Venture Deals

BRAD FELD has been an early stage investor and entrepreneur for over thirty years. Prior to cofounding Foundry Group, he cofounded Mobius Venture Capital and Intensity Ventures. He is also a cofounder of Techstars.

JASON MENDELSON has over twenty years experience in the venture capital and technology industries in a multitude of investing, legal, and operational roles. Prior to cofounding Foundry Group, Jason was a Managing Director and General Counsel for Mobius Venture Capital. He is also a cofounder of SRS/Acquiom.

Foreword by Fred Wilson (3rd Edition) xi

Foreword by James Park (3rd Edition) xiii

Foreword by Dick Costolo (1st and 2nd Editions) xv

Preface xvii

Acknowledgments xxiii

Introduction: The Art of the Term Sheet 1

Chapter 1 The Players 3

The Entrepreneur 3

The Venture Capitalist 4

Financing Round Nomenclature 7

Types of Venture Capital Firms 9

The Angel Investor 10

The Syndicate 12

The Lawyer 13

The Accountant 14

The Banker 15

The Mentor 15

Chapter 2 Preparing for Fundraising 17

Choosing the Right Lawyer 17

Proactive versus Reactive 18

Intellectual Property 20

Chapter 3 How to Raise Money 23

“Do. Or Do Not. There is No Try.” 23

Determine How Much You are Raising 24

Fundraising Materials 26

Due Diligence Materials 32

Finding the Right VC 33

Finding a Lead VC 34

How VCs Decide to Invest 35

Using Multiple VCs to Create Competition 38

Closing the Deal 39

Chapter 4 Overview of the Term Sheet 41

The Key Concepts: Economics and Control 42

Chapter 5 Economic Terms of the Term Sheet 45

Valuation and Price 45

Employee Option Pool 47

Warrants 50

How Valuation is Determined 52

Liquidation Preference 54

Pay-to-Play 63

Vesting 66

Exercise Period 70

Antidilution 71

Chapter 6 Control Terms of the Term Sheet 77

Board of Directors 77

Protective Provisions 81

Drag-Along Agreement 85

Conversion 88

Chapter 7 Other Terms of the Term Sheet 91

Dividends 91

Redemption Rights 93

Conditions Precedent to Financing 95

Information Rights 97

Registration Rights 98

Right of First Refusal 100

Voting Rights 102

Restriction on Sales 102

Proprietary Information and Inventions Agreement 103

Co-Sale Agreement 104

Founders’ Activities 105

Initial Public Offering Shares Purchase 106

No-Shop Agreement 107

Indemnification 110

Assignment 110

Chapter 8 Convertible Debt 113

Arguments for and Against Convertible Debt 114

The Discount 116

Valuation Caps 117

Interest Rate 119

Conversion Mechanics 119

Conversion in a Sale of the Company 121

Warrants 122

Other Terms 125

Early Stage versus Late Stage Dynamics 125

Can Convertible Debt Be Dangerous? 126

An Alternative to Convertible Debt 127

Chapter 9 The Capitalization Table 129

Price per Share with Convertible Notes 131

Pre-Money Method 132

Percentage-Ownership Method 133

Dollars-Invested Method 133

Chapter 10 Crowdfunding 137

Product Crowdfunding 137

Equity Crowdfunding 139

How Equity Crowdfunding Differs 141

Token Crowdfunding 143

Chapter 11 Venture Debt 145

The Role of Debt versus Equity 145

The Players 147

How Lenders Think about Loan Types 148

Economic Terms 151

Amortization Terms 154

Control Terms 157

Negotiation Tactics 161

Restructuring the Deal 163

Chapter 12 How Venture Capital Funds Work 167

Overview of a Typical Structure 168

How Firms Raise Money 169

How Venture Capitalists Make Money 171

How Time Impacts Fund Activity 175

Reserves 177

Cash Flow 179

Cross-Fund Investing 179

Departing Partners 181

Corporate Venture Capital 181

Strategic Investors 183

Fiduciary Duties 184

Implications for the Entrepreneur 185

Chapter 13 Negotiation Tactics 187

What Really Matters? 187

Preparing for the Negotiation 188

A Brief Introduction to Game Theory 191

Negotiating in the Game of Financings 193

Negotiating Other Games 194

Negotiating Styles and Approaches 195

Collaborative Negotiation versus Walk-Away Threats 199

Building Leverage and Getting to Yes 200

Things Not to Do 203

Great Lawyers versus Bad Lawyers versus No Lawyers 205

Can You Make a Bad Deal Better? 206

Chapter 14 Raising Money the Right Way 209

Don’t Be a Machine 209

Don’t Ask for a Nondisclosure Agreement 210

Don’t Email Carpet-Bomb VCs 210

No Often Means No 211

Don’t Ask for a Referral If You Get a No 211

Don’t Be a Solo Founder 212

Don’t Overemphasize Patents 213

Don’t Be Silent If You Witness Bad Behavior 213

Chapter 15 Issues at Different Financing Stages 215

Seed Deals 215

Early Stage 216

Mid and Late Stages 217

Chapter 16 Letters of Intent: The Other Term Sheet 221

Structure of a Deal 222

Asset Deal versus Stock Deal 225

Form of Consideration 227

Assumption of Stock Options 228

Representations, Warranties, and Indemnification 232

Escrow 233

Confidentiality/Nondisclosure Agreement 235

Employee Matters 236

Conditions to Close 237

The No-Shop Clause 238

Fees, Fees, and More Fees 239

Registration Rights 240

Shareholder Representatives 241

Chapter 17 How to Engage an Investment Banker 243

Why Hire an Investment Banker? 243

How to Choose an M&A Adviser 245

Negotiating the Engagement Letter 247

Helping Your Banker Maximize the Outcome 251

Chapter 18 Why Do Term Sheets Even Exist? 253

Constraining Behavior and the Alignment of Incentives 254

Transaction Costs 255

Agency Costs and Information Asymmetry 256

Reputation Constraints 257

Chapter 19 Legal Things Every Entrepreneur Should Know 259

Intellectual Property 259

Patents 261

Trademarks 262

Employment Issues 263

Type of Corporate Structure 264

Accredited Investors 265

Section 409A Valuations 266

(83)b Elections 267

Founders’ Stock 268

Consultants versus Employees 269

Compensating Service Providers 270

Authors’ Note 273

Appendix A: Sample Term Sheet 275

Appendix B: Foundry Group Term Sheet 285

Appendix C: Sample Letter of Intent 295

Appendix D: Additional Resources 303

Glossary 307

About the Authors 321

Index 323

Excerpt from Startup Communities 333