(Editor’s note: Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs. He submitted this column to VentureBeat.)
A reader asks: My co-founder and I are about to approach VCs for funding for the first time. We’re both first-time entrepreneurs and don’t want to make any rookie mistakes. What are some of the common missteps you’ve seen guys like us make dealing with financiers?
Answer: You’re always at a disadvantage when dealing with the venture capital community, since their experience almost certainly outweighs yours. But there are ways to can go into the negotiations prepared. Here are five quick things that startup owners often get wrong:
Cold Calls. One of the classic rookie mistakes is cold-calling or emailing a VC you don’t know personally. In short, you’re wasting your time. The best way to get a meeting with a VC is through a “warm” introduction – that is, an introductory phone call or email from a middleman (or woman) whom the VC respects and trusts.
The ideal middleman is a successful entrepreneur whom the VC has backed; other investors can be good middlemen – and lawyers or accountants may also be helpful.
Homework. Startups often make the mistake of not doing their homework when talking with VC firms. Even before you get an introduction, do some research and figure-out which VC firms are a good fit for your startup. This can be based on a number of different factors, including their space/industry focus, their investment criteria, their fund size, their geographic focus, their “sweet spot” and their track record.
It’s also wise to learn as much as you can about the particular partners with whom you are interested in working, including determining their reputation, character, domain expertise and capacity to take-on a new deal.
NDAs. Rookies often ask a VC to sign a Non-Disclosure Agreement (“NDA”). It ain’t gonna happen.
VC’s are inundated with business plans and executive summaries and are constantly talking to entrepreneurs whose ideas may be similar to yours. There is no way a VC is going to risk getting sued as a result of funding a startup with a similar idea or business plan to yours. Moreover, they would need to hire a lawyer to review and negotiate NDA’s – which from their perspective is a waste of time and money. To the extent you have any “secret sauce” or proprietary technology that you’re concerned about disclosing, you should just not share it with the VC.
Valuation. Startups often focus too much on valuation. Obviously, the pre-money valuation (or “pre” as it is commonly referred to) of the company is an important deal term. However, inexperienced startups make the mistake of obsessing over pre – and will often a sign a term sheet with the VC firm that gives them the highest pre.
This is the wrong approach for two significant reasons. First, there are other important terms that affect the economics of a financing, including the size of the option pool and the liquidation preference. Also, a top-notch VC firm (like a Sequoia) can add extraordinary value to a venture. Thus, even if those firms come in with a lower pre than another VC, a smaller piece of a huge pie is better than a bigger piece of a little pie.
Negotiations. Rookies often make the mistake of trying to negotiate VC term sheets (or some of the key investment terms) without having spent the time to fully understand them and/or retaining strong, experienced counsel. Term sheets are complex and a potential minefield for first-time entrepreneurs. Moreover, VCs spend their careers negotiating term sheets and know every term (including every nuance) inside out.
Accordingly, startups need to be smart (and demonstrate a certain level of credibility with the VCs) by getting a good corporate lawyer involved early on, among other things, to coach and prepare them for their preliminary negotiations with the VCs.
Startup owners: Got a legal question about your business? Submit it in the comments below or email Scott directly. It could end up in an upcoming “Ask the Attorney” column.
Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.
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