Business Startups Finance

Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist (Summary)

by Brad Feld and Jason Mendelson

Imagine you sell your startup for $10 million, the exact valuation VCs invested at. You own 80%, so you should get $8 million, right? Wrong. Thanks to a single clause in your term sheet—the liquidation preference—your investors could get all their money back first, plus interest, leaving you with far less, or even nothing. This is the financial fine print that can turn a founder's dream exit into a nightmare.

Economics and Control Are The Only Things That Matter

Every complex clause in a 15-page term sheet can be boiled down to one of two things: who gets the money (economics) or who gets to make decisions (control). By viewing negotiations through this simple lens, founders can focus on what's truly at stake.

The 'option pool shuffle' is a classic economics game. VCs often require founders to create a large option pool for future employees before their investment. This lowers the pre-money valuation and means the founders' ownership is diluted more than the VCs', directly shifting the economic split.

The Term Sheet Is a Blueprint for Your Relationship

The term sheet isn't just a financial document; it's the prenuptial agreement for your relationship with your investors. It dictates how you'll make decisions together, what happens when you disagree, and how you'll part ways in both good and bad scenarios.

A 'protective provision' clause can give a VC with only 20% ownership the power to veto major company decisions, such as selling the company or taking on debt. This term isn't about money; it's about shifting fundamental control from the founders to the investors.

Your Lead Investor Matters More Than the Firm

You aren't getting an investment from a brand like 'Sequoia' or 'Andreessen Horowitz'; you are getting an investment from a specific partner at that firm who will sit on your board. That individual's reputation, network, and engagement level are far more important than the firm's logo.

A junior partner at a top-tier firm might not have the internal clout to secure follow-on funding for your company in a crisis, whereas a seasoned partner from a smaller firm might call in personal favors from their network to save your business.

Valuation Is an Art, Not a Science

Founders obsess over their pre-money valuation, but it's often a negotiated fiction. VCs can offer a high valuation to win a deal but claw back the economics through other, more complicated terms like aggressive liquidation preferences or participation rights.

A VC might offer a $20M valuation with a 2x participating preferred liquidation preference, which could be a worse deal for a founder than a $15M valuation with a standard 1x non-participating preference, especially in a modest exit scenario.

Go deeper into these insights in the full book:
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