How do you structure VC deals?

YC SAFE Note (form of convertible) has become the gold standard. One thing to keep in mind is how many SAFE notes you do before doing a price round. If there are multiple notes, then the compound effect might leave the founders diluted too much. Regardless of whether you go with equity or convertible, it's important to ensure that 🅰️you don't under raise 🅱️ you have a clear execution plan.

1️⃣ I have done Equity deals 💼, where I have helped startups raise $75 Mn capital 💵 from VCs in exchange for ownership 📈, and convertible deals 🔄 to raise $50 Mn convertible notes 📝 to add flexibility and benefit from future valuation increases 🚀. 2️⃣ Equity deals work for late-stage, and the valuation is determined at closing 📌, resulting in high dilution 📉. 3️⃣ In convertible deals, the conversion price is determined later 🕒, possibly offering less dilution and better value to VCs 🤝. 4️⃣ Convertible notes are complex 🧩 and often come with caps or discounts that affect the conversion price, providing additional protection for the investor 🛡️. They work for early-stage startups where determining valuation is challenging 🏋️♂️.

VC deals are no evergreens. The idea is not to build a dynasty but to fund a profitable exit - via trade sale/IPO. Without believing in an exit, there is no entry. Only 1 - 3 % of all businesses qualify for VC funding. Agency businesses scaling linearly with persons employed never make it, and product businesses targeting a niche with a small TAM do not make it, either. Businesses with recurring XaaS revenues and a large TAM are in demand. Most start-ups applying fail because even when they reach all milestones (which never happens) the calculated exit value is too small to save the VC performance. VCs need a few big winners, they know that 70 % of their investments will fail. The other 30 % must win big so the fund has a +20 % return p.a.

In the recent Series A funding round the startup was valued at $20 million based on its disruptive AI technology. Our VC firm committed $5 million for a 25% equity stake, implying a $15 million pre-money valuation. Terms were established, granting us one board seat and certain veto rights to protect our investment. Milestones were set, triggering additional funding rounds upon achieving key product milestones. The founder's shares were structured with a standard four-year vesting schedule and a one-year cliff. An exit strategy was also discussed, we secured a 1.5x preferred liquidation preference in the event of an exit. Due diligence was conducted covering legal, financial, and market assessments.

Both are great. However the essential factor is the social deployment of the capital Sustainably in Favour of the overall stakeholders equitably.

A late-stage VC once engaged me as an advisor 🤝 when they decided to invest in a startup that raised $75 Mn 💰 at a $875 Mn valuation at 15% dilution. At 1x liquidation preference, VC will get their $75 Mn investment 💵 before any other shareholder if the startup gets sold or liquidated. VC will have antidilution protection 🛡️ if the startup raises capital at a lower valuation. In exchange for the investment, VC got two board seats 🪑 and voting rights on future financing 🗳️. After 100 exhausting days 📆, working 12 hours a day ⏰, a $75 million investment was secured at a $875 million valuation. Negotiating and settling on these terms is time-consuming ⌛ and requires legal acumen 🎓 and strong negotiation skills 💪.

In my view key terms can be broadly categorized into Ownership and Governance. Ownership terms include factors like the equity stake an investor receives, pre-money valuation, anti-dilution provisions, and convertible notes. On the other hand, Governance terms encompass board seats, voting rights, drag-along and tag-along rights, and information access. These terms collectively shape the investor's role, ownership percentage, and influence in the startup's journey.

Interest rates have risen dramatically. For investors, things have changed on how they will be using their money/fund. If you are a startup looking for money, please have a good VC lawyer to help you review your term sheet. There will be more "ingredients" in the term sheet because of the cost of capital. It just won't be only your valuation that is impacted.

Don't forget that future investors would like to have at least the same rights you give in your first round of investment. Be careful on what you give and run scenarios with your advisors, especially regarding liquidation preferences. Usually, your employees will have options for ordinary shares, meaning, they will get hurt the most from the liquidation preferences. Negotiate smartly the rights of your employees - you owe them the success of the company.

In addition to the 4 phases of VC deals, I would recommend preparing and discussing the 5th Phase which is the “Post Investment / Partnership” phase. As value-adding investors, it is important the support the startup after the investment in this phase. Where and how will you support the startup in growth, will you provide further resources beside capital. It is a phase which requires agreement already during negotiation phase and is critical for the startups and VC investment success

1️⃣🤝 I advised a Startup Raise Capital from Sequoia in the food delivery market 🍔🚚, which was an exciting prospect for VC. 2️⃣🎤 The startup stood out during the pitch sessions 🗣️, owing to its approach to logistics 🚛 and restaurant partnerships 🤝🍽️. 3️⃣🔍 Sequoia dug deep into the firm's unit economics 💵, growth metrics 📈, and competitive positioning 🥇. They validated the scalability of the business model 👌. 4️⃣📝 We secured multiple funding rounds 💰, each with their own term sheet 📄 and SHA 📜. 🎉 We Succeeded due to: 🤝 A better investor/founder fit not just in the business model but in working style 👥 and vision 🌠. 🏆 VCs' reputation can affect sourcing because startups want to pitch to VCs with a solid track record

Having knowledge of market terms is essential to any early-stage founder when going into any negotiation. It is important to understand certain factors such as typical dilution per round, median valuations, and preferred stock terms. Fortunately, there are many great open source resources that help founders gain fluency in these areas, including Carta, CB Insights, and Pitchbook!

📚 My learnings from negotiating 20+ deals for startups in the last year during the funding winter ❄️: 1️⃣ The party who is less desperate generally holds more sway 🤹♀️. Prepare backup plans 📝, possibly talking with multiple investors 💼, which can provide you leverage during negotiations 🤝. 2️⃣ Not just financials 💵 and growth 📈, but also culture 🎭 and values ❤️ should align. This is a long-term relationship 👥, and you need to be comfortable with who you're doing business with 🤗. 3️⃣ It's essential 🌟 to discuss what the post-investment relationship will look like 👀. What sort of reporting 📊, meetings 🗓, or involvement 🤲 do the VCs expect? 4️⃣ Legal fees ⚖️ are expensive 💸, negotiate if investors can share the expense 🤔.

Over the past 20 years I've done 6 start-ups and in the institutional fund I run have done 69 deals. Negotiation begins authentically when both parties want to make a deal and requires listening and understanding how both parties view the deal "success." Defining success in the deal is the first step in successful negotiations which often, more likely than not, is a compromised final outcome that leaves the door open to a sustained relationship and continued long term success. While many try to negotiate from a disadvantaged position of power to gain the "best" deal terms, this is unlikely to lead to long term successful deals which afford both parties the opportunity to continue to work together. Be fair, honest, flexible.

Having done many equity & debt/equity investments, my biggest recommendation are (1) be fair (it’s the start of a partnership and not an one-time deal), (2) be prepared in terms of what is important to you and what is less important to you and (3) choose good partners and focus as well on less-sexy, but very important terms (anti-dilution protection, liq pref, etc).

A valuable tip for founders fundraising is to remember that valuation is not the sole measure of success. It's a common pitfall to fixate on achieving a high valuation, but it's equally crucial to consider the terms and conditions of the deal. Sometimes, a slightly lower valuation with favorable terms and a supportive investor can be more advantageous in the long run. Building a strong partnership with your investors and ensuring alignment on strategy and goals can outweigh the allure of a higher number. So, focus on the bigger picture, not just the valuation figure.

Unlike frequent investors, founders rarely navigate multiple VC negotiations. Two key resources for successful deal-making are "Venture Deals" by Brad Feld and "Secrets of Sand Hill Road" by Scott Kupor. These books are VC "bibles" that can tip the scales between a good and bad negotiation.

As said above, the best way to get to a VC is via a "warm" introduction. But think hard before you ask for one. Is this the right VC for me? Does my company match their investment strategy? If not, could they introduce me to the right people? What am I getting except for money (mentoring, connections to potential clients? follow up investment? etc.)