When I first started as a startup CEO in 1999 there were no guides on raising venture capital. There were no explanations for all of the confusing details outlined in a term sheet.
Drag along rights? Um, OK. That sounds fine to me. I barely understood it. I asked my lawyer for an explanation. He gave me the human explanation for what the term meant. It sounded logical enough, so I moved on to the next point. Only later did I learn how it could be used to screw me.
Redemption rights? Sounds harmless enough. But know that every term in your term sheet is there as a result of some dispute of the past between shareholders or between shareholders & management. Founders don’t often think about “primary” stock vs, “fully diluted” stock in terms of voting rights. I never did. VCs always know the voting thresholds and no number in your term sheet is there by accident.
To this day I’m still surprised how few CEOs really understand the differences between 2x liquidation preference and a liquidation preference with a 2x cap. Or what “participating preferred” stock is and how it can screw you. Or what “flat spots” on a cap table are.
If you want to see a quick summary of some terms & a video that walks you through how VCs view a cap table my colleague Kelly Hwang & I produced a quick tutorial here:
In fact, some of the biggest surprises I learned about term sheets were:
1) how the language never says anything remotely like “blocking rights” for terms that VCs want to use to block certain actions of your company. Liquidation preferences never say things like “participating preferred” although we all talk about it. It’s hidden in legal language. Blocking rights and liquidation preferences exist for rational reasons and when used properly are fair. Used egregiously and you’ll have problems later. You need to understand them.
2) how seldom lawyers walk you through the “how can this term be used against you” scenarios or the “pragmatic guide to VC terms” overview. They are helpful, certainly, but often if you don’t know the right questions to ask you’ll be left unawares.
3) VCs are anal about things like voting thresholds, seniority of their stock, protective provisions, etc. – entrepreneurs never seem to focus on anything other than ownership percentage.
I was significantly wiser by 2005 when I started my second company. Even so, I found myself reading Feld.com every day. I think that’s around the time when Brad & Jason did their famous “term sheet series,” which was the authoritative guide I never had the first time. I read every post several times.
This series inspired me to start my blog as a VC. I also decided never to spend much time on term sheets on my blog because they had already covered it far better than I thought I ever could (Jason was a lawyer with Cooley Godward, one of the top VC law firms, after all).
From there VentureHacks was then launched which gave entrepreneur advice on fund raising from your point of view. It is also a must read.
Now Brad & Jason have raised the bar. They’ve written this comprehensive book called Venture Deals that should be read by anybody dealing with funding of startups – whether you’re a startup CEO, CFO or other founder or whether you work in the ecosystem (lawyer, debt provider, banker, VC). It goes far beyond any other book I’ve seen on the topic in helping you understand the key terms, plan the negotiation and understand the motives of the various actors at the table.
It’s a gem. I think the industry works better when all sides are informed. The fact that Brad so routinely puts out information like this is what earned him the number one spot on this list of VCs that entrepreneurs most respect. And while Jason is less high profile as the ever-present Brad Feld, I think even Brad would acknowledge that when it comes to the knowledge supplied in a book like this, Jason is the man with the deep knowledge.
Let’s get rid of the information asymmetry problem. Every startup needs the knowledge in this book.