How to Raise Money from a Venture Investor | Summary and Q&A

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June 14, 2019
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a16z
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How to Raise Money from a Venture Investor

TL;DR

This video series explores the mechanics of fundraising and how to interpret the terms of a term sheet to have a meaningful dialogue with venture capitalists.

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Key Insights

  • ðŸĪŠ Choosing Delaware as the state of incorporation offers legal advantages and a seamless path to going public.
  • 🏃 Entrepreneurs should exercise caution when navigating potential conflicts of interest between their current employers and side projects.
  • 🏁 When determining funding amount, it's essential to consider future investors' expectations and milestones required for their participation.
  • ✋ Balancing valuation and ownership can be challenging, with high valuations potentially impacting future financing rounds and employee perceptions.
  • 😘 Convertible notes are a popular choice due to simplicity and low legal costs but can inadvertently lead to share dilution if not carefully managed.
  • 🏂 Independent board members can provide balance and expertise, but their inclusion is usually more common as the company approaches an IPO.
  • 😊 Pro-rata rights allow existing investors to participate in subsequent rounds, but the amount of participation can vary depending on the company's growth and investor preferences.
  • ðŸŠĄ Stock restrictions can limit the ability to sell shares, and striking a balance between employee incentives and the company's financing needs is crucial.
  • 🏃 Lengthening the exercise period for employee options can be employee-friendly but can also create an overhang of unexercised shares.

Transcript

hi welcome to the a 16c YouTube channel I'm Frank Chen today I'm here with Scott Cooper and we're doing a three part series you've landed in part two which is all about fundraising what we're gonna do is dig into the mechanics of how you work with a VC during the fundraise process how you interpret the terms of the term sheet and hopefully this wil... Read More

Questions & Answers

Q: Why is Delaware a popular choice for incorporating a business?

Delaware offers a well-established legal framework, extensive legal precedent, and allows for different classes of shares and easy transition to going public.

Q: How can I protect myself from my old company coming after me?

To ensure you own the technology, avoid using work laptops, maintain physical separation, and take leave or quit your current company before commercializing your own idea.

Q: How much money should I aim to raise in a Series A round?

The amount should be based on the milestones and objectives necessary to attract the next round of financing, keeping in mind the need for a favorable valuation increase.

Q: Why should I be careful with high valuations during fundraising?

High valuations can lead to diluted ownership and potential issues in subsequent financing rounds, making it challenging to show progress and impact employee engagement.

Summary

This video is part two of a three-part series on fundraising. In this part, the focus is on the mechanics of working with a venture capitalist during the fundraising process and interpreting the terms of a term sheet. The goal is to help entrepreneurs understand the terms and the art and science of fundraising.

Questions & Answers

Q: Why do I need to be a Delaware C Corp?

Being a Delaware C Corp is beneficial due to the legal precedent established in Delaware and the well-established legal framework for different classes of shareholders, which is important for growth and going public.

Q: What advice do you have for someone still working at a company before incorporating their startup?

It is important to have a clear understanding of who owns the technology developed while working at the company and to avoid using work resources for personal projects. Taking a leave of absence or quitting the job when the startup becomes a real thing is recommended to avoid any conflicts.

Q: How much money should I raise and should I mention a specific check size when talking to VCs?

The amount of money to raise depends on the objectives and milestones needed to raise the next round of financing. It is important to think about the pitch for the next round of investors and work backward to determine the amount of money needed. It is appropriate to mention a specific check size and articulate what can be accomplished with that amount.

Q: What are liquidation preferences and why are they important?

Liquidation preferences determine the order in which money is paid out in the event of a sale or liquidation of the company. It is important for venture capitalists to protect their investment, but it can also create tension if the founder and common shareholders are left with nothing. A 1x non-participating liquidation preference is commonly considered more entrepreneur-friendly.

Q: What are the potential risks and concerns with liquidation preferences?

The risks include potentially postponing the inevitable and not knowing the impact of the liquidation preferences until the next financing event. Additionally, the structure of the liquidation preferences can create tension and negative signaling effects with subsequent investors if expectations are not managed.

Q: Why should I consider adding an independent board member and when should I do it?

Independent board members provide a balanced perspective and can bring industry expertise or skills in specific areas like sales and marketing. It is recommended to add independent board members as the board grows in size, generally around the time of the Series B or C funding rounds. Going public also often requires having independent board members.

Q: What are pro-rata rights and how should I have a conversation with investors about them?

Pro-rata rights allow existing investors to invest additional funds in subsequent funding rounds to maintain their economic ownership in the company. It is important to have clear communication with investors and align expectations regarding participation in future funding rounds.

Q: Should I expect my early investors to participate in subsequent funding rounds?

Generally, early investors are expected to participate in subsequent funding rounds, but it may vary depending on the firm and the situation. It is important to discuss and align expectations with investors early on to avoid signaling concerns with new investors.

Q: What are stock restrictions and how should I think about them?

Stock restrictions are limitations on selling shares, typically applied to investors and sometimes employees. It is important to strike a balance between providing flexibility for employees and not creating competition for capital with the company's own fundraising efforts.

Q: How should I structure employee incentives, such as vesting schedules and back-loaded options?

The traditional vesting schedule of four years with a one-year cliff is still the convention. However, there is ongoing discussion about longer vesting schedules and back-loaded options to incentivize employees to stay longer. There is currently no significant change in convention regarding this.

Takeaways

It is important to understand the mechanics of working with a venture capitalist during the fundraising process and interpreting the terms of a term sheet. Being a Delaware C Corp has benefits due to legal precedent and established frameworks. It is crucial to protect intellectual property when still working at a company to avoid conflicts. The amount of money to raise should be determined based on objectives and milestones needed to raise the next round of financing. Liquidation preferences determine the order in which money is paid out in a sale or liquidation, and it is important to carefully consider the structure to avoid negative consequences. Adding independent board members can bring necessary expertise and balance to the board. Pro-rata rights should be discussed with investors to align expectations. Stock restrictions should strike a balance between flexibility for employees and fundraising efforts. Employee incentives can be structured in various ways, but the conventional four-year vesting schedule is still the norm.

Summary & Key Takeaways

  • Delaware C Corp: Delaware is a popular choice for incorporating a business due to its extensive legal precedent and well-established legal framework for different types of shares.

  • Protecting Yourself: When working at a company while developing a new product on the side, it's crucial to ensure you own the technology and not risk any legal disputes with your employer.

  • Determining Funding Amount: The amount of money to raise depends on the milestones and objectives needed to secure the next round of financing, with consideration for future investors' expectations.

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