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Venture Deals

Authors: Brad Feld, Jason Mendelson
Published: 2019
About: This books is about how to prepare your startup for deals with venture capital funds.
Status: Currently reading…

Zero to One book cover by Peter Thiel
Venture Deals - Brad Feld, Jason Mendelson

The Players

This process is not just about the entrepreneur and the venture capitalist. There is a whole bunch of people involved in the financing deal:

  • Entrepreneur: One or more founders who started the company. Should control the whole (financing) process. Picks lawyer and defines relationship between cofounders.
  • Venture Capitalist1: Firm with commonly defined hierarchy.
    • Managing director (or General partner): The most senior person in the firm. Makes final investment decisions. Sits on the board of directors of companies they invest in.
    • Partner: Not the actual partner. Usually junior deal professionals. Involved in specific aspects of the investing process (e.g. due diligence). Not involved in investment decision process.
    • Principal: Junior deals professional. Has some power, but can’t make a final decision.
    • Associate: Works directly for one or more deal partners. Spends the most time with the capitalization table2.
    • Analyst: Very junior people, usually recently graduated from college. Smart, but usually very limited in power and responsibility.
    • Part-time members
      • Venture partner: Experienced entrepreneur who has ability to advocate for a deal.
      • Entrepreneur in residence: Helps VCs with introduction, due diligence, and networking while figuring out his next company.
  • Angel Investor: Usually participates in seed and early stage investments. Could be professional investor, successful entrepreneur, friend, or family.
  • Syndicate: A collection of investors participating in the financing round.
  • Lawyer: Helps shifting focus from nuances to the main matters (economics and control) during negotiations.
  • Accountant: Takes care of concerns around tax treatment resulting from a financing.
  • Banker: Rarely seen in early stage financing.
  • Mentor: Recommended for every entrepreneur. Rarely takes a fee at early stages. Usually helps because someone once helped him.

Preparing for Fundraising

This process is going to be significantly harder and with higher chances of things going wrong without a good lawyer. There is a short list of factors to consider when evaluating candidates:

  • experience level
  • cost
  • comfort with one’s communication style.

For early stage companies, lawyers would ideally have a proven track record of representing startups.

Additionally, there are several things to prepare upfront before receiving the first term sheet3:

  • company structured as a C Corporation registered in Delaware
  • startup qualified to do business in every state it operates in
  • legal and financial records prepared for due diligence process
  • copies of startup’s original organizational documents prepared
  • access granted to any documentation related to its capital stock
  • capitalization table prepared and updated
  • copies of financial records, budgets, major customer lists, and employment agreements included.

The most important differentiator, from an investor’s perspective, from your startup and its competitors is intellectual property. Because of this, anyone who has had contact with company’s intellectual property has to sign confidentiality agreements. There are also cases where founders of a company begin working on their new venture while still being employed by another company. It is advisable to sign an agreement with the primary employer to eliminate the potential of controversies over IP ownership later down the road.

How to Raise Money

Aim to get several term sheets in parallel to negotiate better terms. Since every venture capital firm is different, the general advice would be to make sure you know who you are dealing with. However, there is some practical advice:

  1. Go into a money-raising process with an attitude of presuming success.
  2. To target relevant potential investors, figure out how much money you are going to raise.
  3. Prepare fundraising materials4: an executive summary5, a presentation6, and (ideally) a demo or prototype.
  4. Prepare elevator pitch7.
  5. Understand financial dynamics of your business8.

As part of the due diligence, once VC offers you a term sheet, their lawyers will ask you for documents such as capitalization tables, material customer agreements, and employment agreements. There is an additional list of documents requested once the term sheet offered is signed.

When possible, use your network to reach out to the prospective VCs. Otherwise, use their websites, blogs, and social media presence to understand what types of companies they invest in, what stages they prefer to invest in, their preferred channel, and their track record. The ultimate goal here is to build a long-lasting relationship.

Understand the role of the person within the firm who is your primary connection. Rule of thumb here is not to get overly excited until there is a general partner or managing director spending real time with you. As things unfold through the meetings, either you’ll continue to work with the VC in exploring the opportunity or the VC will start slowing down the pace of communication.

In the end, VCs will decide whether to invest. If they do, the next step in the process is for them to issue a term sheet. The ultimate goal of the process is to close the deal, raise the money, and get back to running your business. First step in closing the deal includes signing of the term sheet and the second is signing the definitive agreements and receiving the cash.

Overview of the Term Sheet

The term sheet is critical. It serves as a blueprint for your relationship with investor and determines the final deal structure. In this context, what VCs really care about when making investments are economics9 and control10.

Economic Terms of the Terms Sheet

Control Terms of the Term Sheet

Other Terms of the Term Sheet

Convertible Debt

The Capitalization Table

Crowdfunding

Venture Debt

How Venture Capital Funds Work

Negotiation Tactics

Raising Money the Right Way

Issues at Different Financing Stages

Letters of Intent: The Other Term Sheet

How to Engage an Investment Banker

Why Do Term Sheets Even Exist?

Legal Things Every Entrepreneur Should Know

  1. There are different types of venture firms usually differentiated by the stage of financing they invest it. It used to be that the Series A round was the first financing, the Series B was the next round, and the Series C was the next round. With time, this nomenclature has changed. Today, there are also seed (even pre-seed) rounds intended for very early stage investments. Generally speaking Pre-Seed, Seed, and Series A are considered early stage companies, Series B, C, and D are considered mid-stage, and Series E or later are considered late stage companies. ↩

  2. Spreadsheet that defines the economics of a deal. Contains a structured overview of ownership percentages, shareholders, shares/options, dilution, convertible instruments, ESOPs, and investor ownership after rounds. ↩

  3. A non-binding document that summarizes the key terms and conditions of a proposed investment deal before final legal agreements are signed. ↩

  4. Business plan is not included in this list since many people consider it obsolete for fundraising, it could be helpful while formulating your business, though. ↩

  5. Short description of your business. This is up to a three-page document which contains a description of your idea, product, team, and business. If there is any interest withing a VC firm in what you are doing, this document will be passed around. ↩

  6. 10- to 20- page PowerPoint or Google Slides presentation consisting of a substantive overview of your business. Ideally includes a problem you are solving, size of the opportunity, strength of the team, level of competition, your plan of attack, and current status. ↩

  7. Short description of business, but not to be confused with executive summary. One to three paragraphs that describe the product, the team, and the business. In the form you can email. This and the document attached containing an executive summary will often be your first communication with a VC. ↩

  8. At early stage companies most of the financial predictions will probably be wrong. However, it is beneficial to think about assumptions underlying the revenue forecast and monthly burn rate prior to the meeting with investors. In later financing rounds, your company’s historical financial performance will matter a lot more to prospective VCs. ↩

  9. The return the investors will get in a liquidity event. ↩

  10. The mechanisms that allow the investors to exercise control over the business or to call off decisions company can make. ↩