance, it seems like there is a good argument on behalf of the company that the shares issuable upon the bridge note are no different from shares issued in the Series A, and should not be included in the pre-money fully-diluted shares outstanding. In addition, warrants issued in connection with the note typically have an exercise price equal to the Series A price, so these warrants are not dilutive like cheap founders common shares.

The response from the VC is (1) the money from the bridge is gone and the value created by that money is reflected in the pre-money valuation, so the shares issuable upon conversion of the bridge count against fully-diluted shares, (2) in any event, there is a conversion discount on the note conversion so these shares are dilutive to the Series A, and (3) even though the warrants aren’t dilutive today with an exercise price at the Series A price, they will be dilutive in the future in the next round of financing, so the pre-Series A investors should bear that dilution.

Of course, with respect to (1), if there is still money in the bank at the time of Series A, perhaps some portion of the shares issuable upon conversion of the bridge should be taken out of the pre-money fully-diluted share number to the extent of the money left in the bank.

And with respect to (2), perhaps the discount portion of the conversion shares should be included in the pre-money fully-diluted share number, but the rest (to the extent there is money left in the bank) should not.

Finally, with respect to (3), perhaps the warrant overhang is not too different from multiple closings on a Series A round, where the price is set at the first closing, and second closings seem to go on for long periods of time after the first closing at the same price per share as the first closing.

I’d be curious in the VC reaction to this, because the last time I tried this, I lost arguments (1) and (2) (with not too much more logic than “no, those shares are in the denominator” – end of argument) and item (3) warrants was not applicable…

Typical disclaimers about legal advice apply to this comment.

Aside from the swipe about startup company lawyers not negotiating hard against the VCs (which I vehemently disagree with as a WSGR partner), I think you’ve done a great job educating entrepreneurs about subtle nuances in negotiations with VCs.”

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Comments: Legal fees, options pools, and vesting

Nivi · April 26th, 2007

We love the quality of the comments on Venture Hacks. You’re missing out if you’re not reading them.

A lot of the comments contain great anecdotes from founders. Others contain good questions which we make sure to answer.

Here’s a few recent ones that are especially good. You can also subscribe to our comments RSS feed.

Legal Fees

Joe Greenstein (from Flixster) says:

“I just want to throw in that my personal pet peeve with regard to the “standard” term sheet is the bit about the company paying the VC legal costs. C’mon – you have $500M and I am raising $1.5M and you want me to take the first $25k to pay your legal expenses for doing the deal? That’s like your dad giving you your allowance and then asking you to buy him a hot dog.

When we were raising money for flixster i thought that must be a trick — like if i agreed to that term they would pull the term sheet at the last second and say i failed the secret fiscal responsibility test…”

Option Pools

Andrew Parker (an Analyst at Union Square Ventures) says:

“In a negotiation, you can also try to change the rules of the game (change the formulas). For example, I know a few CEOs that have successfully negotiated that any option pool be created after the investment by institutional money, not before. So, the investors took the pool dilution along with the founders. This represents a significant increase in valuation without asking for an increase in valuation. It’s a hard chip to win in bargaining, but it’s worth taking a shot considering the high reward.”

Negotiation

“Anonymous” says:

“Some part of the term-sheets is like negotiating “pre nups”. You are basically negotiating the framework to follow when things go wrong or you end up in disagreement in future, just at the point where you are agreeing to work together in present.

One thing the article should expand upon is how to negotiate without scaring of the VCs. An entrepreneur has to balance protecting his interest with not coming across as someone that might be a “problem founder”. No VCs like to work with someone they perceive as a problematic founders. It is a tight rope walk!”

Vesting

Suzie Dingwall Williams (a lawyer) says :

“Whatever you do, make sure that the [double] trigger runs for a period of time BEFORE as well as AFTER change of control. You want to avoid any pre-emptive house cleaning of management before the deal is done.

I still get a good deal of moral outrage from investors when I try to negotiate this provision into the deal. Their objections seem to be a knee jerk reaction to anything that might cut into their ROI on a liquidty event. As if.”

“Entrepreneur” says:

“I would like to add it is possible to raise VC money without founder vesting provisions. I recently closed a series A round for a six month old company with no founder vesting provisions. We took them out of the term sheet and they weren’t discussed again. We’ve worked previously with the same VC with great outcomes so we had a strong hand.”

“A Founder” says :

“I went to these VCs with a new CEO candidate whom I had worked with for 12 months previously. The investment proceeded and I stepped aside. Four months later I was asked if I wanted to leave and sell my shares. The offer was way below the value of the previous round so I said I would leave, but retain the shares and a board seat. However, they really wanted me gone. The deal was I would be terminated without cause, but loss of employment meant loss of board seat, which meant no ability to protect my shareholding (about 20% at that point). I was actually told by the CEO (a buddy?) that they would engineer a down round just to force me out.

Eventually we reached a compromise, but the lessons learned were:

1. Resist vesting if you have devoted time and your own capital to a business prior to VC investment.

2 Have a board seat linked to the shareholding, not the employment contract.”

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Reactions to Venture Hacks

Nivi · April 3rd, 2007

A big thanks goes out to our new readers, commenters, and all those who wrote about Venture Hacks. Here are some of our favorite comments so far:

Andrew Fife says:

Everyone in Silicon Valley benefits from lowering the transaction costs of funding startups, which means more companies get funded, more jobs get created and tax revenues increase without raising taxes.

Shouldn’t executing disciplined business plans around new technologies be the challenge of entrepreneurship? Contacting prospective investors and understanding what they want to hear should be the easy part.

“Counsel” says:

“There are plenty of lawyers who know VC terms and VC deals very well, yet are not in the VC’s back pockets. Ask around your business community — you will quickly learn which lawyers you can trust as being more company/entrepeneur focused, and which ones will be good VC lawyers but too cozy with VC’s for a smart entrepeneur to really trust.

Also, many VC-back-pocket lawyers will sell themselves to you as having all the connections to the VC’s and can get your company in front of all the big players, but that should be an alarm bell. There is a difference — ask around with people who have been there and whose opinion you value and trust, and you will find it.”

There was a good exchange in the comments on Venture Beat:

A GD VC: “You need to trust your investor won’t jack you at every turn otherwise the enterprise is doomed from the beginning.”

startupboy [not Naval]: “You could very well say the same about VCs. You shouldn’t invest unless you trust the founders, so why bother with complicated terms? The core issue here is unequal negotiating power, not trust.”

From the humor pile, “Makeit” says:

“Naval is a God….VCs are bad and Naval is good! Naval talks…I listen.”

We think he is making fun of us.