[Editor’s note: Ted Wang is an attorney at Silicon Valley law firm Fenwick & West. Disclosure: VentureBeat is a client of Fenwick’s, though does not have a relationship with Ted.]
The release of our firm’s Trends in Terms of Venture Financings shows that this remains a strong market for entrepreneurs to raise venture capital. The survey finds that valuations have continued to increase, while some tough terms negotiated by venture capitalists such as multiple liquidation preference and “ratchet” anti-dilution remain comparatively rare.
There is, however, a danger that the current climate is encouraging entrepreneurs to go too far. We are increasingly hearing requests for odd-ball terms such as very short vesting schedules (2 years?!) and founders’ protective provisions that recall the heady days of the Bubble.
In my opinion founders should resist the temptation to think outside the box with respect to the terms in their founders’ agreements and financing documents. Obviously, valuation and liquidation preference are key areas of negotiation, but for other areas I am a strong believer in plain “vanilla” terms.
If the market is good, why shouldn’t founders get the best terms that they can? My rationale is as follows:
â€¢ Standard venture financing terms represent a compromise between investors and entrepreneurs that is informed by years of experience.
â€¢ Developing and negotiating unusual terms is a waste of a company’s two most precious resources, time and money. Unique terms are highly unlikely to provide any return on investment and are certainly not correlated to the potential success of the enterprise.
â€¢ With respect to founders’ vesting, the people who build the company are the most likely to be the ones who lose out with “creative” vesting schedules. Most founders think about how to protect themselves from being ejected by VCs, however, the vast majority of the time, it’s the founders who get rid of one another when someone is behaving badly or not pulling his or her weight. With aggressive vesting, this can result in an ex-founder owning a huge chunk of stock, while the remaining founders work like dogs to make it valuable.
Someone out in the blogosphere has surely already begun typing, “Fenwick represents Kleiner, Sequoia and others and you’re just a shill for the VCs. Founders should get what they can, when they can!”
In response, I note first that the vast majority of my clients are on the company (as opposed to the VC) side. Second, and far more importantly, this is the same advice I give to my company clients. It may seem counterintuitve not to push for the “best” terms, but in my experience the marginal value of improved terms is not worth the investment in time and effort required to incur such gains.
This is an excellent time to form a start-up and raise venture capital. Use standard vesting, get a good valuation with a low liquidation preference and spend your time and effort building a great company.
VentureBeatVentureBeat's mission is to be a digital town square for technical decision-makers to gain knowledge about transformative technology and transact. Our site delivers essential information on data technologies and strategies to guide you as you lead your organizations. We invite you to become a member of our community, to access:
- up-to-date information on the subjects of interest to you
- our newsletters
- gated thought-leader content and discounted access to our prized events, such as Transform 2021: Learn More
- networking features, and more