Too often, I see that returns and carry of VC’s supersede founder considerations. This manifests in financing deals and terms that are fundamentally unfair or unbalanced — where a team’s level of dilution is not in the companys’ best interest, yet the VC can’t see beyond its own personal gain. Or when decisions are made from a VC interest, ego or relationship perspective at the expense of the startup.
In the past few months, I’ve seen a good financing deal get vetoed by personal interest, a product decision forced on founders that is not in any way based on market understanding, investors taking over 40% in a seed deal for less than $500k, an investor threaten not to help close a deal unless it gets “a piece of the action”, and a VC operate under the guise of its “fiduciary duty to its LP’s” by renegotiating deal terms in its favor as the company it was going to back ran lower on cash.
This is not cool. So, a few takeaways:
1/ Your VC should back your idea, not its idea. As a founder, you are in for the long haul and you need to have conviction in what you are doing. You are working for the good of the company. If you do this successfully, your investors should get a great return.
2/ A founder should leverage its investors’ knowledge and network for the interest of the company and to complement his or her own needs. And you should not pay investors extra for it — not in cash and not in warrants.
3/ Taking an inordinate share in a business for too little capital simply kills the founder incentive and creates the environment for failure as there simply is not enough capital in the business to get anywhere.
4/ Pre-emptive rights are a tough issue to deal with as, after all, if one has rights, one is entitled to them. Pre-emptive rights should ideally be seen by the holder as an option to be exercised that balances the overall needs of the business, its future capital structure / funding and in consideration of incoming investors. For every investor that tells you it negatively affects their returns, I will show you others who ended up with a great return or dodged a bullet by not following rights fully or at all.
5/ Other than large VC funds in the early or middle stage of their lifecycle (i.e. ones who still have plenty of cash to invest), you’ll battle to have VC’s lead more than one or two additional rounds, or follow more than one additional round of financing. Plan ahead so that you know where your future funding will come from and the terms generally expected by that funder, and take into account whether or not your immediate funding provider can support you to that point.
(First published on my blog in sep-15)