Month: June 2012

Jun 15 2012

Josh Breinlinger: Why VCs Lie

I discovered Josh Breinlinger’s blog this morning via a tweet from @stefanobernardi. I added it to the Ask the VC blogroll and read through VCs are liars. And so am I. And – Josh is right – it’s super hard to say “you suck” or “your team sucks” as a reason for passing.

I’ve written more about this in the post on Feld Thoughts titled It’s Hard To Tell Someone They Suck.

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Jun 13 2012

Pro-rata Rights For Angels

Joanne Wilson (aka Gotham Gal) has an outstanding post today titled Pro-rata rights. In it she makes two important points about angel investing.

  1. She won’t do a deal if the legal documents aren’t good.
  2. She won’t do a deal if she doesn’t get pro-rata rights.

She then goes on to discuss a thing that happens continually in VC deals. When VCs invest in rounds, they set a threshold for “major investors” and, if you aren’t a major investor, you lose your pro-rata rights. In Joanne’s case, she hates this because her angel strategy is to maintain her pro-rata through the life of the company.

As a VC investor, I always insist on pro-rata rights. I did also when I invested as an angel, although my angel strategy was to invest in only the first two rounds. As an angel, I’d do the seed round, then one more round if needed, and then I’d stop. Occasionally I’d do a later round, especially if my investment was needed for positive signaling, or if it was a down round because of some circumstance, but I still believed in the company.

I know many VC investors who aggressively cut angels out of the pro-rata rights in later rounds. I’ve ended up deals where that’s in the docs, almost always driven by someone else. I’m generally indifferent – I’m delighted to have angels continue to participate if they want, and not if they don’t (my personal syndication agnostic view that I’ve talked about on Feld Thoughts many times.)

As an angel, it’s important to know the lay of the land and how it coud impact you in the future. Joanne does an awesome job of laying to the issue of pro-rata rights in this post – go read it now.

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Jun 12 2012

When Should A Company Be Formed Around an Idea?

Question:

I participated in a company’s “app challenge weekend” (which they described as somewhere between a hackathon and a startup weekend). I am excited to continue working on the product that my team built over the weekend with 2 of the team members (my brother and the guy who pitched the idea).

My preference is to formalize a relationship by forming a company.  My fear is that the guy who pitched the idea will decide in a month or two that he doesn’t need us and tell us we’re not working on it anymore.  He formed a company 2 years ago that he talks about (though from the research I’ve done has no IP or product of any kind) and thinks that this idea fits into that vision, but doesn’t want to include anyone.

Should we form the company now, using fairness and our best sense of who will be doing what work to split shares and come up with a conflict-resolution/decision-making process (I imagine this would be the board) to compensate for the fact that my brother and I just met the guy who pitched the idea a week ago? Or should we continue working on the product and see what happens?

If you have any concerns today, then the last thing you want to do is continue and “see what happens.”  We always tell startups to deal with their issues immediately.  One, they don’t get any easier over time, but more importantly, the issues are easiest to deal with when the company isn’t worth anything / much.  As soon as one of the parties starts seeing dollar signs in their eyes, issues become much harder to deal with.

We’d suggest that you form a company (LLC or S-Corp is fine at this point), divide up the equity and make sure it is subject to vesting.  That way, if someone does decide to leave, they will not leave with all of their equity.  Make sure that there is a strong agreement in place that contributes all the IP that you created during the weekend to the new company.

As for dispute resolution, there are two ways that this can work.  One, the equity owners of the company can vote the issues.  In this case, if you all owned equal amounts of equity, two of the three of you could vote the issue to approval or veto.  Or you can have the board vote, as well.  In general, if you are a three person team and you are already planning on “dispute resolution strategies” it might be time to sit down and make sure that you are all on the same page going forward before you start a business together.  It’s not normal that shareholder and / or board votes are happening very often with companies this small.

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