I'm wrapping up a term sheet with a US VC for a deal with are both looking at. I've been surprised at a few things that see a bit, well, not so cool side. At the risk of every US VC never working with me again, I'll offer up some observations on some of this stuff.
Expenses:
What is this notion that a start up pays expenses even if the deal doesn't close? I think this is unfair, don't ask for that, and don't expect anybody to give on that. Seems to me if all of the white hot start ups out there who are getting multiple term sheets in a bidding war will take a step back and say no, this "its normal" excuse will start to fade.
90 days of exclusivity:
Dharmesh Shah had a great post on this process taking so long. One reason in my view is people let stuff like 90 days of exclusivity become "normal." In my personal opinion, 45 days is pressing it and is all I'd expect to get. 90 days seems unfair. One alternative is to get the VC to buy the exclusive. Offer the 45 days and charge a non-refundable $1,000 a day for every additional day up to a max of 90. At least you get the light/rent paid for. Yes, I know, not likely to happen.
Founder Buy Back:
This is where if the founders quit, get fired with or without cause, the company (or in two cases I've seen the investors) have the right to buy the founder's shares for nominal value, usually less than what the investor valued the company at. This right decreases over time, usually 2 ~ 3 years, on a monthly basis. The investor side of the story goes this is a way to lower the value of the company if the guy(s) we bet on walks and/or can't do the job. The start up gal says, hmmm, the ink is dry, you fire me for no cause, pay me six months and basically buy my shares for some discounted price. Sign me up... NOT.
My view on this is a bit convoluted. I think if you walk out the door after telling me this is the greatest thing in the world, you need to hurt. I bet on you, ma'am, so you need to feel some pain. On the other hand, having the right to toss you on whim is unfair without me taking some pain. What I think is fair is that if you get fired for (well defined) cause, this buy back should have some teeth/rights. If we get up on the wrong side of the term sheet and toss you for no reason at all, this clause simply shouldn't apply. It's not fair and if the investors decide you ain't it, fine, but fair is fair. You steal, lie, cheat, grossly under perform, etc; we make a cause case; buh bye. You don't have the "CEO mojo to take it to the next level" nonsense, screw em, you get to keep your stuff. On change of control this, of course, goes away immediately, etc.
These are the three big ones that have popped up recently.
Next up the last 50 presentations, no harm/foul meetings and some common themes.
A decent lawyer would line most of this stuff out. We certainly would have laughed in the faces of people proposing them. These items are for people too dumb to know that the underlying deal metrics don't require them.
Unless, that is, as a team you are desperate (have already run out of cash), which is when it gets funny, because the VC's who go in for this stuff get hit by adverse selection coming the other way: the provisions they require end up aligning them with the dumber management teams.
Posted by: ZF | September 27, 2006 at 16:34
Founder buy-back sounds to the founder like: we like the idea, we don't like you. We'll take your idea and throw you out as soon as we've put the management team we like in place.
Otherwise why would the VC insist on without cause?
I'm not too familiar with cases of the founder walking out after going thru the wringer to get funding - that would be downright masochistic. Perhaps it happens.
To the VC, it's an investment. To the founder, it's her baby, her idea, her night and day for the foreseeable future. Tell her you have the right to throw her out and take her shares whenever you feel like with no cause, and you have a serious trust problem on your hands.
Posted by: Parand | September 28, 2006 at 21:01
It's contract terms like this that keep me from ever taking my business in a direction that would require VC-level cash. It's heartening to know that there's a VC out there who agrees that such contract provisions are offensive.
Posted by: Matt | September 28, 2006 at 23:01
Excellent post!
Regarding entrepreneurs saying "No" to paying due-diligence expenses, right on! After my last VC experience, I consider it a deal-breaker if the VC insists on it. Who's with me?... Anyone?... Guys??
Posted by: Henk Kleynhans | September 30, 2006 at 14:29
At least you're not being insulted with the expenses PLUS break fee provision a Boston VC recently put on my desk. It offended my manhood, and I'm a woman. Never go with a US fund that has less than $250 Million to deploy - their management fees are too skinny. Let us all praise Canadian LPs for not being as stingy.
Posted by: Suzie Dingwall Williams | October 01, 2006 at 16:22