Archive for the ‘Term Sheets’ Category

Convertible Warrants In A Series A Round?

Question: What’s your take on Convertible Warrants in a Series A round? What are the implications now and in future rounds for the entrepreneur as well as the VC?

(Jason) I like my Series A rounds to be simple. The A round is always precedent for future rounds. If you haven’t read our term sheet series, now might be a good time to start. Warrants effectively “hide” the valuation of the deal. You’ll see warrants in later round financings where the company doesn’t want to consumate a down round and instead decides to raise more money at the last financing price, but with some warrants included.

Yeah, I know, this really is a down round, as the warrants are additional benefit, but the company can say with a semi-straight face that it sold equity at the same valuation as the last round.

On a Series A deal, why play games with the valuation? Just figure out what makes sense from both sides and execute a deal? I can tell you that if I was looking to lead a Series B deal and the Series A folks had warrants, I’d make sure that I would include all of those warrants in your pre-money valuation. I’d also be pretty confused as to why this was done in the first place.

How Do VCs Discount For Lack Of Marketability of Stock?

Question: While valuing a private company and arriving at a valuation do VCs take into consideration a discount for lack of marketability. If at all, how do they objectively arrive at a figure for such discounts?

All of our deals have a lack of marketability in their securities. Startup companies, by definition, don’t have a trading market. We don’t figure this into our valuations, as it is just part of the business of investing in these types of ventures.

One note to consider: over the past few years, there have been several firms that have formed that will purchase private company securities. So, in fact, the marketability of private companies has actually improved over time. That being said, it’s still not something that we factor in.

Tim Wolters on The Liquidation Preference

Tim Wolters – the CTO of Collective Intellect – is in the middle of a financing and blogging about some of the terms.  Today’s is the liquidation preferenceIt’s interesting to compare it to what Jason and I wrote in 2005 about liquidation preferences in our Term Sheet series.

Example Term Sheet

Q: I’ve been re-reading back through your term sheet series as was wondering if you had a sample one that you could send my way (yes, I have found several others online already but they don’t seem to contain much of the same jargon that you give in your examples).  Also, I’m trying to find one most appropriate for an angel round.

We never got around to posting a redacted / sample term sheet, but there are a great set of sample documents up on the National Venture Capital Association web site including a term sheet, stock purchase agreement, and a variety of other standard documents. 

The model documents were drafted over the course of more than a year by a consensus process involving many of the leading VC lawyers in the country which constitutes the NVCA Model Document Working Group. These documents have now been through a second set of intense review, comment and revision by the current working group.

Annotated Term Sheet

Rick Segal has the helpful VC post of the day up on his site at Post Money Value titled Annotated Term Sheet and the Secret PrizeRick links to annotated term sheet for an early stage VC investment from lawyer Craig Brown at  Fasken Martineau DuMoulin LLP.  Having just read through this, it nicely compliments the Term Sheet series that Jason and I wrote on Feld Thoughts last year.

If you’ve never seen a term sheet before, this is a great place to start.  If you’ve seen plenty of term sheets but never completely understood all the terms, take a look.  If you think you know all the terms, take a look anyway – I bet you’ll learn something.  Make sure you also go to the post on Rick’s blog as he’s got a secret prize for you if you are interested.

What Are Standard Terms and Valuations?

One question that we’ve gotten several times is “what are standard VC deal terms?” For those of you who have followed Brad’s blog, you know that he and I wrote an extensive series on term sheet / venture terms. Over time, we’ll update these entries and bring them over to this site, but for now, you can find them here.

To answer your questions regarding what is a “fair valuation” for your deal, that is not an exact science. We’ve receive hypothetical questions like:

“How can I estimate the valuation of a 1 year old startup software company with about $500k revenue?” and

“If we are a healthcare play, is 20% equity for $1M and one board seat in a Series A considered the norm and fair?”

Unlike businesses that have operated for a while, it’s hard to use concrete metrics to derive business valuations. Normal techniques of discounted cash flow, comparable public comparison companies, etc. all are somewhat suspect with a new business enterprise.

There is not a single standard technique that VCs use to value companies. It’s part science, part experience and part “gut.” If the deal is competitive, then that figures into the price as well.

Consider that VCs do not invest in companies because of cash flow and revenue, rather the return potential on a company sale or IPO. If your company has 500k in revenue, that is a good sign that you have some customer traction (and that will help your valuation), but the exact number is somewhat irrelevant.  It’s about the potential exit value. 

As for whether or not $1M should buy 20% of a company in a Series A deal, that would imply a $4M pre-money. Without full knowledge of your company, it’s impossible for me to say what is a reasonable number, but we’ve done deals in this valuation range, so at first blush it’s not completely out of bounds.