Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist is the definitive guide to venture financings. This book is for anyone who wants the insider's guide to raising money, negotiating deals, and to know what really makes venture capitalists tick. Don't believe us? Check out these recommendations:

A must-read book for entrepreneurs. Brad and Jason demystify the overly complex world of term sheets and M&A, cutting through the legalese and focusing on what really matters. That.s a good thing not just for entrepreneurs, but also for venture capitalists, angels and lawyers. Having an educated entrepreneur on the other side of the table means you spend your time negotiating the important issues and ultimately get to the right deal faster. - Greg Gottesman, Managing Director, Madrona Venture Group In my entrepreneurship class at Stanford, the number one topic is venture financing -- how it works and how (or even whether) to get it. There are no two better people to coach an entrepreneur through the venture process than Brad Feld and Jason Mendelson, and next to in-person guidance this book is the next best thing. I am planning to make this required reading for my class at Stanford. - Heidi Roizen, Fenwick and West Entrepreneurship Educator, Stanford University Technology Ventures Program I've been reading and loving Brad Feld's blog for years. He's one of my favorite venture capitalists on the planet. I'm delighted Brad and Jason have written the definitive book for entrepreneurs seeking to learn about raising and going through the venture capital process. - Bijan Sabet, Spark Capital I would highly recommend .Venture Deals. to any entrepreneur, venture capitalist, student, or casual reader who wants to get the .true scoop. on how venture deals come together and what the venture capital landscape truly looks like. The authors are not only veterans of the industry, but are willing to share their unvarnished views of what venture is all about. The reader will not find the insights shared here anywhere else. And, perhaps best of all, the authors write in an easily readable, casual style that makes the book quite fun to read. - Craig Dauchy, Cooley LLP Feld and Mendelson pack a graduate level course into this energetic and accessible book. The authors. frank style and incisive insight make this a .must read. for high-growth company entrepreneurs, early stage investors, and graduate students. Start here if you want to understand venture capital deal structure and strategies. I enthusiastically recommend. - Brad Bernthal, CU Boulder, Associate Clinical Professor of Law - Technology Policy, Entrepreneurial Law My biggest nightmare is taking advantage of an entrepreneur without even realizing it. It happens because VCs are experts in financings and most entrepreneurs are not. Brad and Jason are out to fix that problem with Venture Deals. This book is long overdue and badly needed. - Fred Wilson, Union Square Ventures Venture Deals is a must read for any entrepreneur contemplating or currently leading a venture-backed company. Brad and Jason are highly respected investors who shoot straight from the hip and tell it like it is, bringing a level of transparency to a process that is rarely well understood. Its like having a venture capitalist as a best friend who is looking out for your best interest and happy to answer all of your questions. - Emily Mendell, Vice President of Communications, National Venture Capital Association The adventure of starting and growing a company can exhilarating or excruciating.or both. Feld and Mendelson have done a masterful job of shedding light on what can either become one of the most helpful or dreadful experiences for entrepreneurs.accepting venture capital into their firm. This book takes the lid off the black box and helps entrepreneurs understand the economics and control provisions of working with a venture partner. - Lesa Mitchell, Vice President, Advancing Innovation, Kauffman Foundation

Today’s VC post of the day is from Albert Wenger (USV) and titled Presenting Option Grants to Boards. This is feedback I give to CEOs 98% of the time after my first board meeting. While there is no standard for how to present option grants, Albert lays out a very clear set of eight pieces of data he likes to see. The first four are the the columns in the spreadsheet and each employee / option grant are the rows. The next two are footnotes for options grants that aren’t standard. And the last two are contextual data that should always be included since board members are on multiple boards and won’t remember this from company to company.

Here’s are the eight pieces of data – go read the post for more details on why all eight are necessary.

Spreadsheet data:

• Employee name
• Title/role at company
• Absolute size of grant in number of underlying shares
• Percentage size of grant fully diluted

Footnotes data (for option grants that aren’t standard)

• Special vesting considerations that differ from the plan
• For refresh grants: how many options does the employee already have and how far are those vested?

Context data

• Total size of option pool and remaining available pool (absolute numbers and percentages fully diluted)
• Grant size bands by role (if you have established those already) — if not, include existing employees in similar roles for comparison (including their start dates)

Q: When we talk about the equity percentage numbers for those directors and other early participants, are these numbers based on the total number of shares prior to a funding event or does the base share number include those allocated for investors as well? As the shares for future investors are hard to predict, I assumed that the percentage numbers we talk about here are before any dilutions, is that right?

A: (Brad) The answer is "it depends."  When we have written about equity and compensation in previous posts, we’ve tried to provide some context for the stage of the company.  When we’ve done this, you should assume that this does not include future dilution from other rounds of investment.

However, there are no absolute guidelines.  For example, when you bring on an outside board director, whether it is at the Series A or the Series D, the stock option grant is usually in the 0.25% to 1.0% range.  While this is a wide range (see – there are no real rules) it gets more complex when a director has been with the company for a while and taken dilution from subsequent financings.  For example, assume a director joins at the Series A and gets a grant for 1% vesting over four years.  Three years later, the company has raised $30m and the directors grant now represents 0.3% of the company.  In some cases, the director would get an additional option grant to increase his ownership percentage (say – back up to 0.5%); in others he wouldn’t.  This is a function of the board, the investors, the entrepreneurs – all based on their view and assessment of the director’s contribution.

The same is true for employees.  Most employees will take the same dilution the founders take with subsequent financings.  This is relatively easy to deal with in the success case because the dilution is less significant and the value of the equity continues to increase.  However, in cases where the dilution is significant (e.g. a down round financing) employees need an "option refresh" – this is usually negotiated in the context of one of the financings.  In addition, as employees start to reach the point where their equity is fully vested (as they’ve been at the company for four or five years) there is often a refresh option grant.

There’s no simple answer.  And – any numbers we put on this blog are merely guidelines.  You mileage will vary dramatically with the situation.

Q: I work at a startup in the valley, and I’m wondering what happens to unvested shares in the event of acquisition? I.e., should I expect that they are canceled, accelerated, or stay on the same vesting timeline?

A:  (Jason)  The answer is “all of the above.”  Any of these are potential outcomes in an acquisition.  It really depends on the negotiating strength of the companies involved.  

Most “standard” employee option plans have a provision in it that says if the acquirer does not assume the option plan and does not keep the options on the same vesting schedule and other similar terms, they vest immediately prior to the close of the merger.  So in this case, they are accelerated.

However, there are plenty of times that the option plan is simply assumed by the new owner of the business.  Rarely, have I seen all of the unvested options be canceled with no payout to employees, as this would lead to the acquirer angering all of its new employees.

Note also, that when exercising options prior to the closing of a merger, one heavily negotiated item is who gets the exercise cash, the acquirer or the target company?  Usually, we see this go to the target company unless it’s a distressed deal.

Q: I thought i’d ping you on your thoughts regarding the non-cash compensation for key executives in strategic plays that aren’t strictly early-stage.. as an example, how would you structure your framework in providing equity comp to key executives in strategies involving turnarounds, consolidations and roll-ups etc.

A: (Brad): Equity comp for turnarounds / consultations / roll-ups for management and employees tend to be in the 10% to 20% range.  The structures vary widely, but they are usually some combination of stock, stock options, or a bonus pool based on performance.

It’s usually pretty easy to structure something that is fundamentally interesting to everyone in the success case although the style and approach of private equity investors tends to vary a lot.  Usually, the larger and less messed up the company is, the larger the base package tends to be.  This is counter-intuitive as you’d expect the most messed up companies to have the biggest upside for new management, but my observation (mostly indirectly, although directly in several cases) is that the patterns of comp tend to be more linked to the investors and their historical relationship with management (e.g. investors are more generous with either (a) people they’ve worked with before or (b) superstars that they want to work with.)

I’ve rarely seen situations where the non-investor equity ends up going above 20% in a turnaround or consolidation, but I’m sure there are cases where this has occurred, especially if management is founding the company and then bringing in investors.

Q: You’ve discussed the "typical" equity allotments for founders and senior management. But my question is about the perceived and real value (I presume they differ considerably in many cases) of stock options for employees beyond the first few dozen.  Do you have any historical perspective on whether options grants really drive wealth creation for any hires outside of early founders? Does "Employee #100" ever get rich off options? Does "Employee #1000"? At what point do stock options really cease being a major selling point for recruiting startup talent?

A: (Brad): While you have to define "rich", I’ll use millionaire as a proxy.  There are many examples of companies where the 100th employee made over $1m from stock options.  There are less examples of companies where the 1000th employee made over $1m, but there are plenty (Microsoft, Google, eBay, and Yahoo immediately come to mind.)

A successful company that manages its capital structure can always use stock options (or restricted stock) as a motivator.  The variance of outcomes decreases as the company gets bigger (e.g. it’s much easier to make a fortune as an earlier employee – but it’s also much easier to make $0 when the company fails) but in success cases the numbers can still be pretty large.

That said, if the valuation of a company gets ahead of itself at an early stage, stock options – especially in our new and exciting world of the 409a regulations – could end up having a lot less value because the strike price would be set unnecessarily high.

Dave Naffzinger’s post – Startup Stock Options: Should you Exercise your Options? is a must read post for anyone that has been granted a stock options.  I’ve worked with Dave in two companies and he’s a star.  This post is dynamite and while it doesn’t tell you a specific answer (there never is a "correct answer") it gives you the details you need to make an informed decision.

Jason and I welcome Matt McCall from DFJ Portage as today’s guest VC blogger.  We sent Matt one of our backlog questions – his response is below.  Matt also posted it on his excellent blog under the title How VC’s Determine % Ownership Thresholds.

Question: What’s a completely generic range of equity a VC typically wants for a round 1 or round 2 investment?

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). 

Question: As a start-up with no history and no customers (we haven’t launched yet) how do I figure out how much equity to assign to myself as the founder? I have spent the last one year developing and writing the business plan. I hired two consultants both MBA’s with real world experience to help in polishing the business model and writing the plan. They agreed to do the work on contingency basis to the tune 0f $18,000 so far. I haven’t issued any shares yet. Is it paramount that I issue shares before approaching funding sources. How do I value the company? A company in similar business sold recently for over $300 million and another sold for $1.5 billion. Of course these are mature companies, but still in the same business.

Answer (Brad): If you are the only founder, the answer is simple – 100%.  If there are multiple founders it’s a lot more complex and you may need to resort to arm wrestling or coin tossing.  Based on your question above, it sounds like you are the only founder, so you’ll own the company until the funding event. 

The actual number of shares are irrelevant – you can issue 1 (and own the 1 share – hence 100%), or issue 100 (and own 100 for the 100%), or issue 1,000,000,000 (and own 1,000,000,000 yourself – although I’d suggest this is both unnecessary and can cost you corporate taxes you don’t want in certain cases.)

Regarding valuation – there is no easy and short answer.  We’ve written about this before in How Do VC’s Determine Company Valuations? – I recommend you start there although every case will vary.

Dick Costolo (aka Ask the Wizard) has two excellent posts up titled Options Acceleration and Employee Options and Grant Size.  If you are granting options or receiving an option grant, these are both excellent posts to read.

Q: On average, what percentage of a company does the “typical” entrepreneur own by the time of a “successful” exit? Obviously, huge YMMW, but what’s a reasonable expectation, say, assuming two founders, middle-of-the-road terms from investors, two or three rounds of funding, and an acquisition? Or is the range so broad as to be meaningless? If so, what’s a reasonable upper bound?

A: (Brad) The short answer is “the range is so broad as to be meaningless.”  I love questions that don’t have precise answers, and this is a classic one.  I’ve been involved in companies where the founder equity (sum of all equity the founders have at exit) ranges from less than 5% to greater than 90%.  That’s a pretty big range.

If you assume the law of large numbers, you end up with a normal curve.  Without doing a detailed analysis, most of the deals I’ve been involved with where there are two founders, middle-of-the-road-terms, and two / three rounds of funding result in a tighter range – probably in the 20% – 40% range.  Again – it’s a normal curve so you’ll get higher and lower cases.