Book of the Week: Venture Deals

18 Aug 2015

venture_deals I was inspired to read Venture Deals after reading Heidi Roizen’s delightful blog post about How to Build a Unicorn From Scratch – and Walk Away with Nothing. Very often a new entrepreneur will sign something eager to be finally funded without realizing all the repercussions down the line. Why sometimes it is better to raise less money at a more reasonable valuation to avoid a down round. This book covers how entrepreneurs raise money from venture capital firms and what happens behind the scenes to get the deal done. A must read if you are raising funds. Also read the errata, since there was a error on the term sheet calculations. Term sheets are complicated. The book points out a lot of things to watch out for and tells you how you should negotiate and focus your lawyers. Gender Pronouns I’ve notice a trend that more recent books use the female pronoun “her” when referring to a scientist, an engineer, an entrepreneur, etc. Brad tried writing the book with both genders, but it was confusing, so he stuck with the male pronoun. I would have just used the female pronoun if you make it a point to call it out on your book. It’s like saying, I tried and failed, but I still believe in women. Venture Capital Firm

vc_structure Venture capital firms make money from management feeds and carried interest. Management fees vary between 1.5 and 2.5 percent and are taken out of the fund amount, which could mean not entire fund amount is invested into companies. If venture fund has early returns, then it can use those returns to pay management fees and recycle them in order to invest full amount of the fund. For example a $100M fund that lasts 10 years with a 1.5 % fee will have $15M go to management feeds and $85M go to companies unless the fund can make enough returns to account for the management fee. Firms are only allowed to invest in companies at the beginning of the fund, so they have to raise new funds every 3 to 4 years if they want to keep investing into companies. Firms that can’t raise a new fund become zombies and don’t die until the end of the fund. VC firms take usually 20% of the profits as carried interest if they return more than the principal invested. When the VC invested in your startup in relation to the lifecycle of their fund can cause misalignment if the VC wants to cash out near the end of the lifecycle of their fund. Better to get investments early in a fund lifecycle. Term Sheet The main issues you care about on a term sheet are economics and control. When a VC invests $5M at $20M post money valuation, they take 25% of the company. If they invest $5M at a $20M premoney valuation, that means they are getting 20% of a $25M postmoney company company. $5M/($20M + $5M) = 20% A complicated thing to calculate is liquidation preference. Not all shares of the company are equal before the company goes IPO. Investors have preferred shares, so they get their money back before everyone else. There are two things that go into liquidation preference: preference and participation. Participation can be full participation, capped participation, and no participation. When you read about a founder not making any money in the end, you could probably attribute that to participation. Liquidation Preference Series A investment of $5M at $10 premoney. Investor owns 33.3%. Event 1: Acquired for $30M

Event 2: Acquired for $100M

Event 3: More rounds, raised $50M, such that investors own 60% and entrepreneurs own 40%.

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