Venture

An inside look into a venture negotiation

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Alex Rosen

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Alex Rosen is managing director at Ridge Ventures.

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Even after thousands of published articles about venture trends, hundreds of public pitch decks and numerous investor-penned “why we backed X company” memos, the actual negotiation of venture rounds remains unnecessarily murky. First-time entrepreneurs who have never fundraised are often at a loss for mapping the business values they hold to specific terms during a negotiation. Moreover, many wonder what terms even come up for discussion and why VCs and entrepreneurs may care about a particular term, but barely mention another.

So we (Auren Hoffman, a 6x repeat entrepreneur, founder and CEO of SafeGraph and angel investor in dozens of companies, and Alex Rosen, a longtime investor and founding partner of Ridge Ventures) decided to provide a deeper look into a specific financing round with perspectives from both sides of the table. What were the dynamics and the terms discussed, and which ones evolved into points of negotiation? We hope this serves as a helpful case study for aspiring founders.

In any dynamic of this kind, it’s important to set the context. SafeGraph recently raised a $16 million Series A from Ridge Ventures and individual investors. At the time of financing, the company already had a few customers and a compelling product vision. We were acquaintances who knew each other for more than a decade but who had never worked together directly. Auren knew entrepreneurs that Alex had backed, and Alex knew investors who had backed Auren, so there was evidence of character and track record on both sides. Both of us came into the discussion with deep relevant experience: SafeGraph is Auren’s sixth company and Alex has invested in four dozen companies, including several other data-intensive businesses.

Auren was seeking a fairly untraditional Series A investment structure, and he knew that Alex and his partners at Ridge Ventures had a reputation for flexibility.

Here’s how each of us saw the process, what we cared about and how we closed the deal.

The pitch and initial thoughts

Alex: Auren reached out and we scheduled a time for him to come to our offices within a week. I liked the company idea immediately. I also liked the fact that SafeGraph already had a few paying customers. We provided a term sheet within 24 hours of Auren presenting to us, which is fairly unusual. Also unusual was the length of the term sheet (about three pages). I wouldn’t have thought that important 15 years ago, but simplicity and speed have become more significant over time. Also, we didn’t put a deadline on the term sheet. We operate with the understanding that if a term sheet is going to be presented we’re still going to invest, whether that’s in one week or six. The fundamentals won’t change in that time and that’s what matters most.

Auren: We really appreciated how Ridge Ventures moved quickly and remained flexible. They got our business immediately due to their extensive experience with data businesses.

Ownership

Alex: I cared that we invest at a fair price and that we had meaningful ownership of the company. That does not mean we wanted a huge percentage — we’re talking under the “typical” 20 percent. We knew that Auren wanted to maintain a meaningful amount of control over his company, which was fine with us since were betting on him.

Auren: The fact that Alex and Ridge were flexible on ownership percentage was a big point in his favor. Given that we wanted to sell into a wide variety of verticals, it was important for us to bring a large number of strategic individuals who could introduce us to target customers. We were doing an untraditional investment in that we were looking to add 100 individuals as investors in the A round. In fact, some VCs balked at the idea because it impacted their percentage of ownership. Alex’s flexibility opened the door to us both courting those individual investors while also having a VC partner.

Valuation

Alex: A number of factors contributed to what I felt was a high starting valuation: SafeGraph is in an interesting space, Auren is a highly successful repeat founder, they had attracted paying customers very quickly and the company was in a similar space as previous businesses Auren had built, so we knew he understood it well. I have learned over the years that an extra 20 percent in valuation will not matter in a bad investment, but it can make a difference in being a good one. We also knew there was a lot of enthusiasm from other investors.

Auren: Valuation was actually of low importance to me. That’s something that may surprise other founders, but my goal is always for our investors to do super well and valuation is not that important with that in mind. I’m happy to give up a few percentage points for a better long-term outcome. One thing I do care about in the term sheet is the clause around legal fees. Lower legal fees tend to speed up a transaction dramatically.

Alex: The most important part of these negotiations is that neither party felt squeezed by the other, which can erode trust or make it feel like the other party is being greedy. Funny enough, the valuation probably ended up higher than where both Auren and I thought it would be.

Investment size

Alex: We wanted to invest in the range of $3 million-$6 million, which is our sweet spot given the size of our fund and the ownership range we like to have.

Auren: We wanted to raise about $16 million in equity, leaving a lot of room for individuals. This resulted in $5.5 million from Ridge, $2 million from me and $8.5 million from individuals. There were no major disagreements here, but there was a lot of interest, so we did unfortunately have to cut some individuals from the round.

Option pool & liquidation preference

Alex: At some level, the option pool is a valuation issue, and at another, a future ownership issue (issuance of options dilutes investor ownership, which you cannot buy back). We believe making the Series A as simple a structure as possible, so we proposed 1x non-participating preference, which is the most common.

Auren: We were aligned on liquidation preference and the option pool.

Board members

Alex: We typically take a board seat with our investments, though sometimes we come on just as a formal observer. As the only institutional investor in this round, we definitely wanted a board seat. Typically, the VC firm has the right to designate the board seat to whomever they want.

Auren: We expected to give one investor board seat, and wanted that seat to be specifically occupied by Alex. So, in this case, we pushed for an extra provision that should Alex be unable to serve, his successor needs to have “reasonable” approval from common shareholders.

Approval rights

Alex: When I started as an investor, approval rights on corporate transactions, big and small, were a big deal. These days, I think flexibility and working with the right entrepreneur, at a fair price, is much more important than ultimate control.

Auren: We are aiming to build a multibillion-dollar company that will hopefully eventually go public, so we did not negotiate hard on approval rights.

Information rights

Alex: Here’s a surprise: Not all startup founders and CEOs deliver annual and quarterly financial statements and annual budgets. This is super important to us for information transparency, and we actually like to have that in the term sheet.

Auren: Alex had no idea how organized we are on this one! No arguments here.

Pro-rata rights

Alex: It’s not just customary, but really important to have pro-rata rights on future issuance of stock. At Ridge, we like having the option for “overallotment rights” so we can maintain our ownership levels at later stages of financing.

Auren: I’m more than happy to have the existing investors maintain their ownership. Again, I want to see our early investors do well; they backed us early, after all.

Hopefully this serves as a useful case study for other founders and investors. We’d like to see more entrepreneurs and VCs document the terms and aspects of fundraising they care about (or dislike) most, leading to greater transparency, better experiences and faster learning within the industry.

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