Month: February 2007
Tim Wolters – the CTO of Collective Intellect – is in the middle of a financing and blogging about some of the terms. Today’s is the liquidation preference. It’s interesting to compare it to what Jason and I wrote in 2005 about liquidation preferences in our Term Sheet series.
Q: In modeling out an early-stage deal, do you think it would be reasonable to start with a 20% option pool (Round A) and then plan to refresh that on subsequent rounds (ie, make an assumption about having key hires in place by round C or B)? Or should we just allow that option pool to get crammed down?
The starting point – on average – for an option pool after the Series A financing is 15% to 20% so this is certainly a reasonable starting point. Recognize that there is a nuance here between “pre-money” and “post-money”. I like to talk about the option pool as “post-money” so the valuation doesn’t impact the pool as part of the financing – it makes it a little simpler to discuss.
In each subsequent round, the new size of the option pool will likely be part of the financing negotiation. Most Series A investors expect you to use up most of the option pool for early hires so that when it is time to raise a new round, you’ll likely need additional options to incent your future employees. This often ends up being a three way negotiation – between the founders/management, old investors, and new investor(s). The new investor will want the options to be “pre-money” so the burden of the increase of the option pool is pushed back on the old investors and existing founders/employees; the old investor / founders want this to be “post-money” (or after the financing) so that dilution is shared by everyone, and non-founder management often are indifferent (especially if they are getting additional options in the financing), but want to make sure the size is large enough to cover the option grants they think they will need for the next wave of employees.
There is no simple rule of thumb here – it’s a negotiation. However, the amount needed to incent employees going forward is usually a number that can be determined approximately. Everyone will be incented to have the “correct amount of options” (although the definition of “correct” may vary between parties.) But – the idea that the original 20% option pool will last the entire life of a company is not logical and is pretty unusual.
Q: I’ve been re-reading back through your term sheet series as was wondering if you had a sample one that you could send my way (yes, I have found several others online already but they don’t seem to contain much of the same jargon that you give in your examples). Also, I’m trying to find one most appropriate for an angel round.
We never got around to posting a redacted / sample term sheet, but there are a great set of sample documents up on the National Venture Capital Association web site including a term sheet, stock purchase agreement, and a variety of other standard documents.
The model documents were drafted over the course of more than a year by a consensus process involving many of the leading VC lawyers in the country which constitutes the NVCA Model Document Working Group. These documents have now been through a second set of intense review, comment and revision by the current working group.
Question: I’m curious. I understand that VCs have primarily four functions they perform: raising funds, screening and investing in new businesses, managing current portfolio companies and some level of investor relations and internal operations. How do you divide your work day? What percentage of time do you think you dedicate to each area? Maybe I’m misguided in the ways you spend your time, and you could clarify how you divide up your many tasks?
Our Take: One of the great things about this job is that there is no “standard day.” Every day is different and the division of time reflects that. It’s really hard to say what a typical day is like. Even typical weeks are hard to describe. It all depends on a particular partner’s portfolio is doing and what their role is in the firm.
There are weeks where 100% of a VC’s time is in managing their current companies. If a company or two of theirs is going down a liquidation path, these are very time consuming activities. Alternatively, if your board meeting schedule shakes out to all fall on one week, this can also allocate most of your time to current projects, but perhaps the next week one could spend 50% of his / her time looking at new deals.
Fundraising is done episodically, not on a regular basis (although some would say that investor relations activities are fundraising), so when VCs are raising funds, a material amount of time goes into that effort, but this is most likely only every 4 years or so. Also note that not all the partners in a firm will have to spend a material amount of their time fundraising.
Some partners have operational responsibilities internal to the firm itself, some don’t. In short, you could ask 100 VCs this answer and have 100 different answers. If you forced me to put some percentages on the table, I’d say a normal yearly time allocation (assuming that fundraising is not happening) might look something like this:
Screening, Analysis and Execution: 45%
Current Company monitoring: 45%
Investor Relations / Operations / Other: 10%
I co-own a startup company recently founded between myself and a partner. Neither of us have the core skills to write a clear and coherent business plan. However, we have very forward vision, goals, built-up clients and community, a strong advisory panel and all around great prospects. What would you advise we do, if not hire someone to write the business plan and do the projections?
I put this question in the “check your assumptions category.” I have yet to meet any entrepreneur that doesn’t “have the core skills to write a clear and coherent business plan.” There are a wide range of “business plan writing” products – including many free or inexpensive web resources or non-profit organizations such as SCORE that provide resources for small business owners.
Writing a good business plan is hard. At one point, it was an entry point for discussion with most funding sources (angels and VCs). Today, while a formal business plan is less critical to get in the door, the exercise of writing a business plan is incredibly useful. As an entrepreneur, I was involved in writing numerous business plans. It’s almost always tedious, time consuming, and difficult but resulted in me having a much better understanding of the business I was trying to create.
Today, there are an amazing number of examples of business plans available on the web – both for successful and failed businesses. Using someone else’s plan as a guide is always a great place to start. In addition, there are plenty of great books – such as Business Plans that Work – that can help you with the process.
Now – I’m separating the actual text of the business plan from the financial projections. While your financial model is also important, it does require some specialized knowledge to put together in a logical way. You can learn some of this from resources on the web, including some of the business plan builder software products such as Palo Alto Business Plan Pro 2007or Nova Business Plan Writer Deluxe 2006. Alternatively, you can seek out a local accounting resource that has experience working with entrepreneurs to create financial models.
While ultimately you can just hire someone to do this, I’d still suggest you check your assumptions. I bet one of your advisors has one or more sample plans you can look at and would be willing to work with you to help you create a plan for your business.
Rick Segal has today’s VC Post of the Day with his excellent post A Fatal Paper Cut. Rick tells the story of the death of a promising young startup as a result of a messy early capital structure that wasn’t managed correctly from the beginning. In due diligence, the VC chickened out and the company slammed into the wall. All of this could have been avoided – documenting the early equity grants correctly and taking the capital structure seriously from the beginning would have solved all the problems. Rick gives some great suggestions for this. The VC also might have been able to get comfort with a capitalization rep from the founders, although in this case that clearly wouldn’t have done it.
This is a must read post for any entrepreneur that is setting up a new business and giving out equity grants (options or shares) of any size in exchange for services.
Ah – two great VC posts in one day – what more could you ask for? Scott Maxwell of OpenView Venture Partners has an awesome post up titled 10 best ways to lie with metrics. I’m glad to see Scott blogging again – his MIT background shines through with his critical thinking on any topic he goes after.
It’s late on Friday (queue Amy from background: “Brad, it’s 6:10 on a Friday – get off of your computer and come play.”) Before I figure out where we are going for dinner, I thought I’d leave you with a Madlib to fill in. Remember Madlibs? Yeah – sure you do. I know I’m supposed to tell you the part of speech to fill in, but I’ll let you wing it. A free subscription to this blog for a year goes to the winner (uh huh – I know – it’s already free – now you are getting a taste of a VC negotiating tactic.) Comment away – if I get some creative ones, I might even try this again.
Ah, look at all the ________ ________!
Ah, look at all the ________ ________!
________ ________ picks up the ________ in a ________ where a ________ has been.
Lives in a dream.
________ at the ________, wearing the ________ that she keeps in a ________ by the ________. Who is it for?
All the ________ ________, where do they all come from?
All the ________ ________, where do they all ________?
Today’s Great VC Post doesn’t come from a VC (I couldn’t find any great ones this morning when I went through my feeds in FeedDemon.) Instead, it’s a post by my long time friend Will Herman titled Prepare and Be Prepared that is a follow up to my post titled Don’t Be Casual.
I realize this is a little recursive blog link love but I figured you – my dear reader – could handled it. Will is an extremely experienced entrepreneur that has been a co-founder of or involved in numerous successful VC-funded business. He has also been a co-investor with me in a number of companies as an angel investor or board member (our first investment together was in NetGenesis – it’s hard to believe that 13 years has passed.)
Even though this belongs on AsktheEntrepreneur instead of AsktheVC, I’m imagine Will is ok with it. At least I hope he is.