Takeaway

• A term sheet explains the details of an investment deal between a VC and a startup.
• The most important terms to know about are the ones detailing the economics and control of the deal.
• Startups can raise money by selling equity or contracting debt.
• Reputation is of the utmost importance when raising.
• Choosing a good lawyer is of primary importance.
• When it comes to raising, do, or do not. There is no try.

What Venture Deals Talks About

Venture Deals is a book written by venture capitalists Brad Feld and Jason Mendelson. It teaches entrepreneurs how to Deal with VCs at different stages, how to negotiate a term sheet, what are the most important concepts to know, how to negotiate a buyout, how VCs are structured and work, and much more about startup financing.

This book took me a month to read and summarize. I never thought I’d get to the end. It’s extremely detailed and quite complicated to read for people that had never a law course in their life (like me).

So, should you read this book?

Not sure. If you want to know everything there is to know about a term sheet, yes. But otherwise, I would simply hire a good lawyer and google the terms of the sheet as you read it, like Daniel Dines.

And if you want to know the basics, you can read this summary.

Not sure anyone took as much time as I did to write such a summary of such a boring book, so…enjoy it!

Get the book here.

Table of Content

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Summary of Venture Deals Written by Brad Feld and Jason Mendelson

Introduction: The Art of the Term Sheet

The book will talk about negotiating the term sheet. The term sheet is the sheet with the terms related to an investment in a startup.

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Chapter 1: The Players

The Entrepreneur

If you are an entrepreneur, make sure you direct and control the process.

The Venture Capitalist (VC)

The most senior person in the firm is usually called a managing director (MD) or a general partner (GP). VCs have a hierarchy of their own which entrepreneurs need to respect.

Partners are often not partners. They’re just employees.

Under them are principals or directors. They don’t have much decision power.

Then you have associates which are doing the research. And the analysts, who do the work no one wants to do (crunch numbers, write memos).

Some firms have venture/operating partners, which are seasoned entrepreneurs that can scout for deals.

Bottom line: do some research to see who has the power in the firm. It’s most of the time the MD, or GP.

Financing Round Nomenclature

Most VCs define themselves by the round at which they invest (seed, Series A, etc).

These terms often change.

Today, it goes like this: pre-seed, seed, Series A, Series B, etc.

Types of Venture Capital Firms

• Micro VC: usually seasoned angels with their own firm.
• Seed stage funds: up to $150 million. Focus on being the first institutional investor. Often provide a board member.
• Early stage funds: $100-$300 million, seed to Series B.
• Mid-stage funds: $200-$1 billion. Series B and later. Invest for growth.
• Late-stage funds

Focus on the firms that focus on your stage.

The Angel Investor

Individual investors that invest in early rounds only.

Angels aren’t important enough to influence your company.

The Syndicate

A syndicate is a collection of investors.

Sometimes, syndicates would each invest tiny amounts of Money, which is annoying for the entrepreneur because these VCs don’t have much skin in the game, so they don’t help.

The Lawyer

A great lawyer will help you focus on what really matters (economics and control), while a bad lawyer will make everything worse for you. So choose an experienced lawyer.

A lawyer is a reflection of you: a bad lawyer will tarnish your reputation.

Don’t let VCs decide your lawyer.

Make sure the lawyer caps his fees.

The Accountant

Rarely seen at this stage. Work with one used to work with startups.

The Banker

Rarely there for early stages. Bankers are useful for deals that include a partial recapitalization by a financial sponsor, such as a private-equity firm, or for acquisitions.

The Mentor

Entrepreneurs should have experienced mentors around them that help them with the raise.

These people are usually angel investors.

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Chapter 2: Preparing for Fundraising

Choosing the Right Lawyer

You choose a lawyer based on their experience level, cost, and comfort with the communication style. Try to choose someone you like as they will know every detail about your business.

Try to choose one that is well-versed in the startup world, and that also knows accelerators and investors.

Proactive versus Reactive

The best defense is offense. Here’s what you can do now to minimize the hurdles later.

1. Get the right type of company: make sure the legal type of company you have enables you to raise easily.
2. Establish a data site: use a service that helps investors go through your finances seamlessly. You should also make available on the data site:
   1. The cap table: spreadsheet with who owns what.
   2. Financial records, budgets
   3. Major customer lists
   4. Employment agreements

Intellectual Property

Patents, copyrights, trademarks, and trade secrets. These reassure the investors that no one that has worked with the startup in the past is going to copy it.

A founding team should ensure that anyone who has had contact with their company’s intellectual property has signed agreements with confidentiality and IP assignment provisions.

Sometimes, a founder will work on his startup while being employed at a day job. In some cases, the day job owns what the founder makes because he is still employed.

So it is very important that the founder gets a signed agreement from his employer that states clearly that what the founder makes belongs to the founder. If not, the founder should leave his job asap.

Every employee of a startup, including founders and each of the company’s executives, must sign a Proprietary Inventions and Assignment Agreement to protect the startup’s rights to its intellectual property.

This also applies to advisors.

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Chapter 3: How to Raise Money

Try to get several term sheets from several VCs to apply pressure and get better deals.

Here’s a set of advice.

Do or Do Not. There Is No Try.

You must raise money with the confidence that you will succeed.

You absolutely cannot be uncertain of yourself. This will turn off investors.

Know How Much You Are Raising

This depends on how long you need to reach the next step in your company. The longer you need + the more resources you need, the more money you will raise.

The amount of money you need to raise will determine which VC you will talk to. Don’t talk to the wrong VCs.

Don’t ask for more than you need, especially if the committed funds are far from the amount you are asking to raise.

Don’t use ranges. Be specific.

Fundraising Materials

You need:

• A short description of your business: elevator pitch.
• An executive summary: concise, well-written description of your idea, product, team, and business.
• A slide deck: 10-20 pages. Make sure to adapt it according to your audience. Less is more. Only focus on 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, current status, summary financials, use of proceeds, and milestones.

Whatever you send to a VC is both your first and last impression.

If you already have a demo or prototype, send it too. It’s very important and VCs love them.

• Business plan: useless for VC, interesting for the entrepreneur as writing about his idea forces him to think about it.
• Private Placement Memorandum: a traditional business plan wrapped in legal disclaimers. Only made when lawyers and bankers get involved. Often a waste of money and time.
• Detailed Financial Model: 100% of them are wrong.

Never hide anything. Make sure to disclose all issues you have.

Finding the Right VC

Ask your friends or other entrepreneurs for introductions and feedback regarding VCs, or contact them directly on their website.

Never forget the simple idea that if you want money, ask for advice. Try to develop a relationship that evolves over time, instead of viewing fundraising as a single, transactional experience.

Do some research on the VC and make sure their vision and expertise fit with your product.

Finding a Lead VC

There are three types of investors:

• Leaders: They will give you a term sheet, take a leadership role in driving to a financing, and be your most active new investor. You can get several VCs to compete to be your lead VC.
• Followers
• Everyone else

Your purpose is to find a lead VC.

As you are meeting with VCs, you will get four vibes.

1. VC is interested and wants to lead: aggressively engage with them.
2. VC isn’t interested and wants to pass.
3. Maybe: these VCs hang around, observing what the other VCs do. Keep on meeting with them often.
4. Slow no: they never actually say no, but they will not invest. Hard to figure them out from the “maybes”.

How VCs Decide to Invest

The way VCs behave with you depends on how you were introduced to them. Some only invest in companies that someone they trust introduced them to.

So figure out if you were “rightly” introduced, or “wrongly” introduced.

Then know who you are talking to: are these people the ones that make the final decision?

The way the VC will do its due diligence will tell you a lot about its interest. If they’re getting too curious, they’re likely not serious.

Ask for feedback about VCs from entrepreneurs that worked with them.

If VCs want to invest, they will eventually issue a term sheet.

If a VC met with you then decline to invest, ask why.

Using Multiple VCs to Create Competition

This gives you leverage to negotiate. Aim at 3-6 months if you want to make them compete.

Ask how the process goes for each VC after a second meeting.

If they ask you which other VC you’re talking to, don’t tell them.

Closing the Deal

The most important part of the fundraising process is to close the deal, raise the money, and get back to running your business.

This is done in two steps:

1. Negotiate and sign the term sheets.
2. Sign the final documents and get the cash.

Usually, when the term sheet is signed, you will get the cash.

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Chapter 4: Overview of the Term Sheet

The Key Concepts: Economics and Control

VCs care about two things:

• Economics: that’s the return on investment.
• Control: controlling or vetoing business decisions.

When founders receive stocks, it’s called common Stock.

When investors buy stocks, it is called preferred stock. Preferred stock can become common stock, but not the other way around.

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Chapter 5: Economic Terms of the Term Sheet

The valuation of the company determines how much equity you’re giving away.

It will also determine the price per share.

There are two ways to discuss valuation:

• Pre-money: what the company is worth today.
• Post-money: what the company will be worth after the raise.

Make sure you know which one you are talking about.

Employee Option Pool

The option pool is reserved to give employees stocks to motivate them to work.

The size of the option pool has an impact on the valuation.

Eg: if you have reserved €1 million at a €10 million pre-money valuation (aka 10% for the employee pool), and the VC wants 20% instead, then the pre-money valuation will be €5 million.

Usually, employee option pools are anywhere between 10%-20% in early-stage companies.

The reason why VCs want large option pools is to decrease as much as possible their own dilution.

Warrants

A warrant is a right for an investor to purchase a certain number of shares at a predefined price for a certain number of years.

Eg: 2-year warrant to buy 10 000 shares at €1 per share (it’s a call option, really).

Avoid warrants, as they complicate the whole thing.

Warrants may happen in bridge loan situations. A bridge loan occurs when an investor is planning to do financing but is waiting for additional investors to participate. Accept warrants only as long as they are structured properly.

When a new investor comes in, he’ll ask for a very low valuation. At the next round, he will ask for a very high valuation (to avoid dilution).

How Valuation Is Determined

VCs use the following variables to determine valuation.

• Stage of the company: in the beginning, the valuation depends on the experience of the entrepreneurs, the money raised, and the opportunity. Later, it depends on cash flow projections.
• Competition with other funding sources: the more VCs want to invest, the higher the valuation goes. Don’t pretend there’s competition if there isn’t. Be honest.
• Size and trendiness of the market
• The VC’s natural entry point
• Cash flow
• Economic context

Don’t take valuation personally.

Liquidation Preference

Liquidation happens when the company is sold, or when a majority of its stake is sold.

The liquidation preference is important when the company is sold for less than what has been invested, but also important when it is sold for more.

The liquidation preference is made out of two terms:

1. The actual preference: how much money will be returned when liquidation happens to whom (preferred VS common stock). In case the company is sold for less than the money invested, people may get back X% of what they have invested. Usually, that number is 1x.
2. Participation: which shares are participating, and which aren’t?
   1. No participation: the investor gets his investment and nothing else. Eg: you invest 5 million at a $10 million valuation, the company is sold for 100 million. You get 5 million back.
   2. Full participation: the investor gets his actual preference + the percentage he owned in the company for the rest of the money.
   3. Capped participation: the investor gets his investment back + a share of the rest capped at X% of the original price.

Liquidation event: a liquidation event is an event tied to liquidity, when the shareholders receive proceeds for their equity in a company and includes mergers, acquisitions, or a change of control of the company.

Pay-to-Play

In a pay-to-play provision, investors must keep investing pro-ratably in future financings (paying) in order to not have their preferred stock converted to common stock (playing) in the company.

This is good for both the startup and the investor as this ensures skin in the game.

Vesting

Vesting means that the employee does not receive all of the stocks he is given on the first day of work, but receives it over a certain period (4 years, with a one-year cliff).

Founders often receive one year of their stock right away, then the rest after the next three years.

When someone leaves the company without their stocks, then we have reverse dilution where everyone is getting a bit of those stock.

It’s important to define what happens to the shares in case the company gets acquired before the end of the vesting period (called single-trigger acceleration).

Antidilution

There are two types:

1. Weighted average antidilution
2. Ratchet-based antidilution: if the new round is done at a lower valuation than the previous round, all stocks in the company go to the new, lower valuation.

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Chapter 6: Control Terms of the Term Sheet

These terms define the control a VC firm will have over the company it invests in.

Board of Directors

The board of directors is the most powerful element of a company’s management structure and almost always has the power to fire the CEO.

The board approves many important decisions the CEO makes, such as:

• Budget
• Option plan
• Merger
• IPO
• Hiring executives

Be careful who comes to your board, there shouldn’t be too many people, and whoever comes should be helpful.

After the first round, a board will usually consist of:

1. Founder/CEO
2. VC
3. External board member

Protective Provisions

Veto rights investors have on certain actions the company takes, such as:

• Change the terms of stock owned by the VC
• Authorize the creation of more stock
• Issue stock senior or equal to the VC’s
• Buy back any common stock
• Sell the company
• Change the certificate of incorporation or bylaws
• Change the size of the board of directors.
• Pay or declare a dividend; Borrow money
• Declare bankruptcy without the VC’s approval
• License away the intellectual property of the company, effectively selling the company without the VC’s consent
• Consumate an initial coin offering or similar financings;
• Create a token-based interest in the company.

Make sure that your investors vote as a single class, and make sure that small investors can’t veto big decisions.

Drag-Along Agreement

This agreement enables the company to compel a shareholder to change (or not) his stocks with everyone from his series, or with everyone else in general.

This would help VCs avoid having smaller investors veto decisions they wanted to make.

Today this type of agreement concerns founders. When they leave, their stocks get “dragged along” by other classes of stocks, so they don’t “block things”.

Conversion

It is the right to convert from preferred stocks to common stocks, and this right is non-negotiable to VCs.

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Chapter 7: Other Terms of the Term Sheet

Dividends

VCs don’t really care about dividends because compared to the growth of the share, it doesn’t make much money. When there are some though, they will range from 5% to 15%.

Redemption Rights

Redemption rights exist to allow the investor to exit no matter what.

Eg: the company becomes successful enough to survive, but not enough to IPO or be acquired.

Do not ever agree to an adverse change redemption.

Conditions Precedent to Financing

These are the conditions that must be met for the deal to be signed.

Try to avoid these.

There are three conditions to watch out for:

• Approval by investors’ partnerships: this means the deal the VC presented you with was not yet approved…by the VC itself. Understand: it’s not because you signed the term sheet that you have a deal.
• Rights offering to be completed by the company: the VC wants to offer the previous investors in the startup to also participate in the financing.
• Employment agreements signed by founders as acceptable to investors: know what those agreements are (eg: what happens if you get fired).

Information Rights

What information the VC has access to and the time the company has to give it to them if they ask for it.

Registration Rights

Registration rights define the rights that investors have for registering their shares in an IPO scenario as well as the obligation of the company to the VCs whenever they file additional registration statements after the IPO.

Right of First Refusal

The right of first refusal defines the rights that an investor has to buy shares in future financing.

Only give this to a major investor.

Voting Rights

Voting rights define how the people that own preferred stock and people who own common stock relate to each other in the context of a share vote.

Restriction on Sales

It defines the parameters associated with selling shares of stock when the company is a private company.

Proprietary Information and Inventions Agreement

This is the VC making sure that whatever the company makes belongs to the company. It forces the company to make their employees sign a paper related to inventions and information property.

Co-Sale Agreement

If the founder sells shares, then the VC should be also allowed to sell some too.

Founders’ Activities

This is to force founders to focus on the company 100% and prevent them from doing “side hustles”.

If you don’t agree with this, don’t try to raise money.

Initial Public Offering Shares Purchase

In case there is an IPO, this will give the VC the right to buy shares at the initial price.

No-Shop Agreement

Prevents you from negotiating with other VCs as you are about to close the deal.

Indemnification

This is a clause forcing the company to indemnify its board members.

Assignment

This gives them the right from VC to transfer their shares to other people/company they own/know.

Make sure that whoever the VC transfers shares to agrees to the same conditions.

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Chapter 8: Convertible Debt

Nowadays, most financing happens with convertible debt.

Convertible debt is a loan, so there’s no discussion about valuation. When the company raises money in the future, then the debt converts to equity (often at a discount).

Eg: raising 100k at a 10% discount. If your company is worth 1 million, then the 100k will transform to 100k/0.9 = 111 111.

Here’s what you should know about convertible debt.

1. It’s easier because since it’s debt, there is no need to fix a valuation. In early-stage financing, VCs and founders often fight over valuation. Some investors ask for a valuation cap. If the valuation of the company is more than X when they raise, then the investor will ask Y% of discount. This is good for the investor but not for the company as other investors may not want to invest at a higher valuation than the cap.
2. It may inflate the price of the financing later on. And if the price is too high, your lender will end up with a little share despite being your “first fan”.
3. The cap may influences the overall valuation of the company.

To do it properly, raise debt but wait long enough before raising a round so the cap does not negatively influence the valuation. Offer as well forced conversion to your lender if you end up not raising any round.

The Discount

The discount is there to reward the investor for taking the risk at an early stage in the venture. Indeed, the interest on the debt is too little to be financially significant.

The discount can work in two ways:

1. The price is discounted in the next round: that’s what we explained above. Discounts go from 10% to 30%.
2. Warrant: discussed below.

Valuation Cap

The valuation cap puts a ceiling on the valuation of the company.

Eg: if you receive 100k of debt, the investor will get much more money if you raise at $1 million than at $10 million.

So the cap ensures that the lender can get a good deal. In this case, if the cap is set at $5 million and the company raises at a $10 million valuation, then the lender will see his shares converted as if the company raised at $5 million.

Interest Rate

Since it’s debt, it has an interest rate. These should be as low as possible since the debt will convert at some point.

Conversion Mechanics

Debt holders have more power than equity holders, so you do have an interest in the debt converting to equity.

For the debt to convert automatically, all conditions must be met. These are the terms you should know.

1. Term: the amount of time after which the company must sell equity for the debt to convert. Make it as long as possible.
2. Amount: minimum sum the company must raise.

If the company fails to reach these milestones, then the debt will remain debt unless the holders agree to convert it.

Warrant

A warrant is another way to convert the debt.

A warrant is an option to purchase X stocks at a predetermined price.

Eg: $100k debt with a 20% warrant coverage. In this case, that’s $20k of stocks.

Now, how do you figure you the price?

It can be:

1. 20k of stocks at the last value.
2. 20k of stocks at the round’s price
3. 20k of stocks for the next round

Other terms you should know:

• Term length: the period during which the warrant can be exercised.
• Merger considerations: what happens if the company is acquired? The warrant should expire at the merger.

Other Terms

• Pro rata right: allow debt holders to participate proratably in a future financing.
• Liquidation preference: the debt holder gets back his money first in the event of a liquidation.

Early Stage versus Late Stage Dynamics

These debts were issued so that the startup could develop enough and get to a point where it could raise money (that is, mid to late stage).

But since it was cheap to do, it became more and more popular to save on attorney fees.

Can Convertible Debt Be Dangerous?

When you raise debt, your company becomes insolvent (from a financial perspective). If it goes bankrupt, the board may become liable.

An Alternative to Convertible Debt

SAFE: it’s an unpriced warrant instead of being convertible debt.

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Chapter 9: The Capitalization Table

The cap table summarizes who owns what part of the company before and after the financing.

Don’t blindly trust lawyers and make sure to check the cap table yourself.

Note: this entire chapter used an example to explain the cap table, which explains why I did not include it here.

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Chapter 10: Crowdfunding

There are two types of crowdfunding.

1. Product crowdfunding: product crowdfunding is pre-sales, and there is no equity involved.
2. Equity crowdfunding: selling shares in your company in crowdfunding.

The advantage of crowdfunding is that you are in a position of strength and set the terms of the deal yourself. The disadvantage is that you must do everything yourself.

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Chapter 11: Venture Debt

The Role of Debt versus Equity

Venture debt is a type of loan offered by banks and nonbank lenders that is designed specifically for early stage, high-growth companies with venture capital backing.

Venture debt complements equity. It doesn’t replace it. It is rarely available to seed-stage companies, and comes later.

The Players

Banks and venture debt funds can give you debt.

How Lenders Think about Loan Types

Banks need to ensure that you have two sources of income to repay the loan.

Loan companies don’t, and loan you money based on the cash flow. So if you want to use the loan to grow instead of earning more, then this won’t work.

Most venture debt takes the form of a growth capital term loan that has to be repaid within three to four years. The first six to twelve months are to repay interests only (it’s the I/O period). The company pays accrued interest, but not principal, and begins to pay principal after.

Economic Terms

Economic and control terms should be the primary focus for most entrepreneurs.

• Interest rate: Most VC debt lenders only offer variable rates based on the rate by the central bank.
• Loan fees: 0.25% to 0.75% of the loan amount.
• Final payments: another common pricing mechanism. It is a loan fee paid at the very end of the loan’s life and is typically quoted as a percentage of the commitment amount.
• Prepayments: the longer you take on the loan, the more money the VC makes. So if you repay your loan faster than planned, you’ll have to pay a fee called prepayment.

Warrants as compensation are also common. While a no-warrant loan is preferable to both entrepreneurs and investors because it is nondilutive, in the early-stage market, warrant pricing is considered a critical feature by most lenders.

Amortization Terms

It’s important to ensure you actually can refund the loan.

• The draw period: it’s a period during which you can draw extra cash under the loan and during which the lender does not earn any interest on. The bigger it is, the better it is for you.
• The interest-only (I/O) period: it’s the period during which you repay only the interest of the loan and not the principal. A typical loan structure is 12 months of I/O period followed by 36 months of amortization.

Control Terms

The defining characteristic of growth capital loans to early stage technology companies is the lack of financial covenants.

Financial covenants give the lender the right to cancel its commitment, accelerate the repayment schedule, or seize and liquidate collateral if the borrower’s financial performance fails to stay within established parameters.

Obviously, these are too dangerous for early-stage companies which fail often anyway, so the lenders may ask for warrants instead.

Financial covenants are a subset of a broader category of contractual terms that lenders use to manage repayment risk.

You have two types of covenants:

1. Affirmative covenants are actions that the company promises to take during the term of the financing contract. Such as:
   • Regulatory compliance
   • Government approval
   • Reporting
   • Taxes
   • Insurance
   • Accounts
2. Negative covenants define behaviors and actions that the company may not engage in as a condition of the loan.
   • Dispositions: don’t sell or transfer business assets without the authorization of the lender.
   • Change in control/location
   • Mergers/acquisitions
   • Indebtedness
   • Encumbrance: don’t provide lien interest (the right to acquire a part of the business)
   • Distribution of dividends
   • MAC: Material Adverse Change: this is a big change of circumstances that cannot be occurring before lending. Sometimes it is not written in the sheet. If it is not, ask questions about it.

Negotiation Tactics

The venture capital industry is relationship-driven, which applies equally to debt and equity.

It is important that you have a good reputation. Don’t try to get away with negotiating every term of the sheet if the organization lending you the money brings you benefits (they know lots of people, etc).

You can also leverage the best deal by getting several firms to compete for the loan.

Restructuring the Deal

Once you have a problem and need to renegotiate, do so as soon as possible. Be transparent too.

The first priority will be to see the risk that restructuring the loan will have.

The second priority is to look at how likely the company is to fail. The company may look at raising more equity, focusing on earning more money, or firing people.

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Chapter 12: How Venture Capital Funds Work

Overview of a Typical Structure

A VC fund is made up of three entities:

1. The management company: owned by senior partners, employs all of the people with whom you interact at the firm. Makes money by creating and retiring funds.
2. The Limited Partnership (LP) vehicle: the actual fund that will invest in the company.
3. The General Partnership (GP) entity: This is the legal entity for serving as the actual general partner to the fund.

The management company and the fund can ultimately have different purposes, especially if managed by different people.

How Firms Raise Money

VCs raise from:

• Government
• Corporate pension funds
• Large corporations
• Banks
• Professional institutional investors
• Educational endowments
• High-net-worth individuals
• Family offices
• Funds of funds
• Charitable organizations
• Insurance companies

The arrangement between the VCs and their creditors is in a sheet called the limited partnership agreement and it dictates what the VC must do.

The creditors don’t wire the money to the VC right away. They commit to wiring a certain amount, but give in effect every time the VC asks for it as it wants to make an investment. The money itself arrives within two weeks, usually.

So when a fund “raises $10 million”, this means it got “the legal agreement to receive $10 million of funding within a certain period”. Doesn’t mean the cash is actually there.

How Venture Capitalists Make Money

• Management fees: the smaller the fund, the higher the management fee (between 1.5% and 2.5%, paid per year and starts to decrease after the commitment period has passed, usually five years). The more funds they raise, the more money they make.
• Carried interest: the money they earn after returning the capital to LPs (that is, money on profits). Usually 20%, sometimes 30%.
• Reimbursement for Expenses: VCs charge the company when they sit on the board.

How Time Impacts Fund Activity

The commitment period (usually five years) is the time when a VC can invest in new companies. After, it can only invest in the companies it already invested in the past.

The investment term is the total duration of the fund’s duration, usually 10 years. It is therefore better to invest in a young fund that will not feel the pressure to exit the investment, than in an old fund.

Beware of the VC zombies. These are VCs that can no longer invest as a failure of raising a new fund.

Reserves

Reserves are the amount of investment capital that is allocated to each company that a VC invests in.

This is the money the VC thinks you will need but does not yet give you.

Strategic Investors

Companies that aren’t in the business of making venture capital investments, but for a particular reason want to invest in your company.

It can be your manufacturer, for example. Things get annoying when you want to partner with a company rival of the company that invested in you.

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Chapter 13: Negotiation Tactics

What Really Matters?

1. Achieving a good and fair result
2. Not killing your personal relationship getting there
3. Understanding the deal that you are striking.

Financing is only the beginning of the relationship, so if you don’t have a good relationship in the beginning, it’s unlikely to go better at the end.

Preparing for the Negotiation

Get a plan about what you want and what you to ask and understand.

Make sure you know who you are negotiating, the things they want, the things they think.

One of your few advantages against a VC is time. Most of them want to go very quickly. But you don’t need to.

A Brief Introduction to Game Theory

Game theory states that there are rules underlying situations that affect how these situations will be played out.

These rules are independent of the humans involved and will predict and change how humans interact within the constructs of the situation.

Knowing what these invisible rules are is of major importance when entering into any type of negotiation.

Negotiating in the Game of Financings

Ask the VC to state their top three priorities in the term sheet, and do so too. If they insist on negotiating a term that isn’t their priority, call them out.

Overall, VC financing is easy as it is a win-win game with explicit rules negotiated in the open.

Negotiating Other Games

1. Winner-takes-all: being sued, or having the company close to bankruptcy. In this case, results are all that count. Reputation doesn’t.
2. A founder departs: negotiate hard, but fair as your reputation will matter.
3. Acquisition: this is both a winner-takes-all and win-win situation. Reputation matters as you will likely be working for the company that acquired you.

Collaborative Negotiation versus Walk-Away Threats

Know your walk-away point by looking at the best alternative. If you reach this point…actually walk away. Don’t make threats you cannot back up.

Building Leverage and Getting to Yes

The best leverage is other VCs that want to invest. Be transparent about that without saying WHO these VCs are.

Never share the term sheets you received from a VC with anyone.

Don’t change your mind after signing.

Never provide a VC with a term sheet.

Don’t negotiate point per point, but negotiate the whole sheet.

Don’t assume that others are as ethical as you are.

Great Lawyers versus Bad Lawyers versus No Lawyers

Hire a great lawyer who is a reflection of who you are and of your personality as whatever they do will directly be associated with you.

Can You Make a Bad Deal Better?

You can wait for an exit, renegotiate the deal with a new VC later, or renegotiate the deal with the current VC later too.

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Chapter 14: Raising Money the Right Way

1. Don’t Be a Machine: Fundraising is about people. If the VC doesn’t like you personally, they won’t invest in your company.
2. Don’t ask for a nondisclosure agreement
3. Don’t send the same email to 1000 VCs. They don’t like spam and know when they’re getting it.
4. No means no.
5. Don’t ask to be referred to another VC after a no.
6. Don’t be a solo founder.
7. Don’t overemphasize patent
8. Don’t tolerate bad behavior and speak up.

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Chapter 15: Issues at Different Financing Stages

Seed Deals

While seed deals have the lowest legal costs and usually involve the least contentious negotiations, they often allow for the most potential mistakes.

Getting great terms (aka a high valuation) is not always good as if you fail in the business development, then the next raise will be at a lower valuation and hence your first investor won’t be happy – they may even block it.

You raise based on a great team with a great idea (that is, “hope”).

When you receive a term sheet, it means the investor is ready to invest.

Early Stage

The deals you had for the seed will likely be similar here, and for all the subsequent raises.

Beware of the liquidation preference, as it can drastically decrease return for a common investor.

Another term to pay extra attention to at the early stage is the protective provisions. You will want to try to combine the protective provisions so that all preferred stockholders, regardless of series, vote together on them.

If they vote per class, then one class could veto a future round of financing.

Mid and Late Stages

Every time you raise, you have to give up one seat on the board to an investor.

If lots of people make up your board since will be complicated. If not, your investors will dominate it.

If your investors are nice, that won’t be a problem. But you really need to start thinking about this and see how you can avoid losing control of the board (and the company).

One way to avoid that is to cap the number of VCs that get a seat on the board.

Once again, don’t raise too high if you intend to sell at some point. Few will accept selling a company for less than a round valuation.

Some VCs will give you a term sheet without being ready to invest (they need XYZ’s accord). Make sure this doesn’t happen by asking the VC if the investment is final after you sign the term sheet.

You raise based on financial results, not “hope”.

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Chapter 16: Letters of Intent: The Other Term Sheet

A letter of intent (LOI) is a letter from a company that wants to acquire your company.

-> the tone and stress are much tougher than that of a regular deal.

The LOI arrives after some negotiations and dinners have already occurred. It’s the first step (non-biding) towards the acquisition.

Make sure to get a detailed LOI as the absence of some terms will not be a good thing.

Structure of a Deal

There are only two things that matter: price and structure.

Price:

• Depends on lots of variables.
• The acquirer often has an escrow condition where they set some money aside until they make sure every obligation has been fulfilled.
• The working capital is”: current asset minus current liabilities. Startups have usually a negative working capital, and it shouldn’t be above zero in general in the LOI.
• Retention pool: money to make sure current employees don’t leave.

Asset Deal versus Stock Deal

An asset deal is when the company only buys certain activities from the company (but not everything). A stock deal is when it buys the whole company.

In general, buyers want an asset deal, and sellers, a stock deal.

A stock deal can be settled with cash and an asset deal, with stocks.

In the end, an asset or stock deal depends on the state of the company, what the acquirer wants, the structure, and the taxes.

Be careful when you are selling your company “for stocks” of a company that isn’t publicly traded. It may be worth much less than you think – or impossible to convert to cash.

Assumption of Stock Options

In the past, the acquirer assumed the stock option plan for employees and nothing changed (assumption).

In some cases though, the acquirer did not follow the plan so all employees received right away their options (substitution).

Some companies finally, do neither, and the employees lose their options.

Representations, Warranties, and Indemnification

The reps and warranties are the facts and assurances about the business that one party gives the other.

The reps that the seller makes are more important. First thing to decide is who is making them? The company only, or the company + the shareholders?

The indemnification is what the company will have to pay in case it fails to give proper reps.

Always specify what the indemnification will be like.

If you sell your company for stocks, make the reps and warranties reciprocal.

Back the reps and warranties with “to the extent currently known” and don’t argue with them too much as it is a big red flag.

Escrow

The escrow (also known as a holdback) is money that the buyer is going to hang on to for some period of time to satisfy any issue that comes up post-acquisition that is not disclosed in the purchase agreement.

The carve-outs (or fundamental reps) to the escrow caps typically include fraud, capitalization, and taxes. Often, especially due to the risk of attack by patent trolls, a buyer will press for intellectual property ownership to be carved out

In all cases, the maximum of the carve-out should be the aggregate deal value, as the seller shouldn’t have to come up with more than it was paid in the deal to satisfy an escrow claim.

The seller should never come up with extra money to satisfy the claim.

Confidentiality/Nondisclosure Agreement

Always mandatory in the case of an acquisition because if the deal falls through, each company has now much info about the other.

The NDA should always be reciprocal and strong.

Employee Matters

Defer the details of individual compensation after the LOI is signed. Indeed, negotiating these and doing due diligence is long and annoying, and it causes unnecessary stress.

Conditions to Close

Buyers normally include certain conditions to closing in the LOI. These can be generic phrases such as “Subject to Board approval by Acquirer”. The more conditions, the more it tells about the buyer.

If there are a lot, push back against them.

The No-Shop Clause

Signing a letter of intent starts a serious and expensive process for both the buyer and the seller. As a result, you should expect that a buyer will insist on a no-shop provision similar to the one that we discussed around term sheets (a no-shop clause prevents you from talking to other buyers).

Ask for a deadline of 45-60 days until the acquisition, and don’t accept more than 60 days.

If the no-shop period ends and the company is still not acquired, the buyer will want to extend the no-shop.

As with no-shops with VCs, no-shops with potential buyers should also have an automatic out if the buyer terminates the process.

Fees and More Fees

The LOI will usually be explicit about who pays for which costs and what limits exist for the seller to run up transaction costs in the acquisition. Transaction costs associated with an agent or a banker, the legal bill, and any other seller-side costs are typically included in the transaction fee section.

Buyers always focus on making the seller pay those fees.

Buyers sometimes want to add a breakup fee (fee for them in case the deal falls through). Resist those as much as you can. Technically, you as the seller, should get one. Only ask one if you’re skeptical about the buyer’s intentions.

Registration Rights

If you receive stocks as compensation, make sure it is registered on the stock market. Unregistered stocks can only be sold after a year, but within a year, lots of things could go wrong (the price can dip).

Shareholder Representatives

The shareholder representative represents all the former shareholders of the seller to deal with post-deal issues (managing the escrow, dealing with earn-outs, working capital adjustments, and even litigation concerning reps and warranties).

It’s an abominable job and you should avoid doing it.

If you are though, negotiate for funds you can use in case you need to hire a lawyer.

Don’t ask someone that works for the buyer to be a shareholder rep, and don’t ask a VC either.

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Chapter 17: How to Engage an Investment Banker

Don’t use them for early or mid-stage (raising) but definitely do in case of an acquisition.

Why Hire an Investment Banker?

If you receive a perfect offer from a perfect buyer, or if your company is being sold for a very low price, then no need to have an investment banker.

But if you want to contact as many buyers as possible and sell for as high as possible, then you should hire an investment banker.

How to Choose an M&A Adviser

Use the following criteria.

1. Referral and references: ask around (from investors, board members, etc).
2. Specific industry and expertise: hire someone that knows about your sector.
3. Connection to buyers: the banker should already know companies interested to buy you.
4. Deal experience
5. Personal commitment