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In 2005, Jason Mendelson (my partner and co-author of AsktheVC) wrote what has become an extremely popular series dissecting the “term sheet.” The feedback we got from it encouraged us to write several more series of blogs and ultimately led to us deciding to start writing AsktheVC to answer random questions from entrepreneurs.
Last Friday I pointed to a post from Dave Naffzinger (Judy’s Book) about Stock Options from an Entrepreneurs Point of View. I woke up today to two more great entrepreneur posts on term sheets. The first is from Dick Costolo (FeedBurner) titled Venture Terms – Liquidation Preferences and Participation. The second was titled Term Sheet Hacks was on a new blog titled Venture Hacks and written by Naval Ravikant (Vast.com) and Nivi (EIR at Atlas Ventures.)
When I started this blogging thing back in May of 2004, I stated that I was motivated by Fred Wilson’s post on Transparency. I love that smart entrepreneurs are adding to the body of knowledge out there around the funding process. I’ve always been befuddled that a financing (both angel and VC) and the “term sheet” are such as mysterious thing. It has been rewarding to get thousands of emails over the past two years thanking me / Jason for what we’ve written – and it is fun to see some smart entrepreneurs continuing to add to the demystification of the term sheet.
Rick Segal is in the middle of a negotiation and is having some frustration with his co-investor – a “US VC” – around settling on a few terms that he thinks are silly. I agree with two of them but struggle with the third.
- Expenses: If the deal doesn’t close, the startup pays. I agree – that’s silly, especially for an early stage company. I can imagine some later stage / VC buyout type deals where this might apply, but it doesn’t make sense in an early stage deal. However, the company should always pay (using their newly raised money) when the deal closes.
- Exclusivity Term: 90 day exclusivity is too long. I agree – if you can’t get the deal done in 45 days from the signing of the term sheet, something is wrong.
- Founder Buy Back: This one isn’t simple – it’s very context specific, personality dependent, and linked to stage, capital structure, roles and responsibilities of the founders, existing and future management team, and a whole bunch of other stuff. I don’t think there’s a general case here – I think you have to address this deal by deal.
Rick – don’t worry about the “US VCs” – if they are offended by the philosophy of Canadians, just offer to take them to a hockey game.
Every now and then I run into a new VC term in a term sheet that I’ve never seen before. My legs tremble with excitement as I stare at the words to dissect what they mean. On Friday, a long time friend sent me the following new and exciting term.
Compelled Sale Right: So long as VC (together with its permitted transferees) continues to hold at least 10% of the outstanding common shares (on an as-converted basis), and so long as an IPO has not been completed, then, at any time from and after the seventh anniversary of the transaction, if VC or the Company shall receive a bona fide offer from an unaffiliated third party to purchase 100% of the equity of the Company, VC shall have the right to cause each other stockholder to sell such stockholder’s equity securities on the same terms and conditions applicable to VC.
My first reaction was “what the fuck?” My second reaction was “eh – this is just a different twist on redemption rights.” But – then I thought about it some more and thought “you’ve got to be kidding me!”
So – after seven years, if there hasn’t been a liquidity event, a VC that owns at least 10% of the company can force all the other shareholders to sell their shares to an unaffiliated third party. Read it slowly and think about it. Basically, this term gives a minority shareholder the right to sell the company after 7 years, with no input from any other shareholders.
Be forewarned – this is not a nice term.
Tim Wolters has written a post on anti-dilution clauses from an entrepreneurs point of view. Tim promises to write more on other terms like liquidation preferences, reverse vesting, dividends, class voting rights, “and any other terms that have bitten [him] on the ass before.” Tim is co-founder and CTO of Collective Intellect, a new company that just recently closed a Series A funding. He was previously the co-founder and CTO of Dante Group, a company I funded that was acquired by webMethods. Expect straight talk and some good insights from Tim.
For my 40th birthday, I got a couple of cool t-shirts with photos of me substituted for Jack Bauer on 24. The only thing disconcerting was the image of me holding a handgun. I was pondering how ripped I looked (on Jack’s torso) when two questions on term sheets came in from someone at Ernst & Young. Being the excellent delegator that I am (much better than Jack, if you know what I mean), I forwarded the questions on to Jason who promptly answered them. They are as follows:
1. What would you deem the most hotly contested points of the term sheet? The most hotly negotiated term (after price) is the liquidation preference. In a Series A deal, it is between the company and the investor. While it’s often an intense negotiation, it’s straightforward because there are only two interests to consider (the founders and the Series A investors). In later stage, the negotiations become even more interesting. Take a situation where you have a Series D deal with each Series (A, B, and C) having different prices. By definition each of the different Series investors will have different payouts on their previously purchased stock and the Series D investors will be negotiating with several sets of interested parties (the founders, the Series A investors, the Series B investors that are not in the Series A, and the Series C investors that are not in the Series A / B). Of course, the notion of participating preferred plays into this negotiation also.
2. In your view, how has the role of legal counsel changed over time during the deal process (in the past 10 years or so)? Legal counsel is relied on more heavily these days to be a business arbiter, rather than a “take no prisoner negotiator” who must win every last deal point. These deals aren’t rocket science and any good lawyer knows that. As a result, legal counsel (at least good legal counsel) is now much more of a deal maker than hard ass negotiator.