Adeo Ressi, founder of The Funded, a site where people rate venture capitalists and the Founder Institute, an incubator of sorts, has long ranted about what he calls “the atrocities of investors.”
Now, a lot of people, including prominent angel investors and venture capitalists, are starting to listen to him. Tomorrow Ressi will announce a new, basic term sheet for use by investors and founders. The goal is to protect founders and reduce legal fees, which average $50,000 or more per venture round.
Earlier this month angel investor and Hunch founder Chris Dixon wrote a blog post requesting that venture capitalists start to use standard, founder-friendly deal terms for venture rounds. He set out the terms he proposed in that post. Said Dixon: “My preference is to keep all terms as above and only negotiate over 2 things – valuation and amount raised.”
Investor Fred Wilson agreed with Dixon. In a post titled The Ideal First Round Term Sheet, Wilson said: “Chris laid out the ideal set of first round terms and I agree with them. What’s interesting is that Chris is a serial entrepreneur and I am a VC. And yet we agree on what the term sheet should say. That’s progress.”
Now Ressi has published an actual term sheet that investors and founders can use that reflect those basic terms. The term sheet is here, and is also embedded below.
The key terms include the elimination of participation with preferred stock, a 1x liquidation preference, and single trigger vesting acceleration on acquisition.
What this means: VCs try to increase returns by asking for large liquidation preferences. A 3x liquidation preference, for example, means the VC gets to take out 3 times his/her initial investment before founders and employees get anything. So if you raise $10 million at a 3x liquidation preference and then sell for $25 million, founders and emplyees get nothing. With a 1x liquidation preference, the VC is only able to get the initial investment back before others take their share.
More importantly, participation is eliminated. VCs often ask for this. What it means: Participation rights means the VC gets to take a pro-rata share of money in a sale even after the liquidity preference. With it eliminated, the VC has to choose – either take their 1x liquidation preference or convert and share with common pro rata. For any large deal, they will convert and be treated like the founders and employees.
The single trigger vesting provision is also important. VCs like to keep their founders locked up so they have to keep working even after an acquisition. The provision, called double-trigger acceleration, usually requires a sale followed by a firing without cause. VCs want this because it’s easier to sell a company if the founders are locked into staying on. Founders don’t like it because it sucks.
Most importantly, though, is the cost savings. VCs really need to move to a deal structure that doesn’t burn up so much lawyer time negotiating provisions that are almost never used. I could write 10 posts on how this nonsense works, and may in the future. A term sheet like this can be closed with $10k – $20k in legal fees. When you’re only raising $1 million, that’s a big deal.
Also see the Y Combinator investment docs that they published a year ago. Their documents are ideal for small angel rounds, and strip out a lot of the stuff covered in Adeo’s term sheet here. There are some terms included below that are needed in larger deals and which aren’t absurd for VCs to ask for. So both documents are highly relevant. Start with the Y Combinator docs for your first early angel round, and move to Adeo’s document in your first real round of venture capital.
We’ll highlight VCs that we talk to who indicate that they are willing to negotiate deals under these terms.
Definitely a good step into the right direction. I’ve always wondered about the ‘obsession’ over piling up legal fees over lengthy posturing, ahem I mean negotiations, just to end up with more or less standard agreements in the end anyways.
One man’s “standard” is another man’s atrocious agreement. Many entrepreneurs are not that well versed in signing agreements with VCs. If they don’t get the right tips and lawyers, they might sign an agreement that’ll later come back to haunt them. Having a standard agreement is a fantastic idea that would save a lot of headache, time wasting and legal fees to both sides.
In deed “one size dont fit everyone” – We decided to spin-off this part of our internal development at grow vc and create a separate non-profit, to tackle this problem.
Here’s the items what the SC will focus:
1. create categorizing model to identify different types of early start-ups quickly
2. find/build/attach high level sets of terms for different categories
3. develop efficient web tool to better manage the logistics and communication of the agreeing process (start with high level term sets by category with “blog style” commenting per each term)
As a non-profit SC will make all of the work freely available to it’s members. We also hope this non-profit will have a great life of it’s own, since it’s a vehicle that nobody can own, acting only to support global startup ecosystem.
Anyone wanting to participate, you are welcome to join us. We need plenty of resources.
Michael, could you provide a link to the Y Combinator angel documents? Thanks for a very insightful post.
http://www.scribd.com/ycdocs
sorry, added a link. here’s the direct: http://www.ycom...m/seriesaa.html
This is the beauty of the web, transparency. Fairly soon, typically vague deal terms such as startup funding and artist signings will become standardized. I can say this is something that hopefully will help entrepreneurs in the long run.
Thanks again Michael, I’ll be very interested to see which, if any, of the VC’s you talk to indicate willingness to use those terms.
Wow…this is great info. Thank you!
Peter..
Lawyers/Consulants.. if you’re not a part of the solution there’s money to be made in prolonging the problem.
This is good, thank you, TheFunded.com!
I second that. Great job guys, including you Mike for sharing it with the rest of us.
Thank you! TheFunded and the Founder Institute have the best interest of founders in mind…
Here’s a link to the Y Combinator docs: http://www.ycom...m/seriesaa.html
I love what Aldo’s doing. You should note though that Y Combinator posted a complete set of legal docs, not only a term sheet. As many lawyers try to slip things in after the term sheet, it’d be great if Aldo published the corresponding docs too.
I wrote a blog post a year ago about the YC docs and rounded up some other resources on reducing legal fees for these deals: http://www.vent...out_hellis.html
adeo says he’s now doing the rest of the docs too. and remember, they’re for different situations.
Michael is correct.
TheFunded Founder Institute documents are designed for larger Series A investments lead by professional investors, such as venture capitalists. The Institute “Plain Preferred” includes anti-dilution provisions and an annual dividend that the Y Combinator documents do not, and most professional investors will require basic terms like these. The Y Combinator documents are for smaller angel rounds, and they do not include any terms required by more sophisticated venture capitalists.
The Plain Preferred terms were developed because a major venture capitalist went on record publicly saying that he would support a simplified deal structure with founder-friendly terms. We took him up on his offer by developing the term sheet.
A company could easily use the Y Combinator documents for an angel round and then the Institute Plain Preferred for a Series A.
Aldo, Great to hear. I did not mean to suggest that the YC docs were better or worse, just that they had full docs and not only a term sheet — I realize they’re for different situations. Good to hear via Michael that you’ll be releasing docs too! Any entrepreneur who uses them will owe you a lot of beer for all the legal fees avoided.
Thanks so much for posting this Mike. This is incredibly helpful and highly relevant for me personally.
Arrington’s entrepreneurial career is “raising nearly $20 million after the bubble burst”, then sale to First Data Corp about a year later for $32 million. I’m sure VC terms and valuation in that deal assured he made little to nothing as well.
I’d be really surprised if VCs would agree to single-trigger vesting, especially for first time founders. It seriously lower acquisition prices
If others lead, they’ll follow. I have seen a lot of discussion around this. What it will take is strong willed founders to not bend on their formation.
Do you have any links to some discussion?
As a founder, I’d love to have single-trigger vesting, but I’ve been advised by everyone I’ve talked to that no VC would ever accept that.
Wilson’s remark is spot on. If only a term sheet like this could become and industry standard. Looking forward to those ten blog posts, too…
I have a question: I’m an entrepreneur living in SF and very soon I will need to raise some venture capital, for my internet project.
To make a long story short, because of this economic crisis, my credit history is down substantially (in other words not very good at all) and so my question is, do Angels and/or VC’s look at your credit history when you’re trying to raise money, and if yes, what can be done in my situation?! If somebody knows, please advise!
Thanks in advance guys!
Art
Michael,
Great post and great resources. Well done to highlight the good work by Adeo, YC and WSGR. This no-nonsense approach will provide such payback on both sides by creating huge amounts of trust and goodwill. I look forward to your additional posts on your experience and opinion as a lawyer and as an entrepreneur.
Michael,
In going over these doc’s, I can almost guarantee that you don’t miss your days as a securities atty. Great stuff, but this is enough to convince everyone to start using standardized forms. Valuation and amount raised. Fill-in the blank and save the window dressing for the big rounds. Makes so much sense, it sounds like a campaign promise.
This is a BIG deal. There are so many startup entrepreneurs that are trying to raise money for the first time and don’t have the money or expertise to know how to put together a simple legal agreement that would allow them to raise capital to get their product/business off the ground.
This is an important step forward in helping to simplify the process of starting companies that require investment. Kudos to Adeo to helping get this done.
This will be news when some entrepreneur closes a venture funded round using the document. Until then it’s just shameless PR.
Phil, people need to have the template before it can be used, so this is a first step. The Founder Institute has approximately 60 companies being formed, and some of these will be financed using the Plain Preferred terms. Since financing documents are confidetial, there will only be anecdotal stories of use, anyway.
This is what we learn in our MBA class. For more sample termsheets look up docstoc.
Adeo is the man! This is great, thanks for setting the bar. I’ll be referring to these docs in future fundraising discussions…
I HAVE A QUESTION: I’m an entrepreneur living in SF and very soon I will need to raise some venture capital, for my internet project.
To make a long story short, because of this economic crisis, my credit history is down substantially (in other words not very good at all) and so my question is, do Angels and/or VC’s look at your credit history when you’re trying to raise money, and if yes, what can be done in my situation?! If somebody knows, please advise!
Thanks in advance guys!
Art
the good ones don’t. i raised multiple rounds from both angels and vcs and nobody ever asked me for SSN, permission to check credit etc.
This is awesome. I love that Fred is so honest also. I hope to someday work with both of them…
this is terrific. the legal fees are almost independent of the complexities tho. the company pays the legal fees of the investor as well, and i have seen deals where the investor’s counsel raises dust when there are no disagreements. simply to run their meter to the cap stipulated in the term sheet.
the problem is that there are too many lawyers. and if you think a financing is expensive, try a liquidity event. the legal fees are simply outrageous.
Thanks Mike. This is why I still read TechCrunch.
Finally there is a realization that the legal profession has been charging exorbitant amounts of money to redo a form letter over and over again as if they were doing it from scratch. Legal fees is the biggest single expense for a small round and is stuck in the dot com era pricing model.
In the one case I am very familiar with, the attorney from a well-known brand name firm started with very unfavorable terms for the founder and the founder had to argue with the attorney before negotiating with the investors who had no problems with the founder’s requirements. The end result was very similar to the one in this post but after considerable legal expense.
On a separate note, people may also want to know that Orrick has published a whole set of form documents needed for a startup that can significantly reduce the legal costs by using them as a starting point.
http://www.orri...forms_index.asp
Transactions costs matter. And this is the way to reduce them. Great news.
hm.
that’s all the they want to know…?
Thanks for this great information. Interestingly, I am a member of TheFunded and a daily visitor to the site, yet I didn’t notice anything about this new info there, I read about it here on TechCrunch!
This is a big idea, but will only be a GREAT idea if it gains critical mass in the funding community through semi-widespread adoption. Standardized terms eliminate non-value added negotiation over technical deal features which do little to add value, and allow both sides to focus on valuation and the path forward. Standardized terms which are more fairly balanced towards founders are great as well, as long as the VC’s can still continue to earn acceptable returns for their LP’s with 1X preferences etc.
Deals will get done and funded more quickly, and both sides will feel good about it because they are following “industry standard” structures. A home mortgage loan is a standard document and both sides have gotten comfortable with vanilla. No reason it can’t work in this industry as well.
Wow, seems pretty logical to me.
RT
http://www.web-tools.us.tc
Example investor pitch deck: I recently created a 11-slide EXAMPLE investor pitch deck here: http://bit.ly/ScOYK this deck includes both example slides and descriptions / discussion for each; the powerpoint deck template is also available for download
Awesome coverage Mike. Been following Fred and Chris Dixons great efficiency ideas, and respect the fair treatment they advise. Wonderful that a term sheet has been created with their ideas as input. Great work by Adeo Ressi.
Appreciate you outlining the information here, as I’m intent on starting a business but unfamiliar with many of the details of fund raising.
This is great for entrepreneurs and is long overdue.
Guys this is pure LOVE !
Clearing the space form all the legal hassle will defenitely help great ideas to take off.
All my thanks and respect to The Funded and Techcrunch for trying to make the Etrepeneurial spirit FREE to create the next big thing !
The ideal next step would be to crack the crappy patent system !
Stay hungry and stay foolish…
this is a great discussion and i welcome Adeo’s participation in it. but given that my name is sort of being attached to adeo’s term sheet, i should be clear that i don’t agree with all of it.
in particular the acceleration issue is not to my liking. i prefer the way chris dixon lays it out in this post
http://www.cdixon.org/?p=164
Fred, we included the terms discussed verbatim, and I am happy to make any adjustments that you recommend. The various posts and comments were used.
How would you like the acceleration to be changed?
I agree with Fred, this is fair.
I need to go read what Fred says, but I skeptical that any firm with large funds would ever adopt these terms.
Participation, preference and the double-trigger are primarily designed to make sure the company doesn’t sell cheap and early. (Sure, there is the fin of screwing founders, but that’s a bonus.) If you have a $500M fund, you only want to do A deals where there will be follow-on B and C money and a possibility of exit for $$$.
Completely agreed on the need for standard docs, though, and the waste of lawyers on A rounds.
A few different VCs actually supported these admittedly unusual terms, so TheFunded Founder Institute took the initiative to draft them. Historically, this Plain Preferred term sheet was common just 10 years ago. Terms became complicated after the bubble burst, and investor returns plummeted with the rise in complexity… These two may not be related, but it makes sense that bad founder incentives would discourage good investor returns.
Having now read Fred, I see that he is not one of them. He supports double triggers, and, depending on the circumstance, up to 3x preference.
Again, I am extremely supportive of the need for standard docs. I just think founders seeking A rounds should understand that no top firm is going to let them flip early for $10 or 15M — and they will insist on terms that make sure that doesn’t happen.
If you want folks who will support a fast exit, stick with the microfunds. Less money to put to work means less to return.
Adeo great work. We need to establish a standard for term sheets. This will expedite negotiation and save both parties time and money.
Hello Michael,
What does it happen with the french version of Techcrunch … 5 weeks without news (deal Yahoo/MS, Facebook/Twitter, fundings)… no update, no info.
What don’t at least pay a translator to translate the big news from TC USA to TC FR?
A disapointed and loyal reader of TC FR & USA.
Regarding trigger-acceleration, single vs double is too coarse grained for reality. Not to make things too complicated but as long as standard terms only need to be decided once… I suggest a sliding scale.
In my experience, double trigger is most beneficial to the investor at very early stage of the company – the product is not fully realized, lot of value in what is still in the founder’s head and the dependence on founders to fully realize, etc. They need the founder to be available to value the company properly. For the founders as well, accepting double-trigger in very early exists is not a problem either. It is not that critical the further along you are in the company.
On the other hand, a single trigger is most beneficial to the founders after several years of work on the product/service, especially after a full management has been brought in, founders role less critical etc, and insisting on further years of “servitude” where they are mostly likely to be redundant doesn’t make sense. If the founder is really needed, the acquirer can always sweeten the pot outside of the deal (even if it means reducing the deal a little bit)
So a simple compromise is to start with a double-trigger for the first 2 years which will change to a single trigger for the remaining two years of the vesting.
Of course, there is no one perfect term for every case.
Great article Michael. Really glad to see new open standards moving into the traditionally private funding world. If its adopted, we should see an increase in the general quality of both startups and investment companies. Also, the standard documents will hopefully provide seed stage entrepreneurs a much needed look ‘over the fence’ so to speak and allow for some new and exciting companies to emerge. I am 100% for making that environment more accessible. Too often the great creative people we see via FUEL stop short on their concepts because of the obvious barriers of entering a funded environment.
I have been a lawyer for over 26 years. I have worked with start-ups and venture funding during this entire time. I never understood the need for such large legal bills for these types of transactions. I worked for great and mighty law firms in Boston for 18 years, 9 as a partner. Since 2000, I have been on my own. My legal fees seldom exceed $25,000, and are often much less. It would be good if we could deal with reality, as opposed to fantasies about potential issues. VC’s also need to lower their expectations a little.
this is so naive and arrogant at the same time.
naive to think that VC’s would accept these terms
and
arrogant to think that entrepreneurs do not understand term sheets and do not try to get good deals
the terms (like any other deal) are based on supply and demand not template agreements.
Well done Adeo! It is nice to have you as an exponent for founders…
Jeez, I really hope that upcoming entrepreneurs can fully appreciate just how valuable this topic and this template term sheet are. It’s hard to describe how much time, energy, and emotion (beyond the legal fees) have typically gone into crafting agreements like this and wrapping our heads around what may or may not be key issues.
Hugely valuable.
We might also benefit from a recommended standard size of the initial option pool (% basis). Certainly there are cases where it may need to vary, but there is a risk that entrepreneurs and vc’s will come at this deal point from very different perspectives.
Some investors may use the initial pool as a tool to drive down price per share (which is not always obvious to folks, since many negotiations revolve around ownership stakes rather than share price). Even the perceived risk alone complicates the thought process for the entrepreneur, who often (not always) just wants to do whatever is considered “fair”. Meanwhile, above-market compensation strategies can always be handled in alignment post-funding by issuing more shares (out of both pockets).
Even if we can’t move all the way from negotiating ownership hurdles to real valuation/price per share, you could help us bring more transparency to the process and remove a few more cycles by guiding both sides towards a balanced pool figure, because it is an important deal point that can affect capital structure.
Althought I applaud the effort at eliminating unnecessary paperwork and negotiations, a very small part of the attorneys fees and time to close a transaction is due to a lack of a good template term sheet. 95% of the time and cost associated with a financing is around legal due diligence, reps and warranties and their associated Schedule of Exceptions, negotiations with former investors, clean-up work on corporate structure, etc. In SIlicon Valley, there has always been a de facto term sheet associated with a given round of financing among the various established law firms/venture firms, so this is more of a marketing statement than a real change.
The value in posting a good termsheet template and having this discussion is that it helps entrepreneurs get a perspective of what they can expect. They can tell if they are getting a reasonable deal, and even what terms they should pay attention to. Thanks to Adeo for posting it, and Chris and Fred for bringing up this idea.
Three points I’d suggest:
1. Founders subject to restricted stock agreement. If they haven’t already done this prior to the round, their stock needs to become subject to repurchase – about 4 years, with some vesting for “time served”.
2. Single trigger acceleration. OK to have “some” stock accelerate at acquisition. Not sure how much of Founder’s shares Adeo expects are Series F Common but to be clear, usually a percent of the Founders shares should accelerate (or expressed in “months” something like 6 months). Double trigger (acquisition and termination w/o cause should be full acceleration.
3. Invention assignment agreement signed by all employees. Some leave this out of the term sheet, but it will be in the closing docs so I prefer to make sure it’s understood.
Finally, I agree with Non-participating preferred in general. In almost every case, the Preferred should have a choice to convert to common or take the liq. pref. There are always exceptions as Fred pointed out, but this is the right place to start.
bend over and take it!
I haven’t read them for years so don’t remember the terms, but the NVCA puts out standard docs.
http://www.nvca...&Itemid=136
Nickelback sucks, but Limp Bizkit blows.