A Good Way to Get Rolling

People have asked how I give the entrepreneur a good idea of what the plan is when our firm wants to do a deal.

Below is an email I sent to a start up a few weeks back that started the process we are in now.  I've changed a few things to keep the confidential stuff in place for the company but the rest is as it went out.

Keep in mind this is an Series A thing.

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From: Rick Segal

Sent: Tuesday

To: Roger

Cc:

Subject: Follow up

 

Roger,

 

Thanks again for taking the time to meet with me regarding NewCo.  We’d like to proceed with getting to a deal.  Here are the next steps/general outline of what a deal would be.

 

We would be prepared to co-invest with Partner an amount of 3m dollars into NewCo with the following general, high level, first pass terms:

 

Amount: $3 million at a Pre-money valuation of 5.4 million

ESOP: 15% pool created prior to funding

PT/JLA: $1.5 each

Share form: Preferred Share with a 1x liquidation preference, non-participation, no coupon.

Board structure: You, JLA, PT, Two Independents

Debt: Converts

 

You have not taken a salary in two years. Typically, founders doing that have kept records and get paid in shares.  Because of your seniority and experience, my proposal is call it $200k per year and to issue you $400k worth of Pref shares at the time we close. This accomplishes a number of tasks. First, it rewards you for work done to date. Second, by giving you pref shares, you get some dilution protection/top up.  Third, it keeps cash in the company which means a longer runway for you to build value, less overall money needing to be raised of which can be raised at a higher value because of the longer runway, etc, etc.

 

The next steps would be as follows:

 

- I’ll want to talk with your existing customers (the enterprise people). You’ll need to let them know and give me permission.

- I’ll provide you a DD checklist that you have probably seen before. As a start up, much will be N/A.

- You will need to come and present to my partners as a team. This is different then the 90 second blow through with me. They will want the full presentation and will ask lots of questions, etc.

 

My guess is 40 days or so, we can close something assuming the customers call me back, schedules, lawyers, etc.  It is rarely something in our collective control which causes the delay.

 

Hopefully, this is a good start.  The attorney for us on this is Peter.

 

I’ll be in touch later with additional information.

 

Best,

 

>R<

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Comments

[Peter Cranstone]

Rick,

Another SOLID gold post. These go straight in a folder called "Important things you need to know when talking to VC's". In my opinion you have now replaced every VC on the blogsphere in quality of content and fairness to the entrepreneur.

I took one look at the post above and know instantly this is the kind of investor I'm looking for. One who is alignment on the issues, understands how hard it is to actually build a company and who has an innate sense of fairness.

You've set the bar high. Keep it up there.

Peter

[You Mon Tsang]

Straightforward and detailed followup. What every business partner wants. I would argue with Peter on the fairness of offer (the board structure is out of whack to me), but I hope the entrepreneur on the other returns with his/her straightforward and detailed counter.

[Rick Segal]

You Mon Tsang,

Everything is negotiable. Thanks for stopping by.

[Mukund Mohan]

Rick
If you did not keep documentation on the 2+ years of no salary but kept it as debt on the company books, is that frowned on? thanks

[Rick Segal]

Mukund,

Speaking just for me, I'd be fine regardless, just so long as it is documented.

[Vinit Bhansali]

Good stuff Rick. And definitely helps people like me to get a sneak peak into the process.

I want to guess that where you say "90 second blow through" it just means an elevator pitch/exec. summary or the like.

However, even with the promising sounding letter, you put in a caveat of your partners looking at a "full presentation and will ask lots of questions".
Is that still a part of the "we'll decide after the presentation"?

[Rick Segal]

Vinit,
Thanks for stopping by.

The "90 second" thing was a reference to the fact that I immediately got the space/business and didn't need to really hear the formal presentation.

Part of our process is having my full office get to know the opportunity/people.

[Vinit Bhansali]

Rick,

I thought as much ... that you were definitely "in" with the idea.

However, how do you deal with a situation where you sent out this email and then, during the presentation, one (or more) partners have serious issues with this deal.

I mean, it's easier to say no to Roger than go against multiple partners who don't like the deal, right?

[Rick Segal]

Vinit,
I've been with my partners long enough that I would never go for something I thought they would hate. Funny you should say that tho, we just had one where my partner did work hard to get it over the finish line and into final legals.

But generally speaking, for me/my firm, if I tell you let's move forward things will go there unless there is some material issue that pops up.

[Michael]

Rick: What a great posting, very helpful thanks so much. A few quick clarification questions (apologies, if these seem naive or elementary!):

- What is "PT" & "JLA" & what does the "$1.5" refer to?
- What is the definition of "1x liquidation preference, non-participation, no coupon"? I'm guessing that the last 2 might refer to no board participation expected on your part & no discount for your firm when the note converts at the next financial round?
- If this is a convertible note transaction, why is there a valuation? I thought one of the benefits of doing converts is to not get into valuation?

Thanks!

Michael

[Michael]

Oh, forgot to also ask (perhaps the topic of a new blog entry?): What typically makes up a DD checklist? Thanks.

[Rick Segal]

Michael,
Thanks for stopping by.

PT/JLA are the initials of the firms and the 1.5 meant each of us taking half the deal.

1x liquidation, simple explain: In the case where the company is sold for 3 million we'd get our money back. In the case of the company being sold for, say 10 million, we convert to commons and get our share. No coupon means no interest and no participation simply means we don't get our money back AND then a chunk of profits, it is either you convert or you get 1x piece.

This is equity, not convertable debt.

I'll post a DD checklist shortly.

[Matt]

This is, beyond question, the single most informative post you've ever made about the VC process at your firm.

I expect it to be topped by the DD checklist, though. :)

Thanks much. Even the VC bloggers who talk substantively about process (and although I like you, I'm thankful that you're not the only one of those) never go into this level of detail.

[chrisco]

Excellent post except board structure is not so nice. Common and preferred should have equal number of board seats or roughly relative/proportionate to ownership percentage. Also need to make sure the "independents" are truly independent and not really aligned with one party or the other. Also need to anticipate / plan for what the board structure is going to look like AFTER Series B. And what happens if a new CEO is brought in or there are other changes in top management, founder, etc. Things like that. You want the board to start balanced and stay balanced. Cheers, chrisco

[anon]

Posts like these give entrepreneurs transparency into the process of venture capital. More importantly, these posts work to mitigate the myth that all VCs are bloodsuckers who are only looking out for their own interests. Bravo.