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Fred Wilson has a spectacular post up on how VC funds should think about reserves. It’s even more valuable to entrepreneurs so they can understand how the best VCs think about reserves, giving the entrepreneurs ammunition to ask their investors how they are thinking about reserves.
I only noticed one thing missing from Fred’s post which is a statement about cashflow which I commented on.
“Fred – phenomenal. The only thing I noticed missing was a comment on fund cash flow. To recycle, you have to have the cash flow. If you don’t have the exits to generate funds to recycle, you can hit a cash flow wall where your reserve model breaks (since you don’t have the cash to fund the reserves.) There are several solutions to this, including recalling capital, having an annex fund, and suspending management fees, but the best is having the cash in the first place …”
In addition to the post being great, the comments have a lot of rich stuff in them as well.
Will Herman, an angel investor (we each made our very first angel investment together in a company called NetGenesis in Boston in 1994) wrote a great post titled Convertible Notes – An Angel Investor’s View.
In it, Will covers the history of convertible notes and how they’ve gone from simple instruments intended to get a deal done quickly while saving time and money on the legal front to documents that are just as complex as an equity instrument.
Rather than bitch about it, Will explains the terms he now looks for in convertible notes and how he thinks about each one. He covers:
- Events Prior to Conversion
- Closing of the Note
- Pari Passu with Future Notes
- The Major Investor Clause
Convertible notes have changed a lot since my first angel investment in 1994. Will does a nice job resetting the current reality around them.
There are a few legal issues that we’ve seen consistently become hurdles for entrepreneurs and their lawyers. While in some cases they will simply be a hassle to clean up in a financing or an exit, they often have meaningful financial implications for the company and, in the worst case, can seriously damage the value of your business. We aren’t your lawyers or giving you legal advice here (our lawyers made us write that), but we encourage you to understand these issues rather than just assume that your lawyer got them right.
In this final chapter of the book, we will briefly cover Intellectual Property, Employment Issues, State of Incorporation, Accredited Investors, Filing an 83(b) Election, and Section 409A Valuations.
We hope you’ve enjoyed the overview of Venture Deals: Be Smarter Than Your Lawyer And Venture Capitalist. If you have, grab a copy of the book. We are open to any and all feedback, including topics you wished we had covered, things that aren’t clear, and things you disagree with. Regardless, we hope we’ve helped you be smarter than your lawyer and venture capitalist.
There is another type of term sheet that is important in an entrepreneur’s life—the letter of intent (LOI). Hopefully, one day you’ll receive one from a potential acquirer that will lead to fame, riches, and happiness. Or at least you’ll get a new business card on heavier card stock.
Typically the first formal step by a company that wants to acquire yours is for it to issue a letter of intent. This sometimes delightful and usually nonbinding document (except for things like a no-shop agreement) is also known as an indication of interest (IOI), memorandum of understanding (MOU), and even occasionally a term sheet.
As with our friend the term sheet, there are some terms that matter a lot and others that don’t. Once again there are plenty of mysterious words that experienced deal makers always know how and where to sprinkle so that they can later say, “But X implies Y,” often resulting in much arguing between lawyers. We’ve had LOIs get done in a couple of hours and had others take several months to get signed. As with any negotiation, experience, knowledge, and understanding matter. The LOI negotiation is usually a first taste of the actual negotiating style you will experience from the other party.
To keep things straightforward, we are going to focus on explaining the typical case of a two-party transaction between a buyer and a seller, which we’ll refer to as an acquisition. As with many things in life, there are often more complex transactions, including three or more parties, but we’ll save that for a different book.
As we enter the home stretch of the book, we spend some time talking about financings at different stages of the life of a company.
Not all financings are created equal. This is especially true when you factor in the different stages that your company will evolve through over its lifetime. Each financing stage—seed, early, mid, and later stage—has different key issues to focus on.
Every book we’ve ever read has mistakes in it. Ours is no exception. We tried hard to get everything right, and say it clearly, but we know some errors snuck in.
We’ve created an Errata page on this site. Whenever we find an error, or someone reports a mistake, we’ll put it up on the page. If there’s another edition of the book, we’ll make the changes.
If you find an error, just email us. If you are the first person to report the error, we’ll send you a free signed copy of the Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist.
While most people ask themselves “What should I do?” when seeking VC financing, there are also some things that a person should not do. Doing any of the following at best makes you look like a rookie (which is okay, we all were rookies once) and at worst kills any chance that you have of getting funded by the VC you just contacted. We encourage you to avoid doing the following when you are raising money from VCs.
- Don’t Ask for a Nondisclosure Agreement
- Don’t E-Mail Carpet Bomb VCs
- No Often Means No
- Don’t Ask for a Referral If You Get a No
- Don’t Be a Solo Founder
- Don’t Overemphasize Patents
Regardless of how much you know about term sheets, you still need to be able to negotiate a good deal. We’ve found that most people, including many lawyers, are weak negotiators. Fortunately for our portfolio company executives, they can read about everything we know online and in this book, so hopefully in addition to being better negotiators, they now know all of our moves and can negotiate more effectively against us.
There are plenty of treatises on negotiations; however, this chapter walks through some negotiation tactics that have worked well for us over the years. Although this book is primarily about financings, we’ll talk about a range of negotiation tactics that you can use in your life, and we illustrate some of the different types of characters you’ll probably meet along the way.
Before we talk about the dynamics of the negotiation of the deal, it’s useful to understand the motivation of the person you’ll be negotiating against, namely the venture capitalist (VC). We’ve been asked many times to divulge the deep, dark secrets of what makes VCs tick. One night over dinner we talked through much of this with a very experienced entrepreneur who was in the middle of a negotiation for a late stage round for his company. At the end of the discussion, he implored us to put pen to paper since even though he was extremely experienced and had been involved in several VC-backed companies, our conversation helped him understand the nuances of what he was dealing with, which, until our explanation, had been confusing him.
In general, it’s important to understand what drives your current and future business partners, namely your VCs, as their motivations will impact your business. While the basics of how a venture fund works may be known, in this chapter we try to also cover all the nonobvious issues that play into how VCs think and behave. To do that, we’ll dive into how funds are set up and managed as well as the pressures (both internally and externally) that VCs face.