Term sheet: a letter expressing interest in investing, along with proposed terms

The only two things that matter in term sheet negotiations—economics and control

The way your lawyer represents themselves will directly reflect on you when dealing with future investors

VC hierarchy:

Most senior person in the firm is usually called a managing director (MD) or general partner (GP)

Some titles have an additional prefix such as executive managing director or founding general partner

These VCs make the final investment decisions and sit on the boards of directors of the companies they invest in

Principals or directors: junior deal professionals involved in specific aspects of the investing process, such as deal sourcing or due diligence

Usually don't have decision-making authority

Partners are usually the ones who can make decisions

Associates work for deal partners, usually a managing director

Scout new deals, help with due diligence on existing deals, and write up endless internal memos about prospective investments

Analysts are the bottom of the ladder, very junior, recent college grads, crunch numbers, and write memos

Very limited in power and responsibility

Venture partners or operating partners: experienced entrepreneurs with a part-time relationship with the VC firm

Often need support of one of the MDs, just as a principal would, in order to get a deal done

Often don't sponsor deals, but take an active role in managing the investment as a chairman or board member

Entrepreneurs in residence (EIRs): part-time member of the VC firm

Experienced entrepreneurs helping with introductions, due diligence, and networking

Types of funds:

Micro VC funds:

Often only have one general partner

Funds are usually less than $15 million

Invest almost exclusively at seed and early stage

Invest alongside other micro VC firms, angel investors, and friends and family investors

Seed stage funds:

Scale up to $150 million per fund

Focus on being the first institutional money into a company

Rarely invest in later rounds past a Series A

Often provide your first noncompany board member

Early stage funds:

$100-$300 million

Invest in seed stage and Series A and occasionally led a Series B

Mid stage funds:

Generally invest in Series B and later

Growth investors: company is clearly working, but now needs capital to accelerate or continue, its growth

$200 million to $1 billion

Late stage funds:

Last financing before a prospective IPO

Target the types of firms that invest in your stage of company

Angel investors: key source of seed and early stage investment and are very active in the first round of investment

Make sure the angel investor is an accredited investor

If your angel group is a small, diffuse list of friends and family, consider setting up a special-purpose limited partnership controlled by one of them as a vehicle for them to invest rather than chasing down 75 signatures when you want to do a financing or sell the company

Syndicate: a collection of investors (VCs)

If you raise a party round (ex. $2 million seed round with 10 VCs and 20 angel investors) you will get very little attention from any of the investors since their investments were all tiny relative to what the VCs normally invest

An experienced lawyer who understands VC financing is invaluable

Many lawyers experienced with VC investments will cap their fees in advance of the deal

A very early stage financing can be done for between $5,000-$20,000 and a typical

A typical financing can be completed for between $20,000-$40,000

You can pay out of the proceeds of a deal

Investment bankers are rarely seen in early stage financings and can be a bad sign to VCs

Advisors often implies there is some sort of fee agreement with the company

Many mentors end up being early angel investors in companies or get a small equity grant for serving on the board of directors or board of advisors, but they rarely ask for anything up front

Every employee of a startup, including founders and each of the company’s executives, must sign a Proprietary Inventions and Assignment Agreement to protect the startup’s rights to its intellectual property

Your goal when you are raising a round of financing should be to get several term sheets since competition drives better terms for the entrepreneur

Start with an attitude of presuming success when fundraising

Attitude impacts outcome

Figure out how much money you are going to raise

Focus on the length of time you want to fund your company to get to the next meaningful milestone

If you are just starting out, how long will it take you to ship your first product?

If you have a product in the market, how long will it take to get to a certain number of users or a specific revenue amount?”

Make sure you have enough cash to get to a clear point of demonstrable success while being careful not to overspecify the milestones that you are going to achieve.

You don’t want them showing up in your financing documents as specific milestones that you have to attain

Don't give a range

Elevator pitch: describe the product, the team, and the business very directly

Executive summary: up to 3 page document

Direct indication of your communication skills

We will have different presentation/powerpoints depending on if we are using it to email to an investor or using it to present

VCs get excited about 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

Summary financials, use of proceeds, and milestones are also important

A demo or a prototype can be far more important than a business plan or financial model for a very early stage company

Give more than you get while interacting with VCs on social media

Learn from all the feedback you get and don't take any of it personally

Nothing is as illuminating as a discussion with other entrepreneurs who have worked with your potential investor

If a VC passes on a deal with you, do your best to politely insist on feedback as to why. Ask for the feedback, demand it, get it, absorb it, and learn from it

If you want to create a competitive process between VCs, never answer who else you are talking to

The term sheet is the blueprint for your future relationship with your investor

Founders receive common stock

VCs receive preferred stock

The pre-money valuation is what the investor is valuing the company at today, prior to the investment

The post-money valuation is simply the pre-money valuation plus the contemplated aggregate investment amount

The purchase price is the price per share of the preferred stock

Warrants in an early stage investment tend to create a lot of unnecessary complexity and accounting headaches down the road

In early stage financing, it's actually in the best interest of both the investor and the entrepreneur to have a simple liquidation preference and no participation

Pay to play means if an investor fails to participate in the next financing round, their preferred shares get converted into common stock

Investors that only invest in early rounds will not like pay-to-play since they won't typically invest in later rounds

Typically, stock options will vest over four years with a one-year cliff

Unvested founder stock just vanishes

Unvested employee options go back into the option pool to be reissued to future employees

The board of directors approve many important actions that the company takes, including budgets, option plans, mergers, IPOs, new offices, significant expenditures, financings, and hiring of C-level executives

Redemption rights allow the investors to sell their shares back to the company for a guaranteed return

Try to avoid conditions precedent to financing as much as possible

A proprietary information and inventions agreement clause is good for the company

Convertible debt is a load that has the ability to convert to equity based on some future financing event

Discounts normally range between 10-30%, with 20% being the most common

Safes don't pay interest and they don't have maturity dates

The cap table summarizes who owns what part of the company before and after the financing

An accredited investor is a person who has a substantial net worth and/or income, as defined by the SEC

If you raise from a lot of small angels it will be on you to ask them for help. A lot of small companies that are too small for VCs end up being stranded because they run out of money and their investors aren't bought in

When things go sideways, do not try to hide the problem. Instead, your goal should be to communicate early and often with your lender about your performance as soon as it goes off plan. Surprise is the enemy, and transparency is your friend

It’s important to understand what drives your current and future investors since their motivations will impact your business

VC fund structure

The management company employs all of the people with whom you interact at the firm, such as the partners, associates, and support staff, and pays for all of the normal day-to-day business expenses

The next entity is the limited partnership (LP) vehicle that contains the investors in the fund

“The final entity is one an entrepreneur rarely hears of and is called the general partnership (GP) entity the legal entity for serving as the actual general partner to the fund

There is separation between the management company (the franchise) and the actual funds that it raises (the LP entities)

Carry is the amount of money a VC makes off

The commitment period (also called “investment period”), is usually five years, and is the length of time that a VC has for identifying and investing in new companies in the fund

Ask them when they made their last new investment. If it’s more than a year ago, it’s likely they are a zombie. You can also ask simple questions like “How many new investments will you make out of your current fund?” or “When do you expect to be raising a new fund?” If you feel like the VCs are giving you ambiguous answers, they are probably a zombie.

Reserves are the amount of investment capital that is allocated to each company that a VC invests in for future follow-on rounds

Everyone has an advantage over everyone else in all negotiations

One successful negotiating tactic is to ask VCs up front, before the term sheet shows up, what the three most important terms are in a financing for them. You should know and be prepared to articulate your top three wants as well

In a venture capital financing, the best way to gain leverage is to have competing term sheets from different VCs

You should never make an offer first. There’s no reason to, unless you have another concrete one on the table. Why run the risk of aiming too low?

Make sure you know when to talk and when to listen. You can’t lose a deal point if you don’t open your mouth

Understanding market terms and whether they apply to your situation is important. You can quickly get context on this by talking to other entrepreneurs in similar positions. Understand what market really is, and you’ll be able to respond to an assertion that something is market with fact rather than with emotion.

The first formal step for a company that wants to acquire yours is to issue a letter of intent

Cash is king. Everything else is something less. And it can be a lot less

The best reason for hiring a banker is to maximize your company’s exit value by exposing it to the largest number of logical acquirers

If you are going to raise venture capital, you will want to be a C Corp

If you are not going to raise any VC or angel money, an S Corp is the best structure as it has all the tax benefits and flexibility of a partnership while retaining the liability protection of a C Corp

There are laws that effectively say that only rich and sophisticated people are accredited investors and are allowed to buy stock in private companies. If you try to raise money from people who do not fit this definition, then you’re probably committing a securities violation

Section 409A says that all stock options given to employees of a company need to be at fair market value

An 83(b) election is a notification a recipient of a restricted stock grant sends the IRS electing to be taxed on his or her equity on the date the equity was granted rather than on the date the equity vests

Some important ways to structure proper consulting relationships include: (1) engaging the individual for a specific project; (2) compensating the individual by the project rather than by an hourly or monthly fee; (3) not having direction, control, or supervision over the person; (4) not providing equipment or training; (5) permitting the individual to work for other entities because, ideally, these are professionals with real businesses that work with a lot of different clients; and (6) not making arrangements terminable at will.”

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