Terms, Terms, and First Round Terms
Fred Wilson has a nice post up titled The Ideal First Round Term Sheet. In it he describes the process of closing a financing using a standard set of Series A terms from Gunderson that he agreed to as part of the term sheet. In this case, the VC (Fred’s firm – Union Square Ventures) isn’t using a law firm. Fred states:
“I’d like to see this practice become standard in our industry. We need to lower the time and cost of raising capital. We need to eliminate a lot of bad terms that have caused a lot of harm (tranched investments, mutiple liquidation preferences, super pro-ratas, etc, etc). We need to converge on a set of standard Series A terms that everyone uses.”
I couldn’t agree more. Chris Dixon wrote a post titled Ideal First Round Funding Terms that Fred points to. I agree with almost everything Chris says, and especially agree with his assertion that you should “only negotiate over 2 things – valuation and amount raised.”
When my partner Jason Mendelson and I wrote our Term Sheet series in 2005, we had a lot of people thank us for demystifying the term sheet. Some time last year, both TechStars and Y Combinator open sourced their financing documents – TechStars were done in conjunction with Cooley Godward and Y Combinator’s were done in conjunction with Wilson Sonsini. On top of all of this, the NVCA (National Venture Capital Association) has had a set of model legal documents up on the web for a while (Jason was on the team that put these together).
So – there’s now no shortage of term sheet data (and forms) available. Now the trick is to get everyone to start using the same stuff. It seems like first round deals is a great place to start.
Ironically, if you read through all the various sets of documents with a fine tooth comb, you’ll find an interesting phenomenon – they are all slightly different. So – a next step is to get Gunderson, Cooley, and WSGR to standardize on one set. If there was truly a set of “first round docs” (for angel rounds, seed rounds, and venture capital rounds – whatever you want to call them) – life would be a lot better for entrepreneurs, VCs, and probably even the law firms since most first round deals are money losers for them even though they generally cost way too much.
We’ve funded a company called Brightleaf that plans to help with the document production part of this problem. But we also need leadership from VCs and law firms to realize that there really should only be two terms being negotiated in most first round financings – valuation and the amount raised.
Great advice for both sides, Brad. I completely agree that too much time is wasted when it will stunt the growth of companies that are trying to get ahead in competitive markets.
Additionally, I think this goes back to transparency in the 21st Century. If you enter into an agreement with an investor/entrepreneur, everybody should walk away happy & excited for what's to come. There shouldn't be any second thoughts. Keep things as simple as possible!
Absolutely agree. There are enough barriers to entry without unnecessarily complex terms and documentation.
Totally agree. Not to be a stickler but I would also add founders salaries. Maybe we're taking that as a fixed/non-negotiable number because it would be in the budget and therefore valuation would reflect if the salaries are relatively high/low.
Anything that can focus people on the right issues (price and valuation) is good. The toughest part of all negotiations is everything but the main issues because really what you are doing is focusing on worst case i.e. I need to prevent you from screwing me which gets personal.
[...] 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 & [...]
[...] over the last few weeks about standardized funding docs. I caught wind of it from (no surprise) Brad and Fred’s fantastic posts on the VC side, which led to Chris Dixon’s also amazing post [...]
I’m pretty casual about founders salaries. I view them as a variable that the founders drive, not a negotiation topic. Every now and then I feel like the founders aren’t being reasonable (and I’ll push back), but most of the time the rationale for the salary levels (which vary quite a bit) make sense to me.
Fantastic post Brad
Just blogged a response, but long and short is that I think a potentially more important step would be for firms to publicly state that they agree with a set of legals. I only mention this because a friend had a recent circumstance where the firm they were working with *said* they'd go along with the TechStars sample terms, but when it came time to do the actual closing docs, they changed dozens of terms and totally warped the term sheet.
Bad form either way, but firms publicly declaring their support for one or more "standards" (a la RSS / RSS 2.0 / Atom standards) would go, IMHO, farther than the law firms standardizing on a set of docs.
After all, most of the docs are pretty darn fair, so as entrepreneurs we don't much care *which* standard is supported, as long as *a* standard is supported!
Yup. The worst / most annoying part of all of this is that the VC typically tortures the entrepreneur as part of the “downside planning.” At the earliest stages, this should be really easy as the downside is “you lose all your investment!”
I agree that the VCs should get behind something like this. However, it’s impossible unless there is a legal document standard since every VC will have to read through the “standard docs” to see if they are in fact standard! What a pain in the ass.
It sounds like the firm you mentioned “behaved badly” (shocking!, just shocking!). I’ve never understood why VCs play bait and switch at the beginning of a relationship – it just sets such a shitty tone.
[...] 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 & [...]
Yep. I'll add that there are some unnecessary behaviors on both sides of the equation. There's a healthy body of academic literature about entrepreneurs and metaphors–quite often military ones that drive "us vs. them" behaviors. There's some justification for that–entrepreneurs are either disrupting an existing market or creating a new one that invites competition, but the downside is that they can create adversaries where they didn't have to just by embodying those attitudes. In my practice, I have worked with a firm recently that was trying to raise €250M (construction project) and alienated capital firms that were initially sympathetic. Bad scene. My point is that there are a lot of dynamics that reinforce unhealthy and unproductive behaviors on both sides. The steps you've mentioned in the post and in the comments have the potential to avoid that sort of thing.
Brad, does "aren't being reasonable" mean they are paying themselves too much or too little? Do you look to any standard for reasonable founder's salaries?
Almost always it means “too much”. I don’t look to any particular standard, but there definitely is a direct equity tradeoff, especially in a seed (or first round) investment as there’s limited capital and most of it goes to salaries.
I would love to see WSGR, Cooley, and Gunderson standardize on a set of "Standard Series A Docs," but I'm skeptical of this actually happening because doing so would commoditize their value-add. If those three firms agreed on a Standard, and that Standard were open source, then any firm could come it, play a game of "mad libs style fill in the blanks," and charge 1/4 of what those three firms bill for a Series A closing. So, if those three firms are going to agree on a Standard, it's going to have to be the VCs and Entrepreneurs that drive them there, because they're not incentivized to get there on their own.
I agree. I’ve tried encouraging them to no avail. There is no value add from lawyers at the first round / Series A and they know it, but won’t admit it. Look for the first commercial release of Brightleaf’s software (http://brightleafcorp.com/) – coming soon. That’ll help with the Madlibs game.
Don't worry, I agree, though effectively the YC/TS docs are standards (a standard's only a standard if somebody uses it, right?) since folk are referring to them as starting points.
Anyways, yeah, *shocking* that a firm would bait/switch. My hope is that folk like you getting out in front of this and saying "we support standards" in general will help, especially in places like Canada where less firms investing has meant poorer treatment of entrepreneurs in the last year.
Brad, it would be very useful to know what CEO salaries are for a company you invest in. How about if you take the last ten companies you funded, throw out the lowest and highest number, and listed the eight numbers? It would be useful data.
I don’t have the exact data at my finger tips, but from memory it ranges from $0 to $200k. Seed deals tend to be lower – typically $80k to $120k (although it depends on the specific entrepreneur and their situation). I’ve also had a number of companies with > $5m in financing where the entrepreneur took $80k or less and the management team was capped at $150k.
I don’t have a specific rule for this – I view it as situation specific.
Term sheets should be easier. Unless you need diligence, you don't need lawyers. I am a lawyer. I never understood how the most complex financial transactions in the world–all sorts of financial derivatives–run off the ISDA master swap agreement with a term sheet summarizing terms on it but a VC financing cannot. I finally concluded that lawyers don't understand most derivatives and the transactions need to happen more rapid fire between banks acting as dealers, so they settled on ISDA's and then they don't need lawyers. Lawyers can understand VC financings so make them more complicated than needed, and there are no primary forces in the VC world like dealers to drive consistency. It is baffling to me though. Series A VC financings are just not that hard, but there are too many players–lawyers and VCs–to get to consistency. A big waste of time though.
This was on techcrunch this morning – http://www.techcrunch.com/2009/08/23/the-funded-p...
http://www.docstoc.com/docs/10303638/FFI-Plain-Pr...
Yeah – I saw it. It’s actually missing some basic stuff and has plenty of unnecessary stuff in it. Even worse, the issue is NOT a standard term sheet, it’s a standard set of deal docs. I’ll write a post about this soon.
[...] my share of financings with a set of bullet points in email (I just proposed one today) and I’ve stated that the only things people should care about in the first round financing is (a) valuation a…. That said, there will always be a handful of other things to argue about in a first round [...]
Brad. I have been following this conversation and development for a while. As we started to develop solutions to this in regards our own service http://www.growvc.com, instead of just "work in our own silo" we decided to just "open source" this whole part of our dev. and so http://www.startupcommons.org was created.
Startup Commons have a three item plan for this:
1. create categorizing model to identify different types of start-ups
2. find/build/attach high level sets of terms for different categories
3. develop efficient web tool to better manage the logistics and communication of the agreeing process (start with high level term sets by category with "blog style" commenting per each term)
We have registered the SC as non-profit association, so it can be used as vehicle for the whole global ecosystem.
Would love to get your feedback and input as well.
Super neat!
If memory serves, the term sheet series that you and Jason did stated that the two things worth negotiating are money and control. Where'd control go in the new valuation-and-amount model?
Control is a lot less important in a seed round. While you want light protections – see http://www.feld.com/wp/archives/2009/08/the-chall... – they are more around the acknowledgment that the investors should have to affirmatively consent – at least at some threshold – for transformative corporate actions (e.g. a sale or another financing).
[...] as committed in a convertible note round as they are when they price a seed round and do it as a typical VC preferred financing, albeit with lighter [...]
[...] for the term sheets, I like that as well. People have been attempting standard term sheets for some time, with little success. I hope this move gets them closer to the goal of lowering the [...]