Venture Deals, Brad Feld (9/10)

Rating: 9/10
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🎨 Impressions

A short and sweet book that aims to institutionalise the lessons learned from the authors during their careers as venture capitalists and entrepreneurs.

For anyone interested in entrepreneurship and early-stage investing, it really is a must-read. The book provides a comprehensive overview of the early-stage investment landscape and its key stakeholders. It also outlines the key economic, legal and financial concepts required to gain a deeper insight into the space - and is littered with valuable tips and insights.

The authors offer both the VC and entrepreneur’s perspective throughout the book, which helps remove any biases and makes their arguments more engaging. As you can imagine, things can get quite dry but the authors’ unique sense of humour does help in this regard!

🔍 How I Discovered It

Lara recommended I read it after she was recommended to read it at Columbia. Well known authors in VC space and popular on Goodreads.

🥰 Who Would Like It?

For anyone interested in entrepreneurship and early-stage investing.

☘️ How the Book Changed Me

I now have the VC bible to go back to!

✍️ My Top 3 Quotes

• We haven’t seen a business plan in more than 20 years
• Dividends might be requested by dorky VCs with Private Equity background.
• Don’t carpet bomb VCs.

📒 Summary + Notes

Chapter 1: The Players

You need to be talking to a Managing Director or a General Partner

• You need a good, experienced lawyer: this is an awful place to skimp
• Mentors are great

Chapter 2: How to Raise Money

• You need an elevator pitch, an executive summary and a 10-slide PowerPoint presentation
• “We haven’t seen a business plan in more than 20 years”
• Your financial model must get the potential expenses right; forget about nailing the revenues
• Do your homework on your VC and don’t press any clearly advertised wrong buttons
• If you feel like your VC is a proctologist, run for the hills
• Ask your VC for references from entrepreneurs

Chapter 3: Overview of the Term Sheet

• It’s not a letter of intent; it’s a blueprint for your future relationship with your VC
• Two things matter: economics and control

Chapter 4: Economic Terms of the Term Sheet

• Understand the difference between pre-money and post-money
• The VC will try to stick the options pool in the pre-money valuation
• You must have a Plan B to be able to negotiate good economic terms
• Competition aside, valuation will depend on the stage of the company, the team’s experience, the numbers, the suitability for the VC and the economic environment
• Liquidation Preference arises because VCs come in with preferred stock and means the VC gets its money first. This can be very dilutive if the next round is a down round.
• Fully Participating stock receives its participation amount and then shares in the liquidation process on an as-converted basis
• A cap can be put on the participation
• Under “pay to play” provisions, investors who do not participate in the next round get converted to common stock.
• Typically, employee stocks and options will vest over four years and disappear if somebody leaves
• Consideration must be given to treating the vesting as clawback with an IRS Section 83(b) election
• Acceleration of vesting upon change of control is a key feature, don’t leave it out!
• Antidilution provisions may be requested by the investor for the case where new common stock is created after the financing

Chapter 5: Control Terms of the Term Sheet

• At the beginning it will be 1. Founder, 2. CEO, 3. VC, 4. 2nd VC, 5. outside board member
• Don’t allow observers on your board
• Make sure the Protective Provisions allow you to borrow a reasonable amount of money
• Your investors need to vote as a single class
• There will be a drag-along provision (majority of shares on as-converted basis is the law in Delaware)
• There will be a conversion clause (so VCs can vote alongside common stock when they must)
• An automatic conversion clause can be there to force VCs to give up on their preferred ahead of a sale.
• If there is an automatic conversion threshold, it must be the same for all classes of stock.

Chapter 6: Other Terms of the Term Sheet

• Dividends might be requested by dorky VCs with Private Equity background.
• Noncumulative dividends that require board approval are OK. Supermajority even better.
• Redemption rights on the preferred (say after 5 years) can be put in by VCs that have the maturity of their fund in mind.
• Adverse Change Redemption Rights are evil, because there is no good definition for adverse change.
• Conditions Precedent to Financing should be avoided at all costs.
• Information Rights are A-OK.
• Registration Rights are A-OK. The world is good if you’re going public.
• Right of First Refusal had better be restricted to big investors.
• Right of First Refusal had better be pro-rata.
• Restriction on Sales is a clause that allows the company itself the right of first refusal.
• The Proprietary Information and Inventions Agreement is a clause you actually need.
• A Co-Sale Agreement allows investors to sell along with founders.
• A No-Shop Agreement had better expire automatically if the sale falls through and should have a carve-out for acquisitions.
• A standard Indemnification clause is good corporate hygiene, but it means you need to buy directors’ insurance.
• The Assignment clause needs to be read carefully: look for the loophole “assignment without transfer or the obligation under the agreements” which should not be there.

Chapter 8: Convertible Debt

• Convertible converts at a discount to the next financing.
• The purpose is to defer the discussion about the value of the company.
• A floor on the value of the stock protects the entrepreneur.
• A ceiling protects the investor, but can hurt everybody because it guides (caps!) the next investors on price.
• You should put a reasonable time horizon on an equity financing as a condition, or you will find the debt converted before you had time to do the financing.
• You should set upfront the minimum amount of financing that triggers the conversion.
• The interest rate on the debt should be as low as possible.
• There must be clauses regarding the sale of the firm while the debt is outstanding.
• Technically, a startup with convertible debt is insolvent!!!
• Warrants attached to debt are an alternative to the discount on convertible debt.
• Warrants should deliver the most recent class of stock at the most recent round’s price.
• Warrants are long-term (e.g. 10 year) call options.
• Warrants had better expire at a merger/acquisition unless they are exercised prior to the merger.

Chapter 9: How Venture Capital Funds Work

• Fees received from the LP are higher during the “Commitment Period” during which funds can still be committed to new investments.
• Follow-on investments can still be made during the investment term of the fund.
• VCs recycle their management fee into the LP if returns during the early life of the fund are good.
• If a fund is approaching the end of its life, you don’t want them to invest in you and most probably they can’t anyway.
• Ask your VC when they made their last investment. If it was more than 12 months ago, run for the hills.

Chapter 10: Negotiation Tactics

• Get a good result, do not kill your personal relationships and understand the deal you struck.
• This deal is not your lawyer’s.
• Find out who you are dealing with.
• Have a solid Plan B.
• Get the VC to tell you the top 3 things he wants (erm, good luck with that, I say)
• Always be transparent.
• Never make an offer first.
• Understand what market terms are.
• Bear a bad deal, because the acquirer might deliver you from it.

Chapter 11: Raising Money the Right Way

• Don’t ask for an NDA.
• Don’t carpet bomb VCs.
• No means no.
• Don’t be a solo founder.
• Don’t overemphasize patents.

Chapter 13: Letters of Intent – The Other Term Sheet

• (N.B. that means you’re selling the firm)
• They will beef up the options plan, right out of the offer they’ve shown you.
• An asset deal is crap: you have no assets but must still close the firm down.
• If they are offering illiquid stock, that’s something you’ll need to invest the time to evaluate yourself!
• You will have to give representations and warranties and if they are qualified by “to the extent currently known” you will have to sign them.
• Escrow is the practice whereby part of the offer is put to one side until some conditions have been met. This is a big burden, especially if the consideration is in stock. Fight it as much as possible.
• No-shop clauses should expire the moment the buyer terminates the process.
• Don’t negotiate your deal at the beginning (that looks awful) but don’t leave it last either.

Chapter 14: Legal Things Every Entrepreneur Should Know

• IP issues can kill a startup before you even really begin.
• Delaware
• Non-accredited investors have a right of rescission!
• Don’t forget to file an 83(b) Election
• When you write options to your employees, get them 409A - valuated