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Angel Poison

I was helping an entrepreneur evaluate a term sheet recently.  He was very excited to have a Venture Investor leading his series A round, but as is often the case, the devil (or in this case poison) was in the details:

In the Investors Agreement

For purposes of the Section A, "Major Investor" means any Investor that holds at least ten percent (10%) of the shares of the Series A Preferred Stock or the Common Stock issued upon conversion thereof (subject to adjustment for stock splits, stock dividends, combinations, reclassifications or the like) originally issued to all Investors pursuant to the Purchase Agreement.  A Major Investor includes any general partners, managing members and affiliates of a Major Investor, including Affiliated Funds.

A._    Right of First Offer.  Subject to the terms and
conditions specified in this Section A._, the Company hereby grants to each Major Investor a right of first offer with respect to future sales by the Company of its Shares (as hereinafter defined).  For purposes of this Section A._, Major Investor includes any general partners, managing members and affiliates of a Major Investor, including Affiliated Funds.

madonna true blue download So "what is this all about?", he asked.  The thought that popped into my head was "angel poison".  Basically the Big Valley VC doesn’t want to share if this deal turns into a rocket ship, or their lawyer isn’t interested in chasing down a bunch of individual investors for signatures (which having done it multiple times, is in fact a pain in the neck).  Bottom line, unless you are a "Major Investor" you don’t get the guaranteed right to continue to invest in future rounds. 

What should the entrepreneur do. ?

daybreakers

1:  Ideally have multiple term sheets so you can quickly negotiate terms like this away.

2:  Have a frank discussion with the VC along the lines of:  "Look Mr. Big VC, my angel investors have been very good to this company.  I don’t expect most of them will play along in future rounds, but it really is kicking sand in their faces to tell them they can’t."   Regardless this dialog will tell you a lot about how your potential new partners are going to be to deal with down the road.  If they aren’t going to be unreasonable on a term such as this, you can bet on more difficult issues, they will be even more difficult.

3:  There are cases when a limit on future participation make sense, these primarily come into play when angels own a significant portion of the company when the first professional round is negotiated.  Nobody wants prior funding to block future rounds, this has to be worked out on a case by case basis, but requiring no participation is over the top.

The entrepreneur wanted to know what these "Affiliated Funds" were all about.  This is topic is worthy of a separate post, however the quick answer is most venture funds also have "side car" or "affiliate fund" where partners in the firm, and friends of the firm are committed to funding a portion of each of the fund’s investments (frequently with different internal economics which is why they are done in separate funds).  This arrangement doesn’t change the total committed capital a VC is putting into a deal, just provides a mechanism for meeting their contractual obligation to share an investment with their partners and friends… yes there is an irony here.

 

 

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