Common Shares: If it walks like a duck and quacks like a duck; it's a chicken

(This one's for you, Frances)

Common Shares.  We here at JLA invest in common shares.  We've done it a number of times.  The definition of a common share is simple; it is the same share you have. No special rights. No special privileges. No special favors.  If the company is bought, I get my share.  If the company needs to have a shareholder vote, I vote my shares. Period.  Common shares.

Anything else isn't common shares and lots of times there is the common share cha cha to convince entrepreneurs that, well, they are really common shares except for [fill in all the terms].

Here is a real life example of how it can get twisted.

Founders show up with good company. Founders insist on common shares. Ok, says VC, let's first look into the opportunity.  VC looks into the opportunity and tells the founder:

"I'm good with a common share structure save and except for one item. If I put in my $5 million and the company isn't sold for enough money to pay my $5 million back, I get that back first. Then the rest of the shareholders can have what's left.  If there is a big exit, no problem, I get my share just like anybody else."

The entrepreneur is ecstatic.  He is getting funding and those magic common shares.  It's a chicken.  This is a liquidation preference. Simple, get my money back, preference but it is a liquidation preference.  What will end up happening in this scenario is the lawyers on both sides will get extra fees making documents to cover this, getting the shareholders to agree, etc, vs. a preferred share structure.

I, personally, take the following approach.  If I'm sold on a straight common share, the above paragraph simply doesn't apply. It is straight common shares.  If, on the other hand, I get the business term of "I get my money back in a disaster scenario" agreed to, I leave it up to the entrepreneur's lawyers to create the first draft of the legals.  In both cases where this has come up, the other side's lawyer has convinced the company that it's a chicken, take the preferred share structure since that is, in effect, what we are creating. 

I'm good either way but my primary motive is transparency and clarity for the entrepreneur.

My council to you is simple: Agree on the plan language business terms.  Don't talk preferred shares, liquidation preferences, double dips, or back flips. Agree on the plan language business terms and then have your lawyer (not theirs) explain what you've agreed to.  Naturally, the key here is a lawyer you trust and not Uncle Ned giving you the advice/translation.

Comments

[MRM]

that's good counsel
MRM

[Keith Glover]

Great advice as usual. If one exists, I would love to see the "secret" checklist of criteria VCs use to decide if they even want to pursue talks with companies, or is every business / idea always evaluated with a fresh set of eyes? In other words how do you get in the door and make your company stand out among the hundreds of proposals?

[Investment possibilities]

Your views are straight and effective. I am very much inspired by your savvy. I thank you greatly for sharing the wonderful experience.