Tips On Venture Capital Deal Terms ? Part Two
Article by Alvin Donovan
I will be discussing Venture Capital Deal Terms from two different perspectives, Business Venture Capital and Angel Funding. As I go through each subject below I will point out the nuances of dealing with each type of investor. Some of the differences are minor others are significant.
Keep in mind that not all investors fit the same mold. There are great differences in deal structures from one Angel investor to the next, and likewise with VC firms.
1. Term Sheet. At the end of your Business Plan you may want to include a Term Sheet with the Deal Terms that your Management Team is comfortable with. Better to include the Term Sheet when you are talking with Angel Investors. It is not necessary to include one when dealing with a Business Venture Capital Firm. They will usually dictate the terms and financing structure anyway.
Investors will not commit to a Term Sheet without conducting due diligence. So don?t try to get them to commit, just use it to weed out investors who may waste your time. Try to prevent potential investors from conducting extensive due diligence on your company, for their own benefit. For instance, maybe they funded one of your competitors and are simply on a fishing expedition.
If your company has been operating you need to determine its book value. Ask your accountant to help you with this. Then offer Angel investors a percentage based on the book value and the amount of funding you are seeking.
If your company is a pure start up then focus on the percentage of the company you are willing to sell for X dollars, rather then a number of shares. Your Management Team needs to be in agreement on what they are willing to give up if they get the full amount of funding they are looking for.
Here are some questions the Team needs to agree on:
Will they give up voting control?
Will they agree to accept another Director to the Board?
Will they agree to the funding being secured by all the assets of the Company? Will they agree to an anti-dilution clause?
Will they agree to a reverse merger and become a public company in six months?
2. Anti-Dilution Clauses. If the Management Team feels that strongly about its business model or the company?s revenue potential, offer investors an ?Anti-Dilution? clause. I would not offer it to a typical Angel Investor unless it was able to close the deal and get you the funding. In other words, use it as a carrot to close the deal.
On the other hand, most Venture Capital investors that provide the first round of financing will probably demand an Anti-Dilution clause. If you offer it first, it will show your confidence in carrying out your business plan and achieving success.
Don?t put it in the Term Sheet though, hold it until you are fairly certain they may fund. Then you can offer it, or at least not be so surprised, when they require it for investment protection.
3. Super Preferred Stock. Use a Super Preferred Stock issuance to give your Management Team voting control. If a Venture Capital firm requires majority stock ownership, you may be able to maintain voting control. Make the Super Preferred non-convertible into common stock.
It works something like this: Management would own 1,000,000 shares of preferred stock with voting rights of 20 votes per share for 20,000,000 votes. So if management owns 4,000,000 shares of common stock, but Angel investors own 6,000,000 shares, management still controls the company. The preferred stock holders would be entitled to vote on any matters on which the common stock holders are entitled to vote. This would include electing the Board of Directors, increasing the number of shares authorized and other corporate governance matters.
If the investor does not like the idea of the super preferred you can always discuss their concerns. Maybe they are worried that Management may increase the number of directors or drastically increase the number of common shares, thereby diluting the investor in a second round of financing. You can always ?carve out? or limit the use of the Super Preferred.
About the Author
Alvin Donovan, Institutional investor partner substantial funds, bestselling author, hedge fund industry pioneer, completed several billion dollars transactions, consultant to fortune 500 companies, faculty member most of the world?s largest management institutes, raised over USD.5 billion for funds
http://www.alvindonovan.com
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