The Good, The Bad and TheFunded.

FFI Plain Preferred Term Sheet -

There has been quite an outbreak of rational behaviour in startupland in recent weeks, the gist of it being that a set of simplified agreements could be used rather than individual negotiations every time. This would save a lot of money in legal fees as wll as time and hassle. I was reminded of this via TechCrunch's post on TheFunded's Adeo Ressi's Sample Memorandum (see above). I have a few other articles on the spike about this too:

Firstly, Chris Dixon did an excellent summary of very common terms over here. The post is so good I've reproduced it entirely:

I have come to believe there is a clearly dominant set of deal terms. Here they are:

- Investors get either common stock or 1x non-participating preferred stock. Anything more than that (participating preferred, multiple liquidation preferences) divide incentives of investors and the entrepreneurs. Also, this sort of crud tends to get amplified in follow on rounds.

- Pro rata rights for investors. Not super pro rata rights (explaining why this new trendy term is a bad idea requires a separate blog post). This means basically that investors have the right to put more money in follow on rounds. This should include all investors - including small angels when they are investing alongside big VCs. There are two reasons this term is important 1) it seems fair that investors have the option to reinvest in good companies - they took a risk at the early stage after all 2) in certain situations it lets investors “protect” their investments from possible valuation manipulation (this has never happened to me but more experienced investors tell me horror stories about stuff that went on in the last downturn - 2001-2004).

- Founder vesting w/ acceleration on change of control. I talk about this in detail here. If your lawyer tries to talk you out of founder vesting (as some seem to be doing lately), I suggest you get a new lawyer.

- This stuff is all so standard that there is no reason you should pay more than $10K for the financing (including both sides). I personally use Gunderson and think they are great. Whoever you choose, I strongly recommend you go with a “standard” startup lawfirm (Gunderson, Wilson Sonsini, Fenwick etc). I tried going with a non-standard one once and the results were disastrous. Also, when you go with a standard firm and get their standard docs it can expedite later rounds as VCs are familiar with them.

- A board consisting of 1 investor, 1 management and 1 mutually agreed upon independent director. (Or 2 VCs, 2 mgmt and 1 indy). As an entrepreneur, the way I think of this is if both my investors and an independent director who I approved want to fire me, I must be doing a pretty crappy job and deserve it.

- Founder salaries - these should be “subsistence” level and no more. If the founders are wealthy, the number should be zero. If they aren’t, it should be whatever lets them not worry about money but not save any. This is very, very important. Peter Thiel said it best here. (I would actually go further and say this should be true of all employees at all non-profitable startups - but that is a longer topic).

- If small angels are investing alongside big VCs, they should get all the same economic rights as the VCs but no control rights. Economics rights means share price, any warrants if there are any (hopefully there aren’t), and pro-rata rights. Control rights means things like the right to block later financings, selling the company etc. I once had to track down a tiny investor in the mountains of Italy to get a signature. It’s a real pain and unnecessary.

- Option pool - normally 10-20%. This comes out of the pre-money so founders should be aware that the number is very important in terms of their dilution. Ideally the % should be based on a hiring plan and not just a deal point. (Side note to entrepreneurs - whenever you want to debate something with a VC, frame it in operational terms since it’s hard for them to argue with that).

- All the other stuff (registration rights, dividends etc) should be standard NVCA terms.

- Valuation & amount- My preference is to keep all terms as above and only negotiate over 2 things - valuation and amount raised. The amount raised should be enough to hit whatever milestones you think will get the company further financing, plus some fudge factor of, say, 50% because things always take longer and cost more than you think. The valuation is obviously a matter of market conditions, how competitive the deal is etc. One thing I would say is if you expect to raise more money (and you should expect to), make sure your post-money valuation is one that you will be able to “beat” in your next round. There is nothing more dilutive and morale crushing than a down round.

I also have the Venture Hacks analysis of option allocation, hat tip Christine.net

"To allocate the option pool from the hiring plan, use these current ranges for option grants in Silicon Valley:

Title Range (%)

- CEO 5 - 10
- COO 2 - 5
- VP 1 - 2
- Independent Board Member 1
- Director 0.4 - 1.25
- Lead Engineer 0.5 - 1
- 5+ years experience Engineer 0.33 - 0.66
- Manager or Junior Engineer 0.2 - 0.33

"These are rough ranges – not bell curves – for new hires once a company has raised its Series A. Option grants go down as the company gets closer to its Series B, starts making money, and otherwise reduces risk.
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"The top end of these ranges are for proven elite contributors. Most option grants are near the bottom of the ranges. Many factors affect option allocations including the quality of the existing team, the size of the opportunity, and the experience of the new hire."

Then there was Fred Wilson on the travails of Tranche Investing, which partly comes about because the transaction costs of any particular round are so high:

I agree with Chris that tranched investing is a bad idea all around. But first, let me explain how it works.

The entrepreneur will agree to raise a set amount of money, let's call it $3mm for a set amount of equity, let's say it is 25% of the company ($9mm pre, $12mm post). If it is three tranches, then $1mm will come in at the first closing and the entrepreneur will dilute 8.33% (1/3 of 25%). There will be a set of agreed upon milestones set in advance. Let's say tranche two miletstone is the shipping of a product and tranche three is the first contracted revenue for that product. When each of those milestones is hit, the investors will invest the second and third $1mm tranches and the entire round will be completed and the full 25% dilution will have been taken.

Let's be honest and see this as what it is. It's an option for the investor to put more money in at the old price as the investment increases in value and the risk is mitigated. It's a bad deal for the entpreneur and a great deal for the investor.

But as Chris explains, there are other problems with this approach:
Milestones change anyway: At the early stage you often realize that what milestones you originally thought were important actually were the wrong milestones. So you either have to renegotiate the milestones or the entrepreneur ends up targeting the wrong things just to get the money.

The idea that you are going to hard wire the key goals of an early stage company is nutty. The best entpreneurs weave and bob their way into the market, changing things as they go. Setting hard goals is a mistake early on in the life of a company.

You all know this blog well enough to know what we're thinking, right

Thats right - why now? Why, after all these years of VC handle cranking is everything being changed? Standardised T&C's, and even the worker bees getting some money early like at Facebook?

Some people hypothesize its the open nature of the Internet, information flows around so fast now that it will force transparency and homogeneity into the market. We think its much simpler than that - its about transaction and opportunity costs.

Transaction Costs

Simply put, Moore'Law seems to apply to startups too - at least it has since abput 2000 - ie every 2 years you can launch the same startup with half the money the last one needed. This means that after 8 or spo years they are starting up on 1/10th the costs of the dotcoms, so having £30,000 ($50,000) terms negotiations makes no sense - the transaction costs more than the company.

Opportunity Costs

Most startups aren't worth the wallpaper they buy after about 18 months, but some make a lot of money. Those are the nes every Funder wants. But, in a world of little differentiation between funders (everybody will introduce you to the right people, hire the right talent, yadda yadda), and the probable oversupply, one way to differentiate is to hand value back the entrepreneur. And instead of handing back the funders' stake, this way they hand back cash consumed in the early stages - gold dust to startups - while keeping stakes and valuations

Update - interesting discussion from VentureBeat on how, owing to a combination of lower cost to startup and nervous climate, "Seed" funding ($0.5 - $2m) is the new "Series A" ($2-5m) - but beware:

Many VCs will propose a seed deal using a Series A term sheet (whether by design or mere convenience), and this can end up costing the company much more than it bargained for. Here are some tips for entrepreneurs when negotiating seed deals (with the caveat that each deal is different, and rarely will an entrepreneur get their way in all of these categories):

- Don’t give away too much of the company too early. VCs shouldn’t expect more than around 20-40% of a raw start-up when investing seed-stage.
- Avoid giving investors more than a 1x liquidation preference, and try to ensure that it is “non participating” (i.e., after the investors’ preference is taken, all remaining proceeds are allocated only to the holders of common stock).
- Don’t give investors Series-A-type control rights. A VC should expect to receive one board seat, but not to control the board, following a seed financing. Also, while it is customary to give investors voting “block” rights on financings and on a sale of the company, entrepreneurs should avoid granting voting rights that give VCs blocks on operational matters at this stage.
- Keep other “investor rights” to a minimum. For example, try to avoid granting demand registration rights, ROFRs on founder stock transfers or drag-along rights.
- Many VCs will want a “super-pro rata” right in seed deals, giving the VC the right to increase its ownership percentage in the next round. This is not necessarily unreasonable, but take care to ensure that in agreeing to super pro-ratas the company is leaving room for a new VC to lead the next round.
- Beware of the negative market perception that results when the VC that seeded your company declines to participate in the Series A. This happens. Raise this issue with the seed VC early on to assess the risk of this happening, and always keep your communication channels open with other VCs interested in what you are doing.

On the other hand, Seed funding is far more risky, so the funder will require tighter safeguards......