Negotiating and Closing Your Series A
Coming to the end of your Series A round can drum up a few significant feelings. Relief, joy, fear, and excitement, usually top the list—just to name a few. While it may seem more comfortable to stand back and let things play out, now is the time to refill your coffee, so you’re extra attentive. Though you’re over “selling yourself” to venture capital (VC) investors, you still want your hands on every single part of this endeavor. We’ll show you how.
As the final post in our series on Series A funding, we explain negotiating details as well as how to close your Series A successfully. Featuring insights from a seasoned VC investor—Mike Rogers, partner at Interplay Ventures–we help you to make the most of your Series A round.
Let’s begin by reviewing the most crucial document in this entire process.
In the previous blog post of this series, we took a deep dive into term sheet details, which you can read here: Series A Term Sheet.
To recap, a term sheet is a blueprint for the business deal. It’s usually the first real piece of paper an investor hands you upon deciding to invest. This document outlines conditions for a particular investment. Lawyers frequently use the term sheet to draft legal documents to close the deal, though it’s not legally binding in itself.
Some vital parts on a term sheet include:
- Funding – Stipulates how much money you’ll receive and what conditions you’ll be receiving those funds.
- Corporate Governance – This portion outlines who’s in charge of the company; VC-friendly vs. entrepreneur-friendly stockholders can influence your company significantly.
- Liquidation and Exit – These are also part of the economics of the deal; who gets what money upon an exit event
Negotiating conditions on the term sheet is a reasonably standard procedure for entrepreneurs and VCs to trudge through. However, you must fight for the right things. Otherwise, you may end up feeling duped or extinguishing the deal altogether.
Although you want a say in every aspect of this deal, it’s vital to pick your battles wisely.
To start, work with the VC to land on a “fair” valuation for the company. This approach will get you started on the right foot. Unlike a decade ago, a handful of helpful resources exist to guide you in the process of assessing your company accurately.
When it comes to valuation, VCs attempt to find a deal structure that balances three key considerations. According to Mark Peter Davis, venture capitalist and author of The Fundraising Rules, the terms must be:
- More attractive than the entrepreneur’s other options
- Provide the VC with ownership sufficient to generate an acceptable risk-adjusted return
- Designed to provide key managers with enough equity to align incentives
Investors will propose a new (and rebalanced) cap table when issuing a term sheet. The cap table aims to ensure both parties that they each have sufficient stake in the company. It also confirms that incentives align with company leaders.
Keep in mind that the tricky part of any investment is making sure both sides benefit from the deal. In other words, the VC must meet investment requirements, and the entrepreneur must have plenty of incentive to grow the company. The cap table often represents a picture of this particular “juggling act.”
Next on your to-do list is to negotiate the option pool. More importantly, do your math when it comes to this point (10% is standard). VCs and entrepreneurs tend to calculate in different ways when considering the option pool dilution. Take your time and think ahead before landing on a solid figure.
Entrepreneurs often find it challenging to know how much equity to give people who join their team early on. Since you can’t take equity back once you’ve granted it to an employee, partner, or service provider, you must get it right the first time.
According to Davis, it’s vital to vest every equity grant that you make—giving the recipient rights to more equity as they achieve milestones.
A liquidation preference offers VCs assurance that they won’t lose money, even if your company shutters. A typical number is 1x liquidation preference, and anything higher is worth exploring (or fighting). Also, watch out for how participation rights and dividends are outlined on the term sheet. Some terms to pay attention to include preferred stock and common stock.
Frequently included on a term sheet is provision for dividends to be paid to the investor. Briefly, dividends are commonly structured in three ways:
- When declared
Keep in mind that investors will vary on which structure they use. However, the most common dividend structures are “when declared” and “cumulative.”
Control of the Company
In the seedling and Series A stages, it’s typical for an entrepreneur to maintain control of the company. With each new round you experience, though, you’ll likely lose a bit more power. While this is normal, it doesn’t mean you have to hand over the reins entirely.
You aim to equal out the playing field, having an even number of VC-friendly and entrepreneur-friendly stockholders. If one side is heavy, your company will sway that direction. Some key terms to consider when vying for company control include:
- Board of directors – Your governance body needs to remain balanced, as mentioned.
- Ownership Percentage – Stockholders will often make crucial decisions, too. As a result, your goal should be to keep this pool evenly balanced, as well.
- Participation rights – VCs typically require special provisions, but too many restrictions raise a red flag.
Pick a Closing Date
Most advice you’ll hear will be to close, once you’ve secured the funding, swiftly. However, the reality is that the closing date is typically a moving target. With so many parties involved, it’s often impossible to enforce a closing date.
Avoid the Costs
What’s more; is that the legal fees and interest income of a delayed closing are both substantial numbers. So, the sooner you can close, the better. But, again, you can’t always enforce a closing date.
Communicate to Close Fast
While you can’t necessarily dictate or enforce a closing date—VCs frequently run on their time table and no one else’s—you can practice effective communication to encourage a quick close. For example, let VCs know that you’ll be closing this particular round in a limited amount of time (e.g., two weeks). This approach will motivate them to get other VCs involved and to wrap up any loose ends for themselves.
Another crucial advantage of picking a closing date is that it sends the message to VCs that other investors are interested in or already involved with your company. Although it sometimes happens, VCs don’t like to be the only one at the party, per se. Often, either you have a hefty handful of investors interested, or you don’t have any.
Provide Investment Options
Before diving into this point, let’s review why people and firms invest. Understanding individual viewpoints will help you make sense of investment options—because it all boils down to business. And every participant will invest for their specific reasons.
Mike Rogers of Interplay Ventures explains, “VCs make money when they turn their money into more money. So, it’s a little bit of a different process than even an angel investor or someone else in the capital stack who’s maybe even investing their own money. They might do it more as a personal thing or an emotional decision. The fees, the dollars, that’s their salary. That’s the way they earn a living. So it’s just a little bit of a different mentality when deploying capital.”
That said, when the money you raise is in the form of debt, it’s an excellent idea to offer more than one option for round participation, such as:
- Varying threshold amounts
- Distinct time horizons
- Different repayment schedules
On the flip side, raising money in the form of equity calls for a separate approach. For starters, use convertible debt instead of preferred stock when it comes to your friends-and-family round. Although enforcing a minimum investment threshold would be great, make sure that you’re flexible on the investment amount. This approach is especially handy when you’re leaning on a handful of wealthy friends or family members.
Many professionals tend to think of the VC relationship like a romance—meaning, you must continue courting your partner to keep the flames burning. While “courting” means something different in the investor/investee relationship, the concept rings true.
For example, you can probably recite your entire business story in one meeting, including a concrete plan on how to move forward. But don’t.
Take your time and give VCs the chance to get to know you and your company more in-depth. Even in a new romance, it takes a few dates to get comfortable with someone. So, spread out this grace period over two or three meetings.
Take it a step further and arrange calls or meetings with previous investors or partners who will vouch for your business. This strategy will instill confidence in potential investors. Keep in mind that it’s best to make these introductions near the closing date—after VCs have committed—as opposed to the “first dates.”
Let’s be real; when you start dating a new person, there’s usually one friend or family member offering to do background checks on your new flame. We’re talking about stalking social media and paying the $20 for a full backstory. While this is undeniably one way to go about getting the nitty-gritty on a person, the VC world works slightly different.
For example, you’re never going to find out on social media what doubts or concerns VCs still have about investing in your company. Instead, you’re going to have to ask straight-forward questions.
Of course, asking investors about their concerns means you need to have the answers ready. Before opening up this specific dialogue, be sure to gather all of the information you’ll need to give a sufficient answer. At this point, you’ll likely be armed with loads of industry insight and can (hopefully) calm their nerves.
As your company evolves and you take on new professional endeavors, you’ll face unique exposures, as well—especially during a Series A growth spurt. Founder Shield specializes in knowing the risks you face at each stage of development, and we work to make sure you have adequate protection. Feel free to reach out to us, and we’ll walk you through the process of finding the right policy for you.
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