Month: June 2008
Today’s great post of the day is from Fred Wilson titled The IPO Debate. There were no VC-backed IPOs in Q208 – the first time this has happened since 1978. The National Venture Capital Association (NVCA) is doing a big media push to get the word out about this and what it thinks is the underlying cause and ultimate impact on innovation in the United States. Fred has some great thoughts on the issue.
Q: We just started looking for venture funding and I have a question. Why do VC’s ask us how our idea came about? Are they looking for an emotional and inspiring story or are they worried that we may have taken our idea from someone else or, what I believe is the case, do they want to see if we were driven by an opening in the market that we observed? Of course, if we are giving our answer in a way that addresses one or two of these issues then you are probably missing the third. Please help!
A: (Jason) Without sounding too glib the answer is "all of the above and maybe more, probably." Your guesses as to why are probably accurate and it, of course depends on to whom you are speaking with. I’ll address each of your guesses individually.
1. "Emotionally and Inspiring Story" - Without getting all Sally Struthers-like, it is nice to see engaged and passionate entrepreneurs. Building a successful startup is really, really tough. If you aren’t in love with the company going in, it will not turn out well for you or your investors. That being said, don’t put on an act.
2. "Taken Our Idea from someone else" – This is a big one. If you come and pitch a next-generation social networking site and previously worked at Facebook, we are going to have an in-depth discussion. Maybe you didn’t steal it, but maybe your former employer will have a claim on the intellectual property developed while you were employed.
3. "Driven by a new market" – This also might be part of the question. Whatever VC you speak to, you should know more about your market than they do. I, personally, ask many questions and rely on them as part of my education. Maybe you really have found an "unscratched itch."
One other potential reason is to see how you sell the vision and product. You are going to get this question often from potential customers and this is a way to see you sell and see how efficiently you can answer a potentially complicated question.
Or, perhaps it is just a trite icebreaker and the VCs are just asking you this so they’ll have time to answer emails on their blackberry while you wax poetically.
Q: I have several angels that say the want to invest but non of them wants to lead. In your experience: 1) Is this a "call option" strategy rather than a serious investment intent? 2) any thoughts on how to turn "co investors" into lead? or should I try to get a lead of this "co investors" pack?
A: (Brad) While it’s hard to tell whether this is a call option or serious investment intent, it is not that helpful in getting the round pulled together. When doing an angel round, you need two things: (1) a lead investor who is willing to negotiate terms and (2) supporting investors that won’t lead but are committed to participating on whatever terms the lead negotiates with you.
While you can’t contractually commit the supporting investors, you can usually separate the real ones from the tire kickers (or – more generously – the call option people). Committed supporting investors are going to let you use their names with potential lead investors, will engage in active networking, and will name a specific amount they are willing to invest.
These supporting investors are typically called "soft circles" – you’ve got a commitment from them, but it’s not a legally binding one. A soft circle will always have a dollar amount attached to it.
So – don’t try to convert these "followers" into "leads". Instead, try to get them into a supporting investor / soft circle mode.
Q: I am trying to determine the appropriate equity position for my startup’s board members. They are arguing that they are "founding" board members. They have put in a few hours a month of their time for around a year, have been very helpful with introductions, and have sat in on VC meetings. We are seed stage (pre-A). Can you suggest a range of equity for a "founding" board member? While you referenced the concept in your "Compensation for Board Members" article, you did not detail any specific ranges.
A: (Brad) I think their equity as "founding board members" – given your description of what they have been doing for you – should map to the post Compensation for Board Members or Board Member / Advisory Member Compensation. Specifically, you are in the 0.25-1.0% vesting over 2 to 4 years zone.
I don’t really believe there is a "founding board member" construct. The opportunity for these early board members – in addition to the options you will give them – is to be able to invest at a very low valuation ($1m to $2m pre-money). You should give them this opportunity well in advance of approaching VCs.
I’m not a fan of convertible notes as the form of an angel investment. When I’m making an angel investment, I much prefer to price the round and do a "light Series A" (simple terms, but still a preferred instrument.) Basil Peters has a series of posts up on Angel blog that talks about the problems of Convertible Notes for Angel Investing, suggests Exchangeable Shares for Angel Investors, and even provides a One Page Term Sheet for Angel Investors.
Q: Thank you very much for your term sheet series. Not being that familiar with "specific" term sheets, I have heard something about VC terms that effectively allow the VC to fire the founder(s) and in the process relieve them of their shares since they had then left the company before liquidity. I have read a previous Ask the VC post about the ‘moral’ and ‘reputation’ reasons that VC’s will not do this.
However I am more interested in the legal binds and would like to know if these sort of terms are something that is standard/negotiable in various term sheets.
A: (Jason). There is certainly nothing in a standard term sheet that specifically addresses this. I’ve seen founder / CEO termination clauses in term sheets that effectively say "if X, Y and Z doesn’t happen, you are fired." I’ve always found these to be egregious and worse yet, sets up the VC and founder / CEO to be enemies, not collaborators trying to help the company be successful.
As for different mechanics that a VC might use to remove a founder / CEO / founders, etc.:
1. Board control – if the VC has board control, or the ability to elect a majority of the board, terminating founders and / or executives is fairly simple;
2. Voting rights – be careful that there aren’t any non-standard control provisions in the voting rights that allow the VCs to vote people "off the island."
As far as acquiring the terminated party’s shares, I’ve never seen a VC with a contractual right to be able to do this. I’ve seen some documents which gives the shares back to the company, but never the VC.
And shares going back to the company is rare as well, so long as we are talking shares that have vested under a option plan or are not subject to some sort of repurchase. Those shares should be free and clear the property of the terminated party.