๐ฆ๐ฒ๐ฎ๐ฟ๐ฐ๐ต๐ถ๐ป๐ด ๐ณ๐ผ๐ฟ ๐ฐ๐ฎ๐ฝ๐ถ๐๐ฎ๐น? You may want to think twice about it. As I tell every new entrepreneur, do everything you can to avoid getting investors with your new company. If you truly believe in your idea I recommend bootstrapping, a bank loan, or friends and family before getting involved with Venture Capital.
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Before I dig in, I want to start by saying, not all VCs are bad. In fact, the right one will help you make connections, find new customers, and help you grow professionally in ways you canโt even imagine. VCs like Sequoia, Benchmark, and Andreessen Horowitz are the firms that entrepreneurs dream of working with. However, these VCs are very hard to get into. You basically need to have deep connections or have fame already. Just like the music business, itโs best to make your own fame by truly hustling, building your awareness, and getting sales on your own. Only then will the famous VCs call you. Now for the lesson. ๐
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๐๐ฒ๐ฟ๐ฒโ๐ ๐ต๐ผ๐ ๐ฉ๐๐ ๐ฐ๐ฎ๐ป ๐๐ฐ๐ฟ๐ฒ๐ ๐๐ผ๐:
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๐ ๐ฃ๐ฎ๐ฟ๐๐ถ๐ฐ๐ถ๐ฝ๐ฎ๐๐ถ๐ป๐ด ๐ฃ๐ฟ๐ฒ๐ณ๐ฒ๐ฟ๐ฟ๐ฒ๐ฑ, ๐๐ถ๐พ๐๐ถ๐ฑ๐ฎ๐๐ถ๐ผ๐ป ๐ฃ๐ฟ๐ฒ๐ณ๐ฒ๐ฟ๐ฒ๐ป๐ฐ๐ฒ๐
Participating preferred stock is a type of preferred stock that gives the holder the right to receive dividends equal to the normally specified rate that preferred dividends are paid to preferred shareholders, as well as an additional dividend based on some predetermined condition. Example of Participating Preferred Stock: Suppose Company A issues participating preferred shares with aย dividend rateย of $1 per share. The preferred shares also carry a clause on extra dividends for participating preferred stock, which is triggered whenever the dividend for common shares exceeds that of the preferred shares. If, during its current quarter, Company A announces that it will release a dividend of $1.05 per share for its common shares, the participating preferred shareholders will receive a total dividend of $1.05 per share ($1.00 + 0.05) as well. Now consider a liquidation event. Company A has $10 million of preferred participating stock outstanding, representing 20% of the companyโs capital structure with the other 80%, or $40 million, made up of common stock. Company A liquidates, and the proceeds are $60 million. The participating preferred shareholders would receive $10 million but also would be entitled to 20% of the remaining proceeds, $10 million in this case (20% x $60 million โ $10 million). Nonparticipating preferred shareholders would not receive the additional consideration. (Source: Investopedia). VCs can also set a multiple on a โLiquidation Preferenceโ. This means a VC can specify which investors get paid first and how much they get paid in the event of a liquidation event, such as the sale of the company. Iโve seen some at a 3x multiple, which means that the investors are guaranteed to get 3 times their investment back before you get anything.
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๐ฅ ๐๐น๐ผ๐ฐ๐ธ๐ถ๐ป๐ด ๐ฎ ๐ฆ๐ฎ๐น๐ฒ
This is a biggie and happened to me personally in one of my companies. You need to understand that VCs only care about one little acronym I.R.R. (investor rate of return). They donโt care about you, your family, your employees, your customers, or your company. Their sole measurement is how much their entire fund returns for the limited partners (their investors). VCs seek BIG wins because many of their businesses fail. Typically they like to get at least a 10x return on their investment. So, if you get $1M in funding, they want $10M when you sell. So the bar quickly gets set pretty high for what they are willing to accept as an exit amount.
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๐ฅ ๐ ๐ฎ๐ป๐ฎ๐ด๐ฒ ๐ฌ๐ผ๐๐ฟ ๐๐
๐ฒ๐ฐ๐๐๐ถ๐๐ฒ ๐ง๐ฒ๐ฎ๐บ
Most investments have provisions of who you can hire and fire on your management team. Many even include limits on how much you can pay for your talent, etc. While these are meant to protect the VCโs investment dollars, they can also be a huge pain in the ass. Imagine youโre interviewing for a new VP of Sales (like I was) and not only does the candidate need to interview with you and your management team, but also your investors who know nothing about your business or industry, yet have very strong opinions on who they like with zero facts to back up their choices. Additionally, imagine that you hired the wrong person on your management team and you desperately want to make a change but the investors wonโt let you terminate that person. VCs can take over total control of your hiring process and it can hurt your company.
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๐ฐ ๐๐ฒ๐๐๐ถ๐ป๐ด ๐ฌ๐ผ๐ ๐๐น๐ฒ๐ฒ๐ฑ ๐๐ฟ๐, ๐ง๐ต๐ฒ๐ป ๐ฆ๐ฎ๐๐ฒ ๐ฌ๐ผ๐
Getting money from a VC is great for growing your company, but it can also be bad. I was often called a โfiscally conservative CEOโ by my investors because I spent our money more cautiously than they wanted me to. When you get funded, the investors want you to grow quickly. Their main goal is to increase revenue (in some companies itโs users) as fast as you can, then get acquired for multiples of your revenue before you run out of cash, period. Most VCs donโt care about being profitable, which didnโt sit well for me as a Midwest CEO. I have seen many companies spend their money as fast as the VCs have instructed them to do so and then let them run out of money. When the company is down on its knees, the VC will offer a loan, convertible note, or a bridge round to โsave the companyโ. Although they act as if they are doing you a favor, they will often cut your valuation in half and pick up much more of your company in your time of need.
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๐ต ๐ง๐ฟ๐ฎ๐ป๐ฐ๐ต๐ฒ ๐๐๐ป๐ฑ๐ถ๐ป๐ด
In my experience, this typically happens with Series A rounds only. In a tranche deal, VCs will agree to give you your investment amount, letโs say $1.5M, but want to fund you in stages. So you get $500k now, $500k once you hit the milestone, etc. Donโt be so desperate to take this type of deal. If you fail to achieve the agreed-upon goals, they could take a larger percentage of your company OR let you bleed dry (see above). Iโve fought and WON this approach a few times with investors in the past just by telling them โno thank youโ and that a tranche deal will force us to spend more cautiously. If we fear losing money, weโll not use the funds aggressively and wonโt grow according to our plan. They hate slow growth, so both times, my companies were fully funded and away we went.
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๐ ๐ฉ๐ฎ๐น๐๐ฎ๐๐ถ๐ผ๐ป
If you value your company too low, you get diluted quickly. But if you value your company too high, you might never hit the I.R.R. your VC is looking for and will never see an exit for yourself or your shareholders. Make sure you really believe that you can hit your numbers. VCs have several ways of punishing your performance by taking additional equity, reducing your salary, and even firing you, yes you, if things donโt work out. Always under promise and over deliver on your sales/growth plans.
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๐ฅ ๐๐ถ๐ณ๐ณ๐ฒ๐ฟ๐ฒ๐ป๐ ๐ฆ๐๐ผ๐ฐ๐ธ ๐๐น๐ฎ๐๐๐ฒ๐
In one of my companies, I had decided to sell my stock to a private equity firm. Now, I was aware of Preferred Stock, Common Stock, Warrants, and Options, but I did not know that VCs could create different classes of stock within those investments. So the VC who bought my stock wanted to create a Preferred A2 class stock which would grant them more rights than Common shareholders (i.e. my dad who helped me get started) but would be less rights than the Preferred A guys (the big VC firm). Be aware of your VCโs ability to create additional classes of stock without your approval. It can ultimately screw over your original investors and thatโs just not cool.
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๐ธ ๐๐ฑ๐ฑ๐ถ๐๐ถ๐ผ๐ป๐ฎ๐น ๐๐ถ๐น๐๐๐ถ๐ผ๐ป, ๐๐ฒ๐ฏ๐, ๐ฃ๐ผ๐ถ๐๐ผ๐ป ๐ฃ๐ถ๐น๐น๐
There are tons of ways VCs can write additional ways of controlling your company into your term sheet. VCs can issue additional stock if you fail to hit any of your promises. I remember one of our first funding rounds where we had about $150,000 in outstanding debt. We told the VC that we could โprobably pay off that debt within a yearโ. Well, they held us to it. In fact, we had to get rid of it all within a certain time period or they would receive an additional equity stake in our company. Surprisingly, my co-founder negotiated almost all our debt to zero within the first 14-days of getting funded. I think the VC was shocked we were able to pull that off. We saved ourselves a lot of equity. There are also โpoison pillsโ that can be written into deals. According to Investopedia, there are two types of poison pills: 1. A โflip-inโ permits shareholders, except for the acquirer, to purchase additional sharesย at a discount. This provides investors with instantaneous profits. Using this type of poison pill also dilutes shares held by the acquiring company, making theย takeoverย attempt more expensive and more difficult. 2. A โflip-overโ enables stockholders to purchase the acquirerโs shares after theย mergerย at a discounted rate. For example, aย shareholderย may gain the right to buy the stock of itsย acquirer, in subsequent mergers, at a two-for-one rate.
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5 ๐๐ฒ๐ ๐ง๐ฎ๐ธ๐ฒ๐ฎ๐๐ฎ๐๐:
1) ๐ก๐ผ๐ ๐ฒ๐๐ฒ๐ฟ๐ ๐ถ๐ป๐๐ฒ๐๐๐ผ๐ฟโ๐ ๐บ๐ผ๐ป๐ฒ๐ ๐๐ฝ๐ฒ๐ป๐ฑ๐ ๐๐ต๐ฒ ๐๐ฎ๐บ๐ฒ โ Make sure the VCs you want to work with bring more than money to the table. Nothing is more frustrating than having monthly board meetings with a group of people who have no idea what industry you are in.
2) ๐๐น๐๐ฎ๐๐ ๐๐ฎ๐ธ๐ฒ ๐๐ต๐ฒ ๐ฒ๐
๐๐ฟ๐ฎ ๐บ๐ผ๐ป๐ฒ๐ โ If your goal is to raise $1.5M, go for $2M. Youโll never have enough and you do not want to get bled out (see above).
3) ๐๐ฒ๐ ๐ฎ๐ป ๐ฒ๐บ๐ฝ๐น๐ผ๐๐บ๐ฒ๐ป๐ ๐ฐ๐ผ๐ป๐๐ฟ๐ฎ๐ฐ๐ โ This is different than an employee agreement that youโre used to seeing when you had a day job. Top executives get employment contracts that guarantee severance pay, stock awards, etc. Get one and know in advance what happens to you if the board wants you out.
4) ๐๐ต๐ผ๐ผ๐๐ฒ ๐๐ผ๐๐ฟ ๐ฏ๐ผ๐ฎ๐ฟ๐ฑ ๐๐ถ๐๐ฒ๐น๐ โ Donโt let your VCs choose your board. Give them the seat they ask for and select people you trust for the rest. Do not go for famous people, they wonโt have time to help you. Trust is key.
5) ๐๐ฒ ๐ฏ๐ผ๐น๐ฑ, ๐ฎ๐ป๐ฑ ๐น๐ฒ๐ฎ๐ฑ ๐๐ผ๐๐ฟ ๐ฏ๐ผ๐ฎ๐ฟ๐ฑ, ๐๐ต๐ฎ๐ฟ๐ฒ๐ต๐ผ๐น๐ฑ๐ฒ๐ฟ๐, ๐ฎ๐ป๐ฑ ๐ฒ๐บ๐ฝ๐น๐ผ๐๐ฒ๐ฒ๐. You made it this far by taking charge initially. Your board should verify your decisions, not make them for you. Make bold decisions that will have everyone walking off the plank with you. Youโre the boss.
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๐ง๐ต๐ฒ ๐๐ผ๐ผ๐ฑ ๐ฉ๐๐
As I mentioned in the beginning, not all VCs are bad. In fact, there are some that truly help in several ways. ๐ค Iโve worked with some that provide full operation support (accounting, recruiting, marketing) and office space for their portfolio companies in addition to capital. If youโre considering raising money through a VC firm, be sure to do your due diligence on them too! Talk to other portfolio company CEOs, ask some of their limited partners how they work, and speak to analysts who know them before making a deal. Check VC firms’ ratings from other entrepreneurs: I hope this post helps aspiring entrepreneurs who are seeking funding. Please let me know if you have any feedback. ๐ฌ
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๐๐ฏ๐ผ๐๐ ๐ ๐ฒ
Jason Weaver is a prominent author, and a thought leader in product innovation, usability, and entrepreneurship. He is considered an authority in social media and mobile marketing. He frequently keynotes industry conferences, summits, and corporate events. Jason founded and successfully exited from two technology companies including Shoutlet, a leading Social Media Management platform. Today, he runsย Halo, a strategic consulting firm that uses innovation, partnerships, and people to fuel rapid growth. His book, โManagerโs Guide to Online Marketingโ, from the Briefcase Book Series (McGraw-Hill) is available atย Amazon.comย and Barnes and Noble worldwide. Jason has also authored articles for world-renowned publications, such as Mashable and Forbes.
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