Control - Founder vs. VC

What the greatest technology investors say about Control - Founder vs. VC

No One Gets More Diluted than the Founders

Fred Wilson venture capitalist  and Co-Founder Union Square Ventures

 Wilson discusses employee equity and dilution in technology and high growth businesses.   

“If anyone goes to the pay window, everyone goes to the pay window. [from [] Jeff Minch, [] JLM [] an active commenter on the avc blog].”

“[] If you [] sold [your company] for $100 million and you and your co-founders are gonna make a bunch of money [] you really ought to make sure that every single person who was involved in making that success happen makes a bunch of money too.”

“[] nobody will get more diluted than [the co-founders] because [the co-founders] are there at the very beginning and the dilution will happen over time.  And the person or the investor who shows up at the very end of the process might never get diluted.  The person who was there at the very beginning gets diluted the most.” 

“[] The sooner you can stop talking about equity in percentages and start talking about it in dollars is the sooner that you are going to own more of your company than you would otherwise.” Fred Wilson  April 19, 2012  MBA Mondays Live: Employee Equity - Archive and Feedback- video;

http://www.avc.com/a_vc/2012/04/mba-mondays-live-employee-equity-archive-and-feedback.html#disqus_thread

 

Early Stage Technology Investments Come Down to 4 'M's'

Mark Suster Partner Upfront Ventures and former entrepreneur

“[] [Almost] all VC investments in early stage technology & Internet investments come down to just four key factors []: management, market, money [i.e., valuation] and above all else momentum [i.e., mostly product momentum]. 

[] The number one thing that investors get their checkbooks out [for is] momentum.  [Momentum has various definitions]:  user numbers, revenue, channel partners, biz dev deals, [etc.]. 

[] [Suster’s investment decision is based] 70% [on] management, 30% [on] product. 

[] [Almost] all VCs care about investing in big markets with ambitious teams.

[] Most VCs want to own between 20-25% minimum of [a] company. [] [Investors need to] own enough [equity] to make it worth their time – thus “money”. And all of this is wrapped up in forward progress that [entrepreneurs] demonstrate over time.”   Mark Suster, The Four Main Things that Investors Look for in a Startup,  October 6, 2010

http://www.bothsidesofthetable.com/2010/10/06/the-four-main-things-that-investors-look-for-in-a-startup/

VCs Want Big Outcomes & May Block a Sale

Mark Suster Partner Upfront Ventures and former entrepreneur

“VCs want big outcomes.  [VCs] will demand a veto right over [a company sale].  [A founder] might be very happy selling [his] business for $9 million and owning 50% of the company.  [A] VC is not necessarily going to be happy getting $3 million for his 33% stake for which he invested $1 million.

[While that’s] a 3x return [] it’s still just $3 million and if the VC has a $300 million [fund] it is just 1% of the money [needed] to reach his “hurdle rate” of when he’s entitled to earn carry (e.g. big bucks).  It’s just too much time to spend [] for such a small total return.  Many VC’s would still let [a founder] sell []” but some would block the sale.  Mark Suster  Do You Really Even Need VC? July 22, 2009; http://www.bothsidesofthetable.com/2009/07/22/do-you-really-even-need-vc/

Fundraising Terms Pile Up with Later Stage Investors

Mark Suster Partner Upfront Ventures and former entrepreneur

“[] any [early stage terms] will certainly be asked for by future investors in [] later funding rounds so all of these terms pile up [after] 3-4 rounds of funding over a 5 year time frame. And by the time most companies get to an exit [which realistically is still 8-10 years,] often the founders own very little of the economic upside."  Mark Suster, Want to Know How VC’s Calculate Valuation Differently from Founders?  July 22, 2010

http://www.bothsidesofthetable.com/2010/07/22/want-to-know-how-vcs-calculate-valuation-differently-from-founders/

Select the Highest Quality Investor Available

Mark Suster Partner Upfront Ventures and former entrepreneur

 Suster advises entrepreneurs to select the highest quality and most experienced investors available.   It’s generally better for the company long term to have the right investors vs. optimizing every last piece of equity up front.  “Worrying about giving up an extra 10% [equity] at [an early] stage can be meaningless if the ultimate outcome is either success or failure.”  Mark Suster, Raising Angel Money, July 19, 2009; http://www.bothsidesofthetable.com/2009/07/19/raising-angel-money/

The VC “Squeeze” and Dilution

Mark Suster Partner Upfront Ventures and former entrepreneur

“[] most VCs have a 20% minimum [equity threshold] so bringing in multiple VCs can be very expensive in terms of dilution. [] The biggest problem [with 2 VC’s in a deal] is the “squeeze.” All VCs want to own between 25-33% [equity]”, above their internal 20% minimum.  A founder with co-founders can quickly get very diluted once an option pool is included.  “[]There are [] VCs [] who don’t cling to the old “20% or the highway” mentality [] and [Suster] suggest[s] [founders] seek them out.” Mark Suster, How Many Investors are Too Many? February 22, 2011http://www.bothsidesofthetable.com/2011/02/22/how-many-investors-are-too-many/

Dilution Benchmarks & Fundraising

Mark Suster Partner Upfront Ventures and former entrepreneur

Negotiations between entrepreneurs and investors include dilution and other fundraising terms.  “[] the “fairway” of [investor’s equity] is 25-33% per round [i.e., entrepreneurs’ dilution]. [] If [the entrepreneur is] “super hot” or “super experienced”, [he] can end up with much less dilution –in some cases 12-15%.  But this is the exception, not the rule.”

“[] [These] dilution numbers don't take an option pool into account [].  Options are additional dilution.”

“[] [Valuation can be driven up] ONLY if there’s [] competition [for] a deal.  [Investors stay honest when entrepreneurs] talk with multiple parties.”

Fundraising also requires considering how many future rounds are needed and expected total future dilution.  It’s not an arbitrary spreadsheet-driven exercise reflecting attaining profitability.  It requires “understanding [industry norms necessary] to build a successful Internet business and where [the company falls] on that spectrum given [its business type].”   Mark Suster,  8 Questions to Help Decide if You Should be Raising Money Now, February 17, 2011 and comments;  http://www.bothsidesofthetable.com/2011/02/17/8-questions-to-help-decide-if-you-should-be-raising-money-now/

The Option Pool Lowers your Effective Valuation

Babak Nivi Co-Founder AngelList and Venture Hacks and angel investor

“The option pool lowers your effective valuation.  Your investors offered you a[n] $8M pre-money valuation. What they really meant was, “We think your company is worth $6M. But let’s create $2M worth of new options, add that to the value of your company, and call their sum your $8M ‘pre-money valuation’”. [] Slipping the option pool in the pre-money lowers your effective valuation to $6M. The actual value of the company [] is $6M, not $8M. [] The [option ‘shuffle’] puts pre-money [valuation] into your investor’s pocket. [] the option pool only dilutes the common stockholders.  [] [The] investor’s norm is that the option pool goes in the pre-money.”   Nivi recommends using a specific hiring plan to more accurately determine option pool size vs. allocating some arbitrary percentage.  Babak Nivi  The Option Pool Shuffle  April 10, 2007;  http://venturehacks.com/articles/option-pool-shuffle

Tips When Raising a Seed Round

Babak Nivi Co-Founder AngelList and Venture Hacks and angel investor

When raising money in a seed round: “[] Take as much money as you can while keeping dilution between 15-30% (10%-20% of the dilution goes to investors and 5%-10% goes to the option pool).

Compare this to a Series A which might have 30%-55% dilution. (20%-40% of the dilution goes to investors and 10%-15% goes to the option pool.)

A seed round can pay for itself  if the quality of your investors and progress brings your eventual Series A dilution down from 55% to 30% (for the same amount of Series A cash).

Don’t over-optimize your dilution.  Raising money is often harder than you expect, especially for first-time entrepreneurs.”  Babak Nivi, Venture Hacks  How do we set the valuation for a seed round?  April 17, 2008;  http://venturehacks.com/topics/dilution

The Biggest Mistake Entrepreneurs make when Raising Money

Babak Nivi Co-Founder AngelList and Venture Hacks and angel investor

Nivi says “the biggest mistake entrepreneurs make when [] raising money” is that “[they] focus on valuation when they should be focusing on controlling the company through board control and limited protective provisions.   (Protective provisions let preferred shareholders veto certain actions, such as selling the company or raising capital.)

Valuation is temporary, control is forever.  For example, the valuation of [a] company is irrelevant if the board terminates [the founder] and [he] [loses his] unvested stock.

The easiest way to maintain control of a startup is to create good alternatives while [] raising money. If [the founder is] not willing to walk away from a deal, [he] won’t get a good deal.  Great alternatives make it easy to walk away.

Create alternatives by focusing on fund-raising: pitch and negotiate with all [] prospective investors at once. This may seem obvious but entrepreneurs often meet investors one-after-another, instead of all-at-once.

Focusing on fund-raising creates the scarcity and social proof that close deals.  Focus also yields a quick yes or no from investors so entrepreneurs can avoid perpetually raising capital.”  Babak Nivi, What’s the biggest mistake entrepreneurs make? , October 14th, 2007  http://venturehacks.com/articles/biggest-mistake; Why do investors want protective provisions? August 2nd, 2007;  http://venturehacks.com/articles/understand-protective-provisions

Investors Only Care About Returns & Control

Jason Mendelson venture capitalist and Managing Director Foundry Group

Generally investors only care about returns and control when making investments.

“[Entrepreneurs] should focus on terms like pre-money valuation, liquidation preferences, board of director elections, drag-along rights and protective provisions.   Most [other standard term sheet terms] aren’t really all that important.  [] Many of these terms have interdependencies and it’s important [to] understand how terms such as option pools, warrant grants and  the election of independent board members will affect returns and control.” Jason Mendelson, Do More Faster  by David Cohen & Brad Feld  copyrt 2011, Get Help with your Term Sheet  pg 238

Investors Only Care about Two Things

Jason Mendelson venture capitalist and Managing Director Foundry Group

“In general, there are only two things that investors really care about when making investments: returns and control.  Returns refer to the end-of-the-day financial return the investor will get and the terms that have direct impact on these economics.   Control refers to mechanisms that allow the investors to either affirmatively exercise control over the business or to veto certain decisions the company can make.”  Mendelson says that if an investor resists terms that don’t impact returns or control,  it may be a negotiating tactic, he may not be savvy or could just be a jackass.  Jason Mendelson, Do More Faster  by David Cohen & Brad Feld  copyrt 2011, Get Help with your Term Sheet  pg 238

Nothing More Dilutive & Morale-Crushing than a Down Round

Chris Dixon General Partner Andreessen Horowitz, angel investor and former entrepreneur

“[] if [an entrepreneur] expect[s] to raise more money (and [he] should expect to), make sure [the] post-money valuation is one that [he’ll] be able to “beat” [exceed] in [the] next round.  There is nothing more dilutive and morale crushing than a down round.” Chris Dixon, Ideal first round funding terms August 16, 2009;  http://cdixon.org/2009/08/16/ideal-first-round-funding-terms/

Think of Dilution over the Company’s Life & How Much to Raise

Chris Dixon General Partner Andreessen Horowitz, angel investor and former entrepreneur

“I prefer to think of dilution over the life of the company. Sometimes you give up more now to give up less later. []    I gave up 50%+ of SiteAdvisor to investors in the first round but in the long run was happy for it.”  That said, Dixon recommends raising “as much as possible while keeping [] dilution under 20%, preferably under 15%, and even better, under 10% [especially] for founders who aren’t experienced “developing and executing operating plans”.” 

“[] I know it sounds self serving as a seed investor but the path to least dilution is investors aligned with you on seed round where you don't raise too much money, and then raise the bulk of your money later.” Chris Dixon, What’s the right amount of seed money to raise?  Comments, December 28, 2009;  http://cdixon.org/2009/12/28/whats-the-right-amount-of-seed-money-to-raise/