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Top 10 Term Sheet Hacks

How to negotiate a term sheet with investors by venturehacks.com

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Top 10 Term Sheet Hacks

  1. 1. Top 10 Term Sheet Hacks Venture Hacks Aug 28 2008 venturehacks.com
  2. 2. + What is Venture Hacks? It!s just Game Theory applied to raising Venture Capital. Looking a few moves ahead. Realizing the consequences of Series A decisions, and knowing how it!ll affect future series, the management of the company, and the exit. Apologize in advance to the VCs. :-)
  3. 3. Institutional Knowledge Read a blog post “It’s Standard” “If Slide is worth $550M...” Why cover it? - VCs know a lot more than you do - Average partner invests in 2-3 deals, many trade away. A VC firm puts out 30-50 termsheets per year, negotiates a dozen. - The first round is the most important - most dilutive, template for later. Experience is the worst teacher - exam comes before the lesson.
  4. 4. Leverage • Two + termsheets • Independent • Credible investors • Create a market for your shares! Otherwise, you have no leverage! I!ll touch on how to raise, briefly - we do cover some of this on the blog too.
  5. 5. “Raising venture capital is the art of younger men seducing older men” - Anonymous Or women, as the case might be.
  6. 6. The Timeless Art • Social Proof - “We’re meeting Sequoia next week” • Authority - “Marc Andreesen is an angel” • Scarcity - “Only room for one investor in this round” • Desirability... Again, not meant to be a “how do I raise money”.
  7. 7. Five Quick Tips • Great team (check the mirror) • Pick a big market (now!) • Even angels don’t fund niche plays • Do something hard • Have a plan for distribution • Stay close to the money Keynesian beauty contest.
  8. 8. The Pitch Your 50-page business plan doesn’t matter • One-liner; executive summary • 10 slides • Financials; micro-economics
  9. 9. The Approach Get introduced... ...to the Partner... ...from someone they respect... ...at roughly the same time. Timing is important - exploding termsheets notwithstanding, deals have a way of going stale.
  10. 10. Synonyms for “NO” “Maybe” “Later” “We’ll follow a credible “NO” lead” “Come back when you have more progress” “It’s not you, it’s me” “We need to see a CEO” Yes means a termsheet!
  11. 11. “Value Add?” Smart money • Wisdom, not Intelligence and Energy Money Dumb Money • Most likely to trumpet value add Unbundle control, advice, and money - advisors are a bargain! Let!s assume you get the termsheet... now for the real hacks.
  12. 12. 1. The Board of Directors Valuation is temporary Control is forever Classic mistake entrepreneurs make is to fixate on valuation. Control matters much more, and most control derives from the board. You can!t divorce your investors. You can!t recover control!
  13. 13. “Trust, but Verify” - Ronald Reagan
  14. 14. “The line between good and evil is permeable and almost anyone can be induced to cross it when pressured by situational forces.” Philip Zimbardo, Stanford Prison Experiment Intentions don!t matter! Contracts are made for worst-case scenarios. Partners come and go. Funds come and go.
  15. 15. Rules of Thumb • Make the Board Composition Proportional to ownership • Independents usually aren’t • Create a new seat for a new CEO • Control is a one way street, from Common to Preferred
  16. 16. 2.Valuation Learn to signal gracefully Purely supply and demand Ignore outliers Money has karma too! It!s an art, not a science, even though people try and calculate or justify it. Investors in Ning and Slide aren!t saying those companies are worth hundreds of millions - rather that Marc and Max are. Down rounds kill you. High valuations seal the exits.
  17. 17. 3. The Option Pool Shuffle Convert apples-to-apples Take the post-money option shares out of the pre-money $6M pre-money $4M raised 25% post-money pool = $3.5M pre-money This one IS simple. Convert by taking the post-money option pool percentage out of your pre-money.
  18. 18. 4.Vesting is Testing With board control, it’s a founder issue 4 years, some credit, single trigger, double trigger Subtleties - do you vest just by being on the board? Definition of triggers. Cliff ? Sweetener to bring on a CEO? Without board control, it!s very important.
  19. 19. 5. Liquidation and Anti- Dilution • “Standard” is 1x, Broad-Based Weighted Average • Designed to protect investors from quick flips and overpriced rounds • Can change the terms dramatically! • Great potential for mischief in private-private transactions
  20. 20. 6. Protective Provisions AKA The Fine Print Protect minority shareholders Hack 1: Sale ok above a certain price Hack 2: Fundraising ok above a certain price
  21. 21. 7. Expiration and Non- Disclosure “We made a commitment to the other investors to give them time to do their diligence” Either the termsheet is binding or it’s not... ...but it’s very bad form to shop
  22. 22. 8. Counsel Get your own advocate There are “entrepreneur friendly” ones available Draft the docs Cap the fees We can recommend you entrepreneur-friendly counsel.
  23. 23. 9. The New, New Thing • RoFR - Spend now, pay later • Super Pro-Rata - Huge option value, negative incentives • One-sided confidentiality • One-sided binding termsheet (pending diligence!) - placeholder • Stock repurchase at FMV In general, pro-rata is all you want. Otherwise, signaling.
  24. 24. 10. Don’t Forget... 83(b) Right to transfer / diversify Founder Preferred
  25. 25. In Parting • Line up your options • Keep control • Friendly investors don’t deliver hostile termsheets! • Raising money is the easy part. Returning it... • founders@venturehacks.com