by Dick Costolo

I've had a few questions recently from folks who have received first round financing term sheets in which the proposed board makeup seems over the top, from my perspective. Here is a composite (sorry, "mashup") of the kind of first round term sheet language for Board participation I recently heard from different founders:

One CEO seat (currently founder X), two Series A investor seats, and and independent nominated by the Series A and approved by the board.

This is silly. A more cynical wizard (who would look like me but say "hmm" a lot more) might interpret this as early investors trying to take control of the company immediately. Can you spot the three things we don’t like about this proposed board structure?

First, "one CEO seat (currently founder X)". That's nice, founder X gets a board seat. How long does founder X have a board seat? Only as long as (s)he is the CEO. New CEO, new board member and out with founder X. No more founder board seats. Let's move on to the other troubles before we re-draft the entire proposal.

Problemo numero dos, "Two Series A seats". Um, I don't get why the first round investors should get two seats. If the Series A is all being done by one institution, then this is particularly annoying, but even in the case of a syndicate, the series A investors should have a single representative on the board. "But but but", you say. "Wait wait wait", you say. “"What if you really appreciate the input of two particular members of a syndicated financing?" Excellent point; the proposed board structure might include a board seat for the lead investor on the round, and board observation rights for one or more members of the syndicate.

Finally, and particularly the way this proposed board is structured, watch out for the wording on "an independent seat nominated by the Series A and approved by the board." In this case, the Series A investor obviously controls the independent seat completely. This entrepreneur’s post-A round board, if accepted, is going to have 3 people representing the Series A and one CEO, who may or may not be the founder six months from now. This is, in legal parlance, "sucky". If this is one investor doing the round, note that we might also raise our eyebrows and wonder why the institution's partners have so much free time that two of them can take board seats in the same company.

Here's a more straightforward Series A board structure: "One founder seat, one Series A seat, and an independent nominated by the founder and approved by unanimous consent of the board". If you're a multi-founder company, then I might change this to: "One founder seat (founder X), one CEO seat (currently held by founder Y), one Series A seat, and one independent nominated by the CEO and approved by unanimous consent of the board". Frankly, you could keep it even more basic in the latter multi-founder case and just go with founder/founder & ceo/series A, but I personally enjoyed having an independent board member once we'd added one ourselves, and I think it's helpful to get this person in sooner rather than later.

In the multi-founder case, when you do a 2nd round financing and you can keep the same general structure, you still have a nicely balanced board: something like two people from founder/management, two investors, and an independent. From here you can do things like layer in more independents as you grow, etc.

Rational investors are comfortable with these sorts of structures, and in fact, in our series B negotiation at FeedBurner, it was the investors who countered with "founder seat and ceo seat currently held by founder" when we originally redlined the first term sheet with two founder seats. This is a perfectly reasonable compromise in most cases and provides the investors with some security that a "renegade founder group" can't hold management and investors hostage, while giving a strong founder group some assurance they will have significant and balanced participation in the board. There is no reason a founder should feel obligated to cede control of the company to a single investor on an early financing.

by Furqan Nazeeri

A lot has been written about how venture capitalists are, shall we say, less than direct in terms of communicating a decision to pass on an investment opportunity.  If you read the forums on sites like TheFunded, you'll see a lot of hand wringing about how VCs show high interest initially and then go dark (Guy Kawasaki's famous S-H-I-T-S principal from his fabulous book Art of the Start).  When I was out raising money, this lack of follow-up drove me crazy.  I viewed it as beyond unprofessional and downright inefficient.  I remember thinking that the VC is either a wimp and is afraid to tell me no or is on an ego trip and doesn't feel I'm worth his or her time for a simple follow up call.

Now, I'm sure there are some VCs out there that do show that level of contempt for entrepreneurs, but I'm sure that's not the reason why most do it.  Having sat in on a number of pitches as an "acting venture capitalist" here's the real reason why even a blue-blooded entrepreneur such as myself is sometimes tempted to breach etiquette--the vast majority of entrepreneurs don't take no for an answer.  As they shouldn't...what company would succeed if the founder quit every time they heard no?  Think about it.  If someone (particularly a VC) told you that, "they were concerned the market wasn't big enough" any entrepreneur worth their salt would come back with a detailed presentation on why the market is "conservatively estimated to be $10 billion."  So in a round-about way, VCs think they are saving entrepreneurs time by doing this (not to mention saving their own time).

So how should VCs and entrepreneurs best deal with this?  The most constructive solution from the investor side of things is one I've learned from Steve Murry.  I've never seen Steve do the high interest / stall thing, instead he either delivers a clear "no and here's why" that leaves no uncertainty or he delivers a "not now, but here is what could change my mind."  And, in fact, I've seen the latter actually turn into an investment a year plus after the first meeting, i.e. the feedback has to be genuine.  As for entrepreneurs, the best response is to be direct.  I think a totally appropriate response a week or two after a meeting without any feedback is to say that you, "normally associate no follow up with a lack of interest and that while you'd love to work with XYZ you want to be efficient with time so unless you hear otherwise you'll assume there is no interest at this time."  If everyone followed these "new rules," the private equity market place would be the better for it.

by T.D. Klein

I asked one of the very best operators I know how he managed his relationships with investors so successfully, notwithstanding going through the ups and downs of a startup.  This, in its entirety, is his response.  It's very insightful and I guarantee if you follow it you are sure to make your investor relations better.

1. Written updates
   1. Weekly at beginning
   2. Phase to monthly over time
   3. Content:  everything that's going on in the business, from sales to employees to partners

2. "Operating reviews"
   1. As often as investors will agree to
   2. Content: in-depth analysis of business, including industry trends, strategic initiatives, benchmarking analysis, etc.

3. Immediate sharing of news
   1. Good news to most junior person first [let them get some credit]
   2. Bad news to most senior person first

4. Communicating among individuals at investor company
   1. If have occasion to meet with senior person, be sure to call next in line and give complete, detailed summary of what was discussed at meeting
   2. Encourage more junior contact to share information with more senior folks; ensure that information is flowing among the individuals at the investor company

5. Identify ways in which investors can be of assistance
   1. Generally speaking, they want to be helpful but are often frustrated because they don't know what to do
   2. Finding something – anything – that they can do to help will ensure their attention doesn't go to non-value producing activities

Overall goals

• No surprises, good or bad, ever
• Ensure that each individual from the investor company will always be able to address any questions that an outsider (e.g., LP) may ask about your company or industry; be sure they learn the details about industry announcements from you on a timely basis.

After sitting through 20+ pitches as a "VC" and having given 10 times that from the "sell-side" of the table, I figure it's time to throw my hat in the ring along with all those offering advice to entrepreneurs pitching VCs. In B-school, we had a thing for "top 10" lists, so please forgive the following format:

10. Get someone you know to introduce you. Everyone knows this, but it's worth repeating. I've seen a lot of CEOs/CFOs with lists of VC funds they are pitching and the status of each (a sort of "fundraising pipeline"). But I've yet to see one of these spreadsheets with the most important two columns: (a) who's going to introduce us to this fund and (b) what's their relationship to the fund, i.e. how does the fund view them. Ideally the person making the intro is someone who's made money for the fund in one capacity or another. Do yourself a favor and add these columns to your spreadsheet.

9. Don't bring the whole company. Who and how many folks to bring obviously depends upon circumstances, but ideally it's the CEO and one other key executive (e.g. founder, VP Sales, CTO, etc.). Any more than that you're fighting for air time or looking like moss on a rock, neither of which help the cause. The best pitch I've seen so far was given by the CEO alone (to a group of more than a dozen).

8. Arrive early and set up your stuff. Every shop has a different A/V setup. Great entrepreneurs come prepared…wireless modem, memory stick, Ethernet cable, hard copy screen shots… Woe to the entrepreneur who starts off the meeting with a bunch of VCs sitting around and yelling "press function-F7!" 

7. Introduce yourself by describing how you've made money for shareholders. Less than 5% of the management teams I've seen have figured this one out. The best intros are ones where multiple people on the management team can say, "I was CXO of Lightning-in-a-Bottle, Inc. for 3 years and we raised umpteen million returning numberteen-X to investors." That's what VCs call an "A-team." Every exec worth their salt should be able to come up with some version of this such as, "I was VP whatever at Blue Chip, Inc. and generated a 5X return on capital with my insert project name" although too many of the later on the team will get a "B" label from savvy investors. At all costs, entrepreneurs should avoid what 95% of us do and launch into an intro with, "I worked at…" and then proceed to name drop 5 companies that are successful but which everyone knows probably had little to do with said executive.

6. Tailor the pitch to the audience. When the VCs are introducing themselves, great entrepreneurs are doing more than just listening; they are qualifying the prospect. Entrepreneurs should take the VC intro part of the meeting to ask a few questions with the goal of understanding the VC's perspective…how much do they know about my market, my company, competitors, etc.? Armed with this, the team can tailor the presentation to the audience.

5. The slide presentation should be at maximum 10 slides. Do the math: 10 minutes for  introductions, 3 minutes per slide (30 minutes) for the presentation, 10 minutes for a demo and 10 minutes for Q&A...that's your meeting. Bring all the slides you want, but a great presentation only needs 10. Guy Kawasaki has a great book called Art of the Start which talks more about this (and gives a description of what a 10-slider looks like). A lot of folks send 40-page drafts to me with the caveat that they "are working on cutting it down." I recommend starting the other way around. Start with 3 slides: what's the market, what's the solution and how does it work. Then add slides to fill in the holes until the magic number of 10 is reached.

4. When a potential investor asks a question, answer it. It's rare that the response, "Good  question! If you could just hold that thought until slide 36, I'll address that point." The trick to understanding why is to realize that, when asking questions, smart investors are really trying to get a feel for what the CEO is like, how they think on their feet, perform under pressure, listen, relate to investors and what it would be like to work with the entrepreneur in question. So every time a VC asks a question, the entrepreneur should think to themselves, "oh, she just asked me what it's like to work with me" and then respond.

3. Don't hide bad news. Entrepreneurs are by definition optimists, but there is a well known fine line between genius and insanity. I've seen a lot of entrepreneurs, including myself, paint themselves into a corner instead of proactively defining holes or unknowns in their business plan as manageable risks. Savvy investors bucket these folks as "first-timers" or "green."

2. Be concise. 

1. Practice, practice, practice! I've heard many CEOs say, "gee, that's the first time I've seen that slide...John (VP of whatever) do you want to walk us through this one?" It sounds silly, but for those of us not gifted with Bill Clinton-like stage presence, we should practice the full pitch at least 50 times, ideally in front of a video camera and a live crowd. A lot of entrepreneurs "practice" with their first 10, 20 or more VC pitches, but that is really a disservice to all involved. If a CEO can develop a total comfort with the presentation (slides and delivery) then that comfort level shows through and they have a chance of really connecting with their potential partner/investor.

by Matt McCall

Most VC's will generally say they target 20-30% ownership in a company to "make it worth their time". This means that if they invest $3m early on, they expect the post-money to be around $10-15m and if, in later rounds, they are investing $10m, they expect to have a $30-$50m post-$.

Often, however, VC's will use the "percentage" threshold as a means by which to increase money into a round or to get the valuation down. I have seen a given VC say they need 25% ownership for deal (to get valuation down) and do a more competitively sought deal at 15% two weeks later. In the end, two things drive all of this. First, there are legitimate minimum investment amounts a firm needs to have per deal. A $500 million fund will never get its capital deployed by doing $2m and $3m deals. They need to put $7-10m to play early and $20m+ over the life of the investment. Second, the valuation (and hence % ownership) will be driven by attractiveness and competitiveness of the deal. In the end, it is really about valuation (assuming their investment appetite remains in a set range).   

by Rick Segal

Starting the day at 4a on a Sunday, having to roll out of a toasty warm bed into the Canadian winter, is not something I’m all that excited about. Unfortunately, duty calls with this, the beginning of a busy week of meetings, travel, and checking out some new companies. 

Over the past several weeks, I’ve been packing in the meetings with new companies. I’ve been impressed with the quality of the management and the opportunities being created.  It’s also nice to see folks doing some homework on our firm.  Many entrepreneurs read this blog, check out our web site and, in general, are doing a good job knowing a bit more about our firm.  Well done. And Albert’s been back all focused and ready to ship stuff, go get em Albert.

One question that comes up is about the VC process and what to expect, timing, process, etc.  I’ve put together this long entry in an attempt to give you our process in the hopes it can help with your expectations. Keep in mind every firm is different and we all have our particular quirks, so your mileage may vary.

WARNING: This post is very very long

Probably way more information then you’d ever need but I did it this way to try and give you as much behind the scenes, so to speak, because there isn’t really much detail to all the checklist and ‘tip’ stuff we VC types like to throw around. 

So, in advance, I apologize to those of you who fall asleep, don’t hit your head on the desk.

Step One: No Harm No Foul

The first step I recommend, if you’ve never done the VC bit before, is to come by for a 30 minute no harm, no foul meeting. You can tell me the general story, give me an idea of what you, your idea, your company, etc, is all about, while getting feedback, suggestions, and a free drink. This meeting typically doesn’t count against you so if the demo blows up, you forget stuff, mess up the names of whatever, etc.  The idea is to lower the stress levels so we can have a great conversation that is valuable to both of us. We can also establish, right up front, if we’d be a target financial solution for you.  

Step Two: The pre-meeting activities

Send me electronic materials to read. This is probably where lots of other VCs will give you different opinions. I like data from a market perspective. I want to understand the problem set, the people who will pay, etc. This can take many forms besides the standard Gartner or whomever stuff. I met a women last week who hit upon a really interesting way to solve a particular problem while she was digging through some PhD thesis documents for an unrelated project. Paper was written in 1974, 30 years before the technology even existed to solve this problem.  It was a fascinating read and she just might be onto something.  When it comes to JLA and my bookworm partners, we will read the stuff you send us. The smarter we can be ahead of time, the better.

Step Three: Face to Face (1)

This is the first meeting where the meter starts running. Up until this point, it really doesn’t count. It is this meeting where we’ve agreed you are starting the process to raise capital from my firm.  This meeting will usually last an hour or so. I say, or so, because I try to leave enough room for the unexpected as well as making sure you feel comfortable that when it b done, it b done, you don’t have to stick around.  You are going to tell the story and I’m going to listen. Really. It is not that complicated. You talk, I listen and then we have some dialog with questions, give -n- take, etc.

Don’t put up with these cocky jerks who think they know more then you because they get to be in the VC office. Don’t accept rude, condescending, treatment. You are working hard on growing a company and that fact alone, affords you respect.  I try to follow my partner, John, who has a great habit. During a presentation, he asks if it is okay to ask questions. Simple, polite behavior and, more often then not, it blows people away. 

Just tell me the story and let’s talk about it.

There are common questions that will always come up so you might want to consider doing a first (i.e. I’ve never seen it); create an Investor FAQ. It could consist of these (and probably other) questions:

• Are you the founder?
• How many founders are still in the company?
• How many full time employees in the company?
• Do you have any revenue today?
• What has been the amount of capital gone into the company to date?
• What is the current capital structure of the company?
• What do you think the total investment is required in order to have the business begin to generate net income?
• What are the key milestones you will use to measure the company’s success/progress?
• What keeps you up at night?
• What factors, outside your control, will have to be in place (or have to happen) in order for this business to be successful?

This isn’t a long, painful, power point deck, rather a simple list of the obvious questions that pretty much everybody is going to ask.

At the end of this meeting, I am likely to tell you that I will speak to my partners and get back to you with a go forward yes or no, typically, within 48hrs.  If I know for a fact that this isn’t for us, I will tell you on the spot.  If you’ve read the web site, asked around about me, know what we do, etc, you’ve probably got a good shot at peaking my interest. I’m new, like you, am growing a brand, like you, and work hard, like you, to make my business successful. Hopefully, we can do it together.

Step Four: The Huddle (1)

At JLA, we have an open office concept. Cubicles, if you will. We do that to insure we all know what’s going on as well as keeping a good buzz around the office. Nothing kills cooperation and teams faster then private offices with doors. Leaving that debate for another day and moving on; we will chat about your idea during that 48hr period. We think about the market, the space, our collective expertise, the docket of pending deals, and the general first pass, collective gut check. 

Assuming nobody reaches for a barf bag and the partner driving the deal is still keen, we move on to step five. If it dies at this point, you will get a phone call or email.  The jury is out on which style is better. I think a rapid response phone call is more personal then email while others thing getting out the email quickly beats telephone tag every time. In the end, speed is the issue. I try hard not to waste your time. It’s just a bad thing for everybody.

I take it as a supreme compliment when an entrepreneur recommends me to another entrepreneur after I’ve said no to their idea. This tells me, loud and clear, that respect for you and your time is appreciated.

Step Five: More info (1)

I try to do as much work as I possibly can before issuing a term sheet. It’s the worst thing in the world you can do or have done to you, it being having a term sheet pulled. I’ve been on both sides of that table and nothing, regardless of the reasons, hurts more then having that paper killed.  To combat this, we try hard to get as much information as we can so that when we give you a term sheet, it is as far down to the legals and reference checks as possible. We’ve made the call to do it, now it’s the pesky details.  Others toss term sheets with no shop clauses, break fees, and other silly things and that’s fine for them but not for my partners and I.

During this phase, we provide a checklist of the items we’d like to see before making the call on a term sheet and valuation, etc, etc.  The checklist we provide list the materials you will likely have to have regardless of who funds you so we try to make this request work you will do anyway and work you only have to do once.  You are, of course, free to decline on some or all of those things and we will make the call on what we have.  A term sheet with less data is likely to have issues with valuation, structure, etc, but we can serve the customer as best we can.  If you are interested in what those checklists look like, drop me a line or come by; I’ll be happy to share this data with you. 

It’s important to note that we will say no as fast as we can if there is something that doesn’t check out or there is a serious problem which impacts our basic thesis. This is the place where “good business but not for us” is reasonable so long as we get you that feedback quickly and with a minimum of pain.

It’s also important to note that we will issue a term sheet if we think something is interesting/good before completing all the work.  I just strongly recommend you think twice about insisting on a term sheet before you know if the party is really interested in your business. Get all your materials together, let them review what they need and make that term sheet count.

Step Six: Face to Face (2)

You and your team will be invited back to our office to meet our entire team. This is basically an opportunity for you to present to our whole group and give everyone a chance to meet and greet.  We are pretty laid back about this but we want you to know everybody. It’s the best part of the process, actually. You get to meet some really smart people who, by this point, are really interested in you, your team, and your ideas.

Step Seven: The Huddle (2)

The JLA team huddles and we spend time going over what you’ve presented. The lead partner on the deal, along with an analyst, will present the basic thesis again, opportunities, a standard SWOT (Strengths Weakness Opportunities Threats) chart, and we will debate the deal to determine the value and structure of a deal.  We usually will make the term sheet call at this point and begin the process of getting a term sheet out the door or somebody will have found a major flaw/problem that, if not resolvable, will kill the deal. Either way, we communicate this to you quickly.

Step Eight: The Term Sheet

At Last! We will issue you a term sheet with fairly standard terms and one that matches what we’ve talked about prior to the paper being transmitted.  The single more important suggestion I can give you is to negotiate this document and take your time! Do not fall into this silly trap of being told, aww hell, its non-binding, don’t worry about it.  Get that term sheet as detailed as you possibly can and have every business term that matters to you spelled out and agreed to before you sign it. Why? Money. You will save a small, well large, fortune in legal bills if you get the business terms clearly spelled out now, before the lawyers go at it.

In addition, you will get a very very clear feel for your ‘partner’ and how they act.  Don’t let the lure of a term sheet cloud your judgment. Don’t be afraid and don’t listen to ‘we don’t do that’, ‘it’s standard’ or any other stuff we toss at you.  Dilution might very well be the solution but make darn sure that it is on business terms that make sense to you.

Again, take your time. Work out your employment agreement. Work out the option plan. Work out shareholder rights, minority shareholder rights, etc, etc.  Read Brad Feld’s term sheet series if for no other reason then he gets standing ovations for showing up late to dinner parties, in jeans and a t-shirt. Plus he is all old now, you know, 40, yowsa.

Step Nine: Validation

It’s numbers and crunching time. We ensure there is agreement on the plan, agree on what will need to be spent, the basic metrics, and where we can add the most value quickly.  During this time we are also continuing to refine the business terms we’ve collectively laid out in the term sheet so we can turn a business list over to lawyers for legal language not a legal debate on our mutual objectives.  This is additional face time between you and I as another checkpoint for both of us to get to know each other.

Step Ten: The Huddle (3)

Our team gets together for a third time to talk about our findings with respect to the final plan, milestones, people, terms negotiated, etc. It’s the time where we ‘sign off’ internally before we head to serious legals. At this point, my partners have had lots of time to review the opportunity, maybe play with the service/app, look at the competition, etc, and just continue to get smarter about the space. It should be noted that along the way, we usually provide the feedback to you. You will notice we forward items of interest from blogs, news clippings, etc, just to make sure we are on the same page and seeing the things you see.  Hopefully, we are already adding value to your team by seeing things you may be missing.

Step Eleven: Legals

Crank up the lawyers and roll out the paperwork. By this point, we should be ‘there’ from the perspective of ironing out legal points that have been translated from the business issues we have agreed upon.  The smoothest part of the transaction or the nightmare from hell with no middle ground is how this step gets classified by me. Nothing kills a deal faster then both sides going off track with respect to legals. Actually, nothing kills the working relationship faster, is probably the more accurate statement.

On the VC side, there are many things which you can assume are going to be required prior to closing. A no material change clause, for example, or a rep and warranty with respect to ownership of intellectual property is likely going to pop up.  On the start up side, you are going to be looking for things to be defined like “for cause” or “best efforts” or “to the company’s knowledge”, etc.  All of these things are in the domain where the lawyers look out for the client’s best interests.

My advice at this step is twofold.  First, common sense and reality rule the day.  This applies to both sides.  There is always a business agreement that is the basis for the legal translation. I find it very helpful that when a sticking point comes up, the business people (you and I) simply agree on the business principal and then, with both lawyers in the room, give instructions to ensure the translation is carried out, no free lancing.  Make the two lawyers work it out and do that as a team.

The second point is risk management. There is risk in everything. If you believe I’m going to steal your company, we shouldn’t be past step zero. If I believe we need eighty layers of protection because there is some question about you, again, we shouldn’t be past step zero.  We either want to do a deal or we don’t.  I know that sounds silly but, in the end, it really will be that simple. Give on points that, in the end, will be the least of your problems.

This applies to both sides of the equation.

Step Twelve: Final Approach

We have a last review of the details, the agreements, put some beer in the fridge, coin in the box, and get cracking!

If you’ve lasted this long, and I know it was painful, thank you.

I hope this long entry will help you get a feel for how at least one firm, ours, operates. Drop by. Canada is always open for business, we’ll keep a light on.