The Post Money Value

Sample Intent Letter

I've been asked by a number of people to provide a sample intent letter of the kind I spoke about in the post regarding Term Sheet vs. Intent.  I've modified this and mixed from two recent ones to give you an idea of what they look like from our firm.  Your mileage with your VC will vary.

Dear Dave,

Thanks for taking time out of your schedule to meet with my partners and I regarding NewCo. I know a second meeting is a pain but it went very well. We think you did a good job explaining it and based on the first pass due diligence on the space, opportunity and you folks, we would be prepared to dig in more and see if there is a deal to be had between your company and our firm.

As we discussed, I wanted to outline our intent inline with setting expectations on process, major terms and your questions regarding share structure/value.

First, given the stage of your company, many of the items on the DD checklist I sent you are not applicable. We will waive the environmental hazard waiver, as a rather humorous example.  My expectation is the there are a couple of weeks of calls, material review, and analysis to do.  We have two other files being worked on, one requiring travel to the west, so there will be some interruptions to the process.  In the past, many hold ups are getting the material from the company lawyers and attorney's so I strongly suggest you send the checklist to them immediately and get them rolling. On items that are N/A, they just are so no worries.  We will need to schedule a site visit and would like to arrange interviews with the named parties that we talked about in my office.  My best guess is 10 - 12 business days to get this done at which time, assuming we are all good, we'll lock down the term sheet.  The materials can be electronic. We have a Sharepoint location you can use as an electronic data room or you can send us a CD/DVD, doesn't matter to us.

On general terms:

Assuming we do this deal, we are proposing to issue a Class A preferred share with a 1x liquidation preference, with an 8% coupon. This is a non-participating preferred share and the 8% is not paid, it accrues until the liquidity event which is usually defined as a sale or IPO.  We require board representation. It is mandated by the way our partnership is structured and is not negotiable. As I mentioned to you in our meeting, if this board seat thing is a problem, we should stop now since we can't waive this.  The size of the board is open to discussion, however my suggestion is 1 from us, a common share rep, you(as the CEO) and two independents which we agree on.

We will ask for drag along and tag along provisions which are fair to all of us. When we get to a formal term sheet, they will be outlined in greater detail.  The sample package of VC documentation I've attached can show you want these and other things look like, but every deal will be slightly different. You are free to have your council review this package so you can get a clear expectation of what's coming. Your lawyers can also go into great detail on each item and how to deal with each one.

We have certain items that fall under the category of "matters requiring special approval." Essentially, this is a list of items that notwithstanding the approval of management and the board, you must have our written consent.  Our board seat and vote from the seat does not necessarily give you approval.  In the 8 years I've been doing this, I've never seen a case where we have said yes at the board and no at the firm level.  Even so, I want to be clear on these issues.  Depending on many things we learn over the next couple of weeks, this list will get adjusted but there are a standard set of items that generally go in regardless.  They are:

• You can't change the corporate structure without JLA's permission. For example, you can't change the incorporation location without our permission. The board may want it and you might want it, but if it (for example) could cause a tax problem or some such for our LPs, we wouldn't sign off.
• You can't modify our share rights without JLA's permission.  For example, you can't have a vote and decide to remove our preference even you have the votes or other shareholders to support it. We have to approve.
• You can't incur outside debt (other than operating lines, etc) over a certain amount (to be discussed) without JLA's permission.
• You can't remove us from the board while we own 10% or more of the company.  While this is normally in the Shareholders agreement, I like to call it out so we all know the facets of this marriage.
• You can't modify the shareholders agreement which changes, in any way, our rights.  This is like the second one but we add it for clarity. This usually is the most contentious so we can have a separate discussion about what we will/won't do.  Rigid flexibility, that's my general motto. 
• No third party transactions (over a negotiated amount)  without JLA's permission. This is there to prevent you from hiring Uncle Ned with us actively approving it.

There are other items which you can read about in the enclosed sample pack but this gives you an idea of what to expect.

Valuation:

You asked about where the value would come in.  Generally and seriously broadly speaking, we believe an investment in this space, at your stage and with the additional capital required, best case, will come in at around a pre-money valuation of $6 million.  Again, this is the best case, no brain farts/problems in the DD process. Typically, what will reduce the valuation are these items:

• Budget adjustments. Essentially, we take your model, do VC Voodoo on it, and come back for a discussion. If we agree on the costs, revenue ramps, etc, and they are materially different than what we start with (your leave behind model), the valuation of the company can change. The key, of course, is getting agreement on numbers which make sense to both of us.
• Market data. Sometimes it will take longer and take more capital to get something adopted. If we think there is more (materially more) risk than when we started this discussion, the value can change.  Yes, we are venture capitalists and we are supposed to take risk, I agree. I make this point only to emphasize the materially more part.

Finally, the references. I've provided you a list of all our portfolio CEOs.  As I mentioned to you in our meeting, please do call them all and meet with as many as you can. I believe this is the best way to find out what I (and our firm) can be like once the deal is done.  Ignore all the he is a nice guy stuff and ask questions about what we did/how we acted when there were problems or issues.  I think you will be pleased with what you find out.

I hope this gives you the information you need in order to determine if we are the right fit for you.  Let me know if you have any questions.  I look forward to hearing from you with respect to proceeding.

Thanks again for coming by and letting JLA take a look at your opportunity.

There you go.  As I said, this will change depending on the company, management experience levels, etc.  I have a package of sample term sheets, shareholders agreements, etc, that are also provided so the management team can get a broad overview of the paperwork pile.

I hope this helps many of you in your financing endeavors.

Dancing With the One Who Brung Ya

Saul Lieberman, a lawyer in NY/Israel asked a great question in response to the intent post.

"Once you send your "intent email" and you and the entrepreneur are on the same page, what are your expectations regarding the entrepreneur continuing to negotiate with other investors?"

Excellent question. I expect him/her to keep talking to everybody.

Here is my view on the whole VC dance process. 

Until you have a signed term sheet where you've agreed, in writing, to some period of either no-shop or exclusivity, entrepreneurs should pursue every opportunity and continue to talk to anybody returning calls.  Given the whims of the day, human nature, what's hot/not in the minds of your potential financing source, keep talking until somebody delivers a term sheet with conditions you can accept.  Once you sign it and you've agreed to work just with the VC (or other financing source) stick to your word and follow through.

Now having said that, the amount of time you should 'lock up' with a VC is obviously a critical issue.  In my opinion, you should talk to everybody, give out the information people need to get to a term sheet (less customer calls), and get people as far down the path as possible before any lock up.  If you take this approach, you don't have 90 days of exclusivity nonsense, it is much much less.

Keep your options open until you get on final approach.

Thanks, Saul.

Dell Computers - Still Crazy After All These Years

Technorati Tags: Dell,Jeff Jarvis

3+ years ago, world class journalist/blogger Jeff Jarvis was in a serious war with Dell computer. Reading Jeff's "Dell Hell" became almost a national obsession.  In fact if you 'Google' Jeff, before you even get done typing his name, you will get:

So, despite this, I figure 3 years, it can't still be that messed up.  Here just the highlights of my side trip to Dell land.

I needed to get just a base desktop unit. No monitor or anything else for that matter, just a cheap box. After making my way through the Canadian web site, I managed to place an order for something around $450.  It was with some decent hardware, memory, large hard drive, etc.  It wasn't a bad price and despite the web site blowing up twice (it happens), I was good to go.

Email one comes in saying, your order is verified, life is good, let's rock -n- roll.

Email two comes in time stamped AFTER email one, 10 minutes or so later saying, just want to let you know we're thinking about this and we'll send you another email shortly verifying/confirming, etc, etc.

Hmmm.. This don't look good for moose and squirrel.

 

One day goes by and I get a phone call from, you guessed it, Dell. They leave voice mail telling me, yo dude, you ain't getting a dell just yet, call our order verification department. <sigh>

I call the 800 number and get this rather lame sequence:

1. Thank you for calling Dell, press one for english (in english) and two for french (in french). Note to French Canadians, this part wasn't lame, don't yell at me.

2. If you got an extension, press one.  If you didn't get an extension press two. (huh? If I don't press one, can't you figure it out?)

3. You will here a series of tones while we transfer your call.  Beep, Boop, Beep.

4. Elevator music. For 45 minutes but, duh, the call is important to them/us/you/him/her/it.

I hang up, of course.

That was yesterday.  This morning, I have yet another voice mail from the Dude at Dell (a dudette actually) basically saying the same thing, give us a call.

Same sequence as above except when we get to item 4.

The new item 4: Elevator music for 7 minutes and then "We're sorry, the department you got transferred to is closed, call back on our next business day." <click>

Right. July 4th, silly me, Dell Canada, of course, July 4th, what was I thinking, Canadian arm of a company open on July 4th, how positively insane.

And it appears those crazy kids at Dell, while wanting to talk to me and show me the love, ran the credit card right on through. 

Not that my trip to Dell should be a total loss, here is a great inspirational video from Steve Harvey, a super comedian, that was sponsored by Dell.

How to Hire the Killer Marketing Person or Company

I've given a bunch of talks at the local universities over the past couple weeks talking about the usual VC things as well as some operational issues such as hiring for companies.

One topic which came up a couple of times was the notion of hiring somebody (or a company) in the all important area of marketing.  On this category, I had a fairly simple way to dig through your options.

First, present this photo:

Then ask this question:

You are now charged with coming up with an Ad/Marketing campaign to counter this. What would you do? 

You'll get a fairly good idea of how that person or agency thinks and what they could potentially do for you.  Lots of students out there had some pretty good ideas to this seriously hard problem.

3 VC Questions You Should Not Answer

Here's a dirty little secret: Most 'confidential' or 'close to the vest' information we get comes from people talking and answering questions they probably shouldn't answer.  I'm not sure why this happens over and over but they do.

So, make a little card for yourself and carry this around with you when you are on the money hunt. Since nobody wants to take my advice to simply not answer these questions, I've provided handy answers so you can feel good about saying something.

1. Who else are you speaking to? [Answer: The usual suspects.]

2. What pre-money value did you have in mind? [We are looking for a deal that provides great returns for all of us.]

3. Can we speak to a few of your customers so we can better understand the value proposition? [No. Customer calls are post term sheet due diligence]

Really. Don't answer these and if you must, see above.

Term Sheets vs. Intent

I've said this many times before but it's worth repeating: Nothing is worse than having a term sheet pulled during the process. It is awful for you and it is actually awful for the VC who pulls it from many perspectives not the least of which is reputation.

My view has always been that you should get a term sheet as late in the process as you can stomach which should be inversely proportionate to the likelihood of the deal closing.  The farther down the road, the more likely it goes the distance.  These term sheets that get flung out to companies so there can be a lock up while the VC does the sniff test is just not a cool business practice.

From the entrepreneur's perspective, they want to know what the VC is thinking in terms of value, structure, etc, etc.  It's fair and, in my view, reasonable to want this data so you can make a decision on spending time with a particular VC, Angel, etc.

I've found over the last few deals and interactions on potential deals that a letter/document which spells out what is being contemplated goes a long way toward setting expectations and getting people on the same page with respect to process.

If I am working on an opportunity and I believe it has a shot at making it through the due diligence process, I will almost always give the entrepreneur the following information in an email and/or a letter:

• An intro paragraph that says deals like yours will typically fall into the following zone for a structure. This is not a term sheet rather a document designed to give you an idea of where my head is at with respect to what I'd be willing to do assuming all the stars line up.  Yeah, I say it that clearly with that language; the lawyers have a serious Maalox moment.
• The share structure (i.e. Preferred, 1x liquidation, etc)
• The best case pre-money value.  I don't do a range rather I say, assuming this opportunity is a 10 out of 10 (or better), this is the value I will subscribe to it.  I do it this way because I want the entrepreneur to know, up front, her best case.  It seems fair and we all know what we are shooting for.  Naturally, this has high risk of people getting seriously annoyed if the value is lower. It can look like a bait -n- switch but I honestly believe people should know that if this is better than sliced bread, this is where I would end up.  I've had entrepreneurs say thanks but no thanks.  The value, in the best case, isn't what they want, so we part friends right there.
• The timing with respect to when a term sheet comes in our process.

By structure, mentioned above, I am referring to things like board seat(s), protective provisions, matters requiring special approval, etc.  Any decent VC can spend 90 minutes with an entrepreneur and get a good feel for what they are likely to want from a structure perspective assuming they are interested. We, for example, always have board representation. Always, no exception. So telling you this immediately seems to be a smart thing to do because if you are not giving up any board seats, your call but not with my coin. 

The upside of this process is we both save time, part friends, and don't go down an expensive path (time and/or money) only to find ourselves at an impasse that could have been avoided with a simple 'here's what I'm generally thinking' memo to the company. 

I wish more VCs would do this.