In the last edition of the Founder-VC series, we spoke about the aspect of Due diligence. Given that the VCs research has led to a yes, we will now delve into how we can close out the investment smoothly. We will touch upon negotiations between the Founder & VC, Understand better the documents that are being signed off on & How the Founder & VC plan to work together going forward!

Negotiations:

Valuations in the startup world are more or less dependent on the VC and the founder agreeing on the funding quantum and desired stake. No VC, whether they operate in the seed stage or Series A or finance growth rounds, uses techniques like the Berkus method or Scorecard Valuation method or First Chicago method or even anything resembling the DCF method.

How it works is like this: Angels / microVCs back idea-stage or near idea-stage startups to reach the stage at which a seed VC would fund them. The seed VC funds the amount that should propel the startup to reach the stage at which a Series A VC backs it. The Series A VC then funds them to get to the stage at which a Series B backs them; and so on till the IPO. Each stage has a funding amount (and a stake target) along with a rough set of qualifying criteria. Eventually, as the startup gets closer to listing, the valuations converge with those of similar listed entities.

Keeping this in mind, Negotiations can take place from a more qualitative headspace. We encourage founders to focus on:

1)     Understanding your leverage

2)     Maximizing trust

3)     Focusing on Value (not just valuation)

4)     Strive for collaboration

The Docs:

Term sheet:

A term sheet is a blueprint for the business deal. It’s usually the first real piece of paper an investor hands you upon deciding to invest. This document outlines the conditions for a particular investment. Lawyers frequently use the term sheet to draft legal documents to close the deal, though it’s not legally binding in itself.

Some vital parts of a term sheet include:

Funding – Stipulates how much money you’ll receive and what conditions you’ll be receiving those funds.

Corporate Governance – This portion outlines who’s in charge of the company; VC-friendly vs. entrepreneur-friendly stockholders can influence your company significantly.

Liquidation and Exit – These are also part of the economics of the deal; who gets what money upon an exit event

Negotiating conditions on the term sheet is a reasonably standard procedure for entrepreneurs and VCs to trudge through. However, you must fight for the right things. Otherwise, you may end up feeling duped or extinguishing the deal altogether.

Founder’s Agreement

A Founders Agreement is a legal contract that governs the business relationships between the founding team. should provide a framework for the relationship between the company’s founders, outlining their respective rights, obligations, responsibilities, and liabilities. It also provides a roadmap for decision-making and conflict resolution.

Key clauses:

·        Intellectual property – A clear description of the IP; who owns it?  

·        Transfer of ownership provisions – Is there a lock-up provision, or can founders transfer shares immediately? Is there a right of first refusal? How will the Foundersexits be governed?

·        Intellectual property – A clear description of the IP; who owns it?  

·        Transfer of ownership provisions – Is there a lock-up provision, or can founders transfer shares immediately? Is there a right of first refusal? How will the Foundersexits be governed?

Shareholder’s Agreement:

A Shareholders Agreement is a legal document that outlines the rights, responsibilities, and obligations of the shareholders of a company. It is usually longer and more complex than a Founders Agreement and is put in place typically at the time a start-up issues shares to external investors.

Key clauses:

·        A Right of first refusal gives the holder a priority right to buy or refuse to buy any existing shares from another shareholder before that shareholder can sell to a third party. It is closely related to a Right of First Offer, meaning the shares must first be offered to the holder of the right of first offer before it can be offered to anyone else.

·        Drag-along rights allow majority shareholders to force minority shareholders to sell their shares to the same buyer on the same terms as agreed to by the majority shareholders. Drag-along can be an important right to ensure that a minority shareholder does not block the sale of the company.

·        Tag-along rights give minority shareholders the right to “tag along” when shareholders want to sell their shares. So, when shareholders propose to sell their shares to a third party, the investor with a tag-along right may also sell a portion of their shares to the same buyer at the same price.

·        Anti-dilution rights are an example of an investor protection clause. It protects investors from excessive dilution of their shareholding in follow-up fundraising rounds when you raise funds at a lower valuation and issue new shares at a lower price than the investor paid. It allows investors to maintain their ownership percentage when new shares are issued. Anti-dilution rights can grant the investor additional shares for free or allow the allocation of proceeds to be adjusted upon an exit.

Roadmap:

Until the deal is closed, both the founder and VC assess if this is the right fit. However, it's crucial to acknowledge the company and all its stakeholders such as employees, customers, suppliers, and the community around it, as they are an important part of the VC/founder relationship. Once they are partnered up, it's vital to collaborate effectively to build the company they envision and work together to achieve their common goals. This relationship will start by brainstorming ideas on how to best use the funds raised by combining the founder's vision with the expertise of an experienced investor.

But there are times when interests diverge and what is best for the Company and its stakeholders may not be what the Founder and VC agree upon. This creates a conflict situation and VCs are often caught in the middle of it.

We will explore this relationship further as we continue our Decoding VC series by sharing our approach to working with the founders we have invested in and the best practices to ensure a productive relationship between the founder and the VC.