For many start-up entrepreneurs, securing venture capital seems a dream, the hard-won validation of an idea still in its infancy. At a time when banks aren’t lending and even family and friends are questioning your sanity, it is the venture capitalist who steps in and says he believes in you. Just sign here.
Yet the dream often becomes a nightmare. The VCs who seemed so friendly in their cool, glass offices, in their pressed chinos and button-down blue shirts, can turn hostile when things go wrong. Founders are hurled out of the businesses they created and early visions are trampled by the urgency to turn a profit. If a company isn’t going well, VCs may simply turn away, ignoring the entrepreneurs’ pleas for help. After all, the VC’s investment strategy relies on placing many bets in the hope that one succeeds on an epic scale. One Google justifies a hundred failures. You may be one of them.
Entrepreneurs, then, need to be realistic about the venture capital process, to understand it from the investor’s perspective as much as their own, and to protect their interests aggressively. The VC is not a fairy godmother. They are there, just like you, to make money.
In Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, Brad Feld and Jason Mendelson, the founders of the Foundry Group, an early-stage VC fund based in Boulder, Colorado, have written an invaluable guide for entrepreneurs.
There is a temptation, they write, for entrepreneurs to outsource negotiations over financing to lawyers. This is a mistake. It is not just money, after all, that is under discussion. It is also control. Every new business starts awash with goodwill. But friendships, however enduring, are no substitute for a well-written term sheet. Investors will want to know what happens if a founding team breaks up. As a founder, you must be involved in that discussion.
Feld and Mendelson provide detailed tips on how to present to VCs and how to negotiate. Less is more, they say of the presentation. VCs only really want to know a few things: “the problem you are solving, the size of the opportunity, the strength of the team, the level of competition or competitive advantage that you have, your plan of attack and current status”. Tack on some basic financials and you should be done in about 10 slides.
Some VCs will demand endless details and degrees of control. But, the authors graphically advise, “if you feel your VC is a proctologist, run for the hills”. The negotiation with the VC, after all, is about just two things: economics and control. If they keep bringing up matters beyond these two core issues, you are best walking out, as it indicates they are either trying to distract you from what’s most important, which is dishonest, or that they will be meddling micro-managers throughout your relationship.
Feld and Mendelson are equally critical of VCs who say “this is non-negotiable” or “this is a standard deal term”.
They call this “ultra-lame and a sign that the people you’re negotiating with don’t really know what they are doing”. Every entrepreneur worthy of investment is equally worthy of a bespoke term sheet that reflects their interests and those of their company.
It is also important for entrepreneurs to look far into the future. Early money tends to stick around and you want to know if this investor has plenty of “dry powder” to invest in the future, or whether you will have to find fresh investors in every round. The authors are clear about what an entrepreneur should focus on and what to let go. Asking a VC to sign a non-disclosure agreement, they believe, is amateur. VCs see new ideas all the time, most of which fail through poor execution. You’re better off proving you can make your plan work than trying to protect the unproven.
These are just a few of many practical lessons in the book. Any entrepreneur hoping to receive venture capital money should read them, to inform and arm themselves for what is almost never a smooth ride.
Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, by Brad Feld and Jason Mendelson, Wiley, RRP$49.95