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Category — Venture

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. ?


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.



May 12, 2008   No Comments

Venture Pattern Matching

Denzel Washington Eli

Venture bloggers occasionally write about our process,  This post continues on the theme, how do VCs really make decisions that result in investing in a company.

A core trait of human nature is pattern matching past experiences to predict future experience. Listening to Blink by Malcom Gladwell, on the way to and from skiing last weekend may be partly responsible for this post. When talking with my partners or potential syndication partners it is very common to define a deal in terms of comparative references. Company X, has a similar model to company A and we all know how that turned out… Whenever we evaluate an investment opportunity we are constantly pattern matching to our previous experiences (25 deals over 12 years) and countless (100s) of deals that we didn’t do, including a number we wish we had.

Don’t worry if your deal does or doesn’t fit the patterns of a particular venture investor.  Patterns don’t govern if an investment will be made, sometime themes do but that is a different topic.   Patterns can provide you with a convenient way to harvest valuable experience.   In the give and take discussion, explicitly ask "does my proposal pattern match, positively or negatively on other deals you have been involved with".  My prediction is you will learn things that will help your business regardless of the outcome of any particular investment discussion.   If you keep hearing about the same problem or challenge to the model or strategy you are pursuing you will have learned something very important.

daybreakers download A CEO of a recent potential investments was presented with a challenge by the input our patterns provided. If his deal follows the patterns we have seen in a number of similarly structured companies, we expect that it will take twice as long to meet his projections and take considerably more money to attain his goals then he currently is planning to raise. This of course puts the CEO in a difficult spot.  Going to other potential investors and saying "hey these guys think it is going to take twice as long and cost twice as much", is a problematic fund raising strategy. By asking leading questions in future investment discussion the CEO can validate or not the issues raised in our meeting.

The irony in this discussion is we passed on the deal with the strongest pattern match in the set, it took twice as long, it cost twice as much and handsomely rewarded early investors…

March 19, 2008   No Comments

Bridges to Nowhere

Bridge notes can provide investors with a discount in exchange for putting up money along the way to a major financing. Bridge notes can allow an individual or small fund to get into a deal when there might not be room in a round being funded by larger institutional investors. Bridge notes leave price negotiations to independent (often times angel investors personally know the entrepreneur) experienced investors. I have recently been asked to evaluate two investment opportunities that came from friends who are active angel investors. As is common, both of these deals were structured as bridge notes. Both of these deals suffered from the condition we call “A Bridge to Nowhere”.

Like the famous Ted Stevens earmarked bridge in Alaska, a bridge to nowhere can cost a lot of money with the added pain it is your money, not just some tax payers from the lower 48.

Bridge to Nowhere Symptom #1: Not Enough Capital Being Raised

Every investment round should have enough money in it (with buffer for unanticipated shortfalls) to fund a company to the next funding milestone. This is not a precise science. There are many ways these milestones can be cast, but regardless they need to be able to answer positively the question “will the accomplishments be sufficient” to motivate new investors to join the party. In a company without professional investors, this can be a big hurdle. This involves real on the ground accomplishments (beyond spending the cash on hand). Putting 1M into a deal that is going to require 5M – 8M to generate enough traction to attract a deep pocketed professional investor isn’t wise.

Bridge to Nowhere Symptom #2: Terms That Spoil the Deal

We have always been advocates of using the cleanest term sheet possible. Avoid special preferences, ratchets, punitive clauses we are definitely out of the build the company and good things will follow school of investing, others make good money by financial engineering.

Bridge to Nowhere Symptom #3: A Badly Priced Round

This one is a bit of an oxymoron, but bear with me. We recently saw a deal where the company had set a price for a small angel round. The price was, needless to say, very company friendly. This has bridge qualities, these funds will carry the company until it needs a larger professional round or the company becomes self sustaining. This next round has four potential pricing outcomes:

  1. No additional funds are needed. The angels now own a small illiquid piece of a small business.
  2. All is incredibly great and new investors are willing to do an up round.
  3. More money is raised at the current price, which means todays money overpaid.
  4. The only way to raise money is in a down round. Down rounds are bad for the current investors and cast a negative light on the company.

Is it ever prudent to invest in a bridge round. Absolutely.

  1. When the funding source for the next round has been identified and has a high likelihood of completing the deal.
  2. When there are deep pockets already at the table who believe in the deal and are willing to continue funding the company.

As a smaller fund, we frequently take bridge positions so we have a seat at the table. Good deals are a bit like musical chairs and small $ tend to get shoved off the last chair by bigger dollars.

February 2, 2008   1 Comment

The Chair, Coaching CEOs and Managing BODs

Seth Levine from Foundry Ventures in Boulder wrote a post a week back or so <Link> as a primer on how to do CEO reviews. In the comment stream the question was asked, who should deliver the review? In my experience this is best done by the Chairman/women of the board, aka the Chair. In my experience the Chair can provide a key mentoring and organizing role that makes a CEO’s job easier.

A few challenges:

  • Boards aren’t always as effective as we would like. Agenda’s can conflict, personalities can be, well personalities.
  • Boards sometimes need to be managed. Agenda’s organized, difficult issues broached. CEOs and particularly first time CEOs need help with these challenges.
  • CEO’s need feedback more frequently then annual performance reviews. A best practice that we use is to always have an executive session at the end of every board meeting, without the CEO, followed by one on one feedback to the CEO.

An active, involved, seasoned Chair can provide a key role across these challenges. The Chair can help the CEO before meetings sorting out the agenda, in the meetings by running the agenda and after the meeting in providing feedback from the executive session. This helps the CEO organize the meeting beforehand. Insures the CEO is focused on the content during the meeting. After the meeting the Chair should provide post meeting feedback to the CEO and begin the planning process for the next meeting. The pattern makes it completely natural for the Chair to be in charge of the annual CEO performance review process.

January 27, 2008   1 Comment