Notes on Venture Deals
Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist by Brad Feld
Original notes here.
Founders should not entrust the heavy lifting of fundraising to their lawyers. If the lawyer you hire does not get along with a future investor, you could have a major problem.
The most senior people in a venture capital firm usually carry titles such as executive managing director or founding general partner (GP), and they hold the power to make or break an investment.
Principals or directors are generally lower in rank. Investment associates are usually not the decision-makers on investments, and their work is highly miscellaneous; they may be the people who spend the most time on the capitalization table (cap table). Analysts are generally the most junior and have limited authority.
Having a capable lawyer who understands venture capital fundraising is an enormous blessing. Experienced venture lawyers will set a fee cap in advance. For a very early-stage fundraising, the fee might be around $5,000 to $15,000 over the first one or two years.
The goal during the fundraising stage is to obtain as many term sheets as possible.
The amount you are raising must be specific; it cannot be a range. Do not raise more than you need, or financiers may conclude that you will not be able to reach your fundraising target.
A good venture capitalist will not ask a company with no revenue and no product to produce detailed five-year financial projections in its first fundraising round.
A good venture capitalist will give you a list of businesspeople they have worked with before.
If they decide not to invest in your business, be as polite as possible and ask them to tell you why. This is an extremely valuable lesson.
The closing stage generally begins with signing the term sheet and then signing the definitive documents. A well-known venture capitalist generally will not sign the former and then fail to complete the deal, because that would seriously damage their reputation.
The final agreements are generally handled by the lawyers.
The things venture capitalists truly care about, and the terms that truly matter, are economic interests and control. Other provisions, such as S-3 registration rights, are almost never used. askthevc.com provides free standard-form documents.
Economic interest means the return the investor ultimately receives, usually when the company is sold or goes public through an initial public offering (IPO).
These are the two things you need to watch from every angle. They determine who wins and who loses.
The first valuation trap: when a venture capital firm says, “My valuation of the company is $20 million, and I’ll invest $5 million,” what they usually mean is a post-money valuation. In other words, they want to invest $5 million in exchange for one-quarter ownership of the company. A founder may mistakenly think the figure refers to the pre-money valuation.
The second valuation trap: a venture capital firm may want the employee stock-option pool to be larger. A sufficiently large pool means there is no need to worry about running out of options to grant, reducing future dilution risk. But the size of the pool is included in the company valuation, which lowers the actual pre-money valuation.
Suppose the pre-money valuation is $20 million, the venture capital firm invests $5 million, and the existing option pool represents 10% of the reserved but unissued shares. The venture capital firm wants it to be 20%. The additional 10% must therefore come out of the pre-money valuation, reducing the valuation from $20 million to $18 million.
In negotiations, you can start with the size of the pool, asking for 15% rather than 20%. You can also start with the pre-money valuation: agree to 20%, but increase the price to $22 million, or move the additional percentage into the post-money calculation.
A warrant is the right to purchase a certain number of shares at a predetermined price during a specified period. Adding warrants to a fundraising often creates unnecessary complexity and accounting problems later, especially in the early stages.
In later fundraising rounds, existing investors often insist that new investors come in at a higher price in order to minimize dilution. But if no new investors can be found, the round will usually be done at the same price as the previous round—a flat round—or at a lower price—a down round. Eventually, new investors will look at whether the existing investors are willing to put in more money and will offer the lowest price at which they believe the deal can be completed.
A venture capitalist’s valuation takes into account the company’s stage of development, whether there are other sources of capital available (competition naturally drives the price up), the founder’s track record and the team, the numbers (historical performance, future projections, revenue, EBITDA), and the economic environment.
Mergers, acquisitions, and changes of control are all liquidation events. After price, the key economic-interest term is liquidation preference. Venture capital firms generally want this right. The customary term is a 1× liquidation preference. During the dot-com bubble in 2001, investors repeatedly pushed the multiple higher, at one point reaching as high as 10×, before eventually returning to normal.
There are three types of liquidation preference participation: full participation, capped participation, and non-participation.
Case: A company has raised only one round. The pre-money valuation was $10 million, and it raised $5 million. In other words, the Series A investors own one-third of the company, and the founders own two-thirds.
Someone now wants to acquire the company for $30 million:
1× liquidation preference, non-participating: the investor receives either one-third of the shares or $10 million in cash; the founder receives either two-thirds of the shares or $20 million.
1× liquidation preference, fully participating: the investor first receives $5 million, then one-third of the remaining value, or $25 million ÷ 3 = $8.33 million in cash; the founder receives two-thirds of the remaining $25 million, or $16.67 million in cash.
1× liquidation preference, 3× capped participation: the investor is in the same position as under full participation so long as the investor has not earned more than three times the investment.
If the acquisition price is changed to $100 million:
1× liquidation preference, non-participating: the investor receives either one-third of the shares or $33 million in cash; the founder receives two-thirds of the shares or $67 million.
1× liquidation preference, fully participating: the investor first receives $5 million, then one-third of the remaining $95 million, or $31.35 million in cash; the founder receives two-thirds of $95 million, or $63.65 million in cash.
1× liquidation preference, 3× capped participation: the investor has already earned more than three times the investment, so the result is the same as under non-participation.
When new investors enter later, there are generally two methods. The new investor’s preference can be placed on top of the earlier investors’ preference, known as a stacked preference, or everyone can have equal rights, known as pari passu.
A company has a Series A pre-money valuation of $10 million and raises $5 million. Before the Series B, the company is valued at $30 million and raises $20 million. Now, because of poor market conditions, the company is sold for $15 million.
Under a stacked preference: the entire $15 million goes to the Series B investors.
Under pari passu: Series A gets 20% and Series B gets 80%.
If the sale price is below the $25 million in liquidation preferences, the founders receive nothing.
The author believes that any arrangement that deviates from a simple participating preference is merely the result of the venture capital firm’s greed. Founders should band together to restore the kick-out provisions that were discussed by companies in the mid-1990s, allowing participation rights to disappear once a significant return has been achieved.
Under a pay-to-play provision, investors must participate proportionally in future financings, or their preferred shares will convert into common stock. If they participate but not proportionally, only the corresponding non-participating portion will convert into common stock.
The provision is usually worded as follows: “In any Qualified Financing, any investor holding Series A Preferred Stock who has participation rights but does not fully participate in such financing by purchasing shares sufficient to maintain its percentage ownership shall have its Series A Preferred Stock immediately converted into Common Stock.”
This is generally beneficial to both the company and the investors. It reduces the liquidation preference of investors who do not participate in subsequent distributions; they must agree to invest in future rounds in order to preserve their preferred shares and the rights attached to them.
The concept of vesting is simple but has far-reaching consequences.
The provision is usually worded as follows: “All shares and share equivalents issued after the closing to employees, directors, consultants, and other service providers shall be subject to the following vesting provisions, except for grants approved by a majority of the Board of Directors: 25% shall vest one year after issuance, and the remaining 75% shall vest monthly over the following three years.”
Unvested shares disappear when the person leaves the company. They are no longer allocated, and everyone else’s ownership increases proportionally. This is what is known as “reverse dilution.”
Beyond simple vesting, other strategies can also be considered, such as allowing the company to require the founder, upon departure, to sell the unvested shares back to the company at the same price as the fundraising.
Single-trigger acceleration means vesting accelerates automatically upon an acquisition. Double-trigger acceleration means vesting does not accelerate until a second event occurs. The latter is more common. Venture capital firms want to reduce the effect that freely tradable equity has on the sale price, while acquirers generally want founders, management, and employees to retain their unvested shares and their incentive to keep fighting. Otherwise, the cost of those incentives will be factored in, reducing the amount available for distribution.
It is usually written as follows: “In the event of an acquisition, merger, sale of assets, or other change of control, any employee who is involuntarily terminated by the company within one year shall receive an additional one year of vesting, and no acceleration of vesting shall occur except under the circumstances described above.”
A reasonable acceleration structure would be something like double-trigger acceleration with one additional year of vesting. Many venture capitalists, however, have their own practices. Some never agree to single-trigger acceleration, while others are not particularly concerned about it.
There are also anti-dilution provisions protecting investors. The advice to founders is not to waste their energy trying to avoid them. The focus should instead be on minimizing their impact by creating value for the company, making the provision irrelevant.
The terms above concern economic interests. The terms that follow concern control.
Board seats: At an early stage, a board generally has five seats:
Founder, CEO, venture capitalist, second venture capitalist, and outside director.
With the voting power distributed equally among the directors, the venture capitalists have sufficient influence.
Protective provisions: these are veto rights over specified corporate actions.
The following examples are generally reasonable:
Changing the rights, preferences, or privileges of the Series A Preferred Stock.
Increasing or decreasing the number of authorized shares of Common Stock or Preferred Stock.
Creating any new class of stock with rights, preferences, privileges, or other terms equal to those of the Series A Preferred Stock.
Amending or waiving any provision of the company’s charter or bylaws.
Issuing more than $100,000 in debt (this limit is better raised).
Increasing or decreasing the number of board seats (this only matters when holders of Series A Preferred Stock represent a sufficiently large portion of the basic ownership structure).
Investors who try to control a company through the number of board seats they hold are being very short-sighted, because directors are legally required to act in the company’s best interests.
Protective provisions can occasionally help founders too, especially when the company is being acquired. Because the investor has veto rights, those rights become bargaining leverage for the company in negotiations with the acquirer.
Ten years ago, negotiating protective provisions could take several days. Later, these provisions came under close scrutiny in court, and they have since become broadly standardized.
Drag-along agreement.
The provision is usually worded as follows: “The founders and holders of Common Stock and Series A Preferred Stock shall enter into a drag-along agreement. Upon the approval by the holders of a majority of the Series A Preferred Stock of a sale or liquidation of the company, the remaining holders of Series A Preferred Stock and Common Stock shall consent to and not object to such sale.”
When a venture capital firm proposes this condition, the most common compromise is to try to make the drag-along right subject to approval by a majority of the Common Stock rather than a majority of the Preferred Stock.
Preferred-stock investors can convert into Common Stock and thereby naturally become the majority. This can also benefit common shareholders because the liquidation preference is reduced.
Conversion
When a company funded by venture capitalists goes public, underwriters almost always require shareholders to convert all shares into common stock. Cases like Google, where a company went public with two classes of stock, are rare.
The automatic-conversion threshold is a major negotiating point. Founders want to lower the threshold; investors want to raise it. Most importantly, never let investors holding preferred shares from different fundraising rounds negotiate different automatic-conversion conditions. Many bad precedents originate this way. For example, a later-stage investor may say the threshold is too low: “Since whether this deal gets done depends on me, I will not agree unless I get benefits such as these.”
The automatic-conversion provision is usually worded as follows: “All Series A Preferred Stock shall automatically convert into Common Stock upon the completion of a firmly underwritten public offering of the Company’s Common Stock at a conversion price then in effect of not less than three times the initial purchase price per share and with an aggregate offering amount of not less than $[X] million. Any portion or all of the Series A Preferred Stock shall automatically convert into Common Stock upon the consent of a majority of the holders of the outstanding Series A Preferred Stock to such conversion.”
After control and economic interests, the importance of the remaining terms drops somewhat; some are even inconsequential.
Dividends: make sure they can only be approved by a majority, or even a supermajority, vote of the board.
Adverse change redemption is an evil provision. Other redemption rights are like dividends; the key is simply to ensure that the board can be trusted.
Minimize conditions precedent to financing as much as possible. If a term sheet contains an exclusivity provision, make sure you understand the key terms before signing it.
Venture capitalists will generally request information rights. Arguing over this is a waste of time and legal fees.
There is no need to be stubborn about registration rights either. Once the company goes public, everything will look fine.
A right of first refusal is not a major problem and can even be beneficial, but it should be limited to the major investors. Give the right only to them.
A right of first refusal on Common Stock is beneficial to the company.
I have never seen a term sheet without a proprietary information and invention agreement. It is best incorporated into the hiring process, requiring everyone—including the founders—to sign it. After all, venture capitalists will not let this provision go.
A co-sale agreement provides that if founders sell their shares, investors can sell a proportional amount at the same time. This cannot realistically be removed, but a minimum threshold can be established.
If you do not agree to the founders’ activities clause preventing side jobs, then do not seek funding from professional venture capitalists. There are, however, exceptional cases in which founders have been allowed to serve multiple companies at the same time.
IPO share purchase: “In the event that the Company undertakes a Qualified Public Offering, the Company shall use its best efforts to cause the lead underwriter or underwriters of such offering to allocate to the investors at least 5% of the shares available for allocation by the Company.”
This provision was widespread in the late 1990s, when companies raising money from venture capitalists could often go public within a short period. However, most investment banks, seeing how fierce the IPO market was, would block the provision. Venture capitalists were usually so intoxicated by the prospect of the stock going public that they had no objection. The advice is that founders should not worry about this provision.
A no-shop agreement is like a marriage agreement prohibiting infidelity. It is designed to prevent founders from agreeing to a term sheet and then going off to work with someone else.
In my experience, no-shop agreements are eventually almost irrelevant. The character and personality of the people involved in the investment can produce radically different outcomes and are much more important than legal provisions.
Founders should also require that the no-shop agreement become void if the venture capitalist terminates the process, and should consider requesting an exception for an acquisition.
An indemnification provision provides that if any third party, including any other shareholder of the company, brings a claim against an investor arising from the financing, the company will indemnify the members of the board and each investor.
An assignment provision provides that each investor shall have the right to transfer all or part of the Series A Preferred Stock it has purchased to one or more affiliated partnerships, managed funds, or any of their directors, senior officers, or partners, provided that the transferee agrees in writing to be bound by the terms of the Stock Purchase Agreement and related agreements applicable to the purchaser.
This generally is not worth spending time or legal fees on. It merely gives venture capitalists some flexibility to request a transfer when the circumstances of the investment require it.
The cap table should be prepared personally by the founder, listing shareholding type, ownership, share price, valuation, and percentage ownership.
Convertible debt financing
Convertible debt is a loan that can be converted into equity in the next fundraising round, usually at a discount.
For example, you raise $500,000 in convertible debt with a 20% discount to the next round.
Six months later, venture capitalist A invests $1 million in a Series A round.
The company has effectively raised $1.5 million, and the venture capitalist receives 1 million Series A shares.
The financier receives 625,000 Series A shares ($500,000 at $0.80 per share).
Compared with an equity financing, the pros and cons are debatable. There is no standard answer.
It is simpler and more economical than a preferred-stock financing. In the past, it could save a great deal of paperwork and legal fees. Nowadays, equity financings have become cheaper, so the gap has narrowed.
It also means the share price does not need to be determined upfront. But even after the discount, the eventual conversion price will still be higher than the price those investors would have paid had they purchased the stock earlier.
For this reason, some investors establish a valuation cap: above X dollars, the conversion still takes place at X dollars.
For the investors in the next round, however, they will try to keep the company’s valuation below that cap. They do not want their own price to be much higher than that paid by the convertible-debt investors.
If the company undervalues itself when issuing convertible debt, even if the venture capitalist was originally willing to pay more, the investor may lower the offer after seeing the cap during due diligence.
To attract seed-stage investors, two additional terms can be considered for convertible debt: a reasonable period for the equity financing, with mandatory conversion once that period expires, and a valuation floor rather than a valuation cap.
For founders, the lower the interest rate on convertible debt, the better. You can look at how low the federal rate can go and then add only a small subsidy for volatility.
Issuing warrants is another way to structure a discount on convertible debt, but it is complex and relatively uncommon, so it is best avoided.
Everyone working at a venture capital firm is employed by the management company, which is separate from the fund it actually raises.
Venture capital firms generally do not keep much cash on hand. Instead, when they are ready to make an external investment, they call the money from the limited partners who signed the agreement. This is called a capital call.
The venture capital firm’s salaries are paid out of the fund’s management fee, generally 1.5% to 2.5%.
These management fees are usually recaptured and reinvested into the fund.
Most venture capital firms raise multiple funds, with one fund raised every three to four years on average.
But the biggest source of money is carried interest, or carry, which is generally 20% of the profits. Established firms or exceptionally profitable funds may even take 30%.
The venture capital firm can also expense reasonable costs for attending the boards of portfolio companies. The amounts are usually not very large. If they become extravagant, it can be brought up openly.
Venture fund agreements generally have a commitment period, also called the investment period, usually five years. This is the period during which the venture capital firm must find investment targets. Once it ends, the fund cannot invest in new companies and can only add to existing portfolio companies.
Some firms continue looking for founders after their investment period has ended without raising a new fund. They are derisively called “zombies.”
Ask them: When was your last investment? If they have not made an investment for more than a year, there is an 80% chance they are a zombie.
Then ask: How many new investments do you plan to make from the current fund? When do you plan to raise a new fund? If they cannot answer directly, the odds are very high that you have hit the jackpot.
A typical venture fund has a ten-year life, with two one-year extensions for a total of 12 years. After that, the limited partners must vote each year to approve allowing the general partner to continue operating the fund.
Venture capital firms generally reserve an amount for subsequent fundraising rounds, although they usually will not tell you how much.
Overestimating the reserve reduces the rate of return; underestimating it means there will not be enough to support every portfolio company.
Sometimes a later fund is used to fill a shortfall in the reserve of an earlier fund, but this can create complicated internal problems.
At the negotiating table, a founder in their early twenties may have less experience than a battle-tested venture capitalist, but they have one advantage: time. They can drag the process out until the venture capitalist loses patience.
Deliberately call just before the venture capitalist is about to leave work for dinner with the family, and pretend to ask for explanations of all the terms you “don’t understand.”
A useful tactic when dealing with a venture capital firm is to ask, before they show you the term sheet, which three terms they consider the most important. At the same time, prepare your own three most important terms.
When they later attack areas they did not mention, it becomes much easier for you to argue your case.
Be firm with bullies, straightforward with nice people, and with bureaucratic types, it is often best to go along with them while keeping your focus. “The Wimp” (on your own side) may be harder to deal with than enemies. With eccentric old-timers, stay cheerful, open-minded, and patient.
When walking away, think through your alternatives first. If there is no alternative, tell them frankly that you are not doing the deal. Make sure they understand where the negotiation has broken down and give them a chance to reconsider their position. Bluffing is pointless.
Your position will be much stronger if you can get all the venture capital firms to agree to invest at roughly the same time.
Be careful about how much you disclose and how much you withhold when using one term sheet to entice other venture capital firms to invest.
Never disclose the identity of the other parties you are negotiating with. They can exchange information and work together against you—unless you actively want them to form an investment syndicate.
Do not sign a deal and then become indecisive. The startup community is small, and information travels fast.
In any negotiation, it helps to make the other side feel good about themselves to some extent. Appeal to their interests and return the favor. For example, with a technical expert, spend more time discussing the details of the investment project.
Experienced negotiators deal with issues in sequence so that the other side cannot identify which points matter most to them.
Unless you have extensive negotiating experience, it is better to start with a few points that are easy to win.
Never prepare the term sheet yourself and present it to the other side. If they ask you to propose the terms first, it may indicate that they are not a professional venture capital firm—or simply that they are professionally lazy.
Do not let the other side handle each decision one by one, saying, “We have to settle this point before we can move on to the next.” By the time you look at the whole thing again, you may discover that the entire deal is in trouble.
Using weak arguments such as “That’s just how the market works” shows that the other side’s negotiating skills are not very good. Turn it around and ask them why those market terms should apply. If they cannot explain the logic, you have the upper hand.
A good lawyer is extremely important. You need to confirm their experience and get a recommendation. Ask entrepreneurs which lawyers they have hired. Smaller firms will usually cost less, and having someone else help keep an eye on the lawyer is safer.
When founders and venture capitalists negotiate openly and honestly, the result is usually much better.
When someone wants to acquire the company, be honest with the investors and work together to settle on the right deal structure. This is even more important when the acquirer tries to drive a wedge between you and the investors.
Six things you absolutely should not do: do not bring up a confidentiality agreement; do not spam investors; do not pester people relentlessly (there can be many reasons for a rejection—it may simply be that the two sides are not a good fit, not that they are testing your persistence); do not ask someone to introduce you (if they have already turned down your fundraising proposal, asking them to make an important introduction creates a conflict); do not go it alone (except in extremely rare cases, very few people can raise money single-handedly); do not exaggerate the importance of product patents (the idea and the execution matter much more).
In early-stage fundraising, be careful with liquidation preferences and protective provisions. In the middle and later stages, pay particular attention to the board, voting control, and valuation.
Letter of intent: the most important things are price and structure.
It is reasonable to assume that the number on the first page of the letter of intent represents the best-case acquisition price.
Sellers prefer an asset deal; buyers prefer a stock deal. A stock deal can be completed for cash, while an asset deal can also be completed with equity.
When a buyer proposes an asset deal, they are intentionally trying to avoid taking on the company’s specific liabilities and only want to buy the particular assets they like.
Asset deals are common when the economy is on shaky ground. For the seller, the most fundamental problem is that the company has not really been sold; what remains is a shell, along with the contracts, liabilities, and tax filings.
A stock deal means buying the entire company. The seller’s company is folded into the buyer’s corporate structure, leaving behind little more than a pile of corporate uniforms and the corporate logo that once hung on the wall.
Letters of intent usually begin by stating that the deal will be an asset deal, making that a major point of contention. A smart seller then prevails, and the deal finally closes as a stock deal.
If someone wants to buy your company with unlisted stock, then thank you very much—but have you ever seen an acquirer walk in offering to exchange a free software product for your company’s assets?
Letters of intent generally include option provisions. Not seeing them is a bad sign. Detailed is always better than vague.
Who bears the stock-option plan? Sometimes the buyer only assumes the option pool outside the base consideration. But if the buyer agrees to assume the stock-option plan, the total price is generally adjusted accordingly.
Most option plans provide that, before the buyer assumes the option plan, all options already granted will be fully vested before the acquisition.
A letter of intent will inevitably involve representations and warranties. These are statements of fact and assurances one party gives the other about the company. They may appear to be minor, but they can have enormous consequences and often consume astonishing amounts of legal fees during negotiations over the definitive agreement.
Do both the acquired company and its shareholders have to make representations, or is it sufficient for the acquired company to do so alone? Letters of intent usually do not specify.
It is advisable to at least outline the broad contours of the indemnification arrangements in advance, rather than first signing the letter of intent, deciding that the deal is going forward, and only then negotiating the details.
If the seller is receiving the buyer’s unlisted stock, the most reasonable approach is for the buyer to make representations and warranties as well.
An escrow arrangement is another major point of contention. It means the buyer holds back money for a period of time. If an issue emerges after the acquisition that was not disclosed in the acquisition agreement, the money can be used to resolve it. Normally, 10% to 20% of the total purchase price is held back by the buyer for 12 to 24 months.
If the buyer says the detailed numbers cannot be determined until more due diligence has been completed, that is simply nonsense.
Employment agreements should be negotiated neither too early nor too late. Many buyers use this tactic to put as much pressure as possible on the seller’s key employees at the very end. Ironically, many sellers think exactly the opposite: once the deal is more or less settled, it is time to put the screws to the buyer.
Do not let the exclusivity period exceed 60 days. If the deal is progressing but the exclusivity period is about to expire, the buyer should ask for an extension several days in advance. At that point, the seller can obtain additional bargaining leverage, such as removing a net-worth threshold.
A smart buyer will be very careful to confirm that transaction expenses are to be paid by the seller.
Serving as the seller’s shareholder representative is usually hard work with little reward. After the transaction, never appoint someone who has gone to work for the buyer as the shareholder representative. Nor should you appoint the venture capitalist. Some of them have no understanding whatsoever of the shareholder representative’s role.
One of the authors, Mendelson, co-founded a shareholder representative services company:
shareholderrep.com
Pay attention to the company’s intellectual property. You meet a friend for drinks and, while drunk, let slip everything about the model for your new company. Six months later, your friend suddenly says that they own half the company because the two of you created the original concept together over drinks.
Things like this happen constantly in the startup world.
The author disagrees with the position that you should simply remain constantly vigilant or make the other party sign a confidentiality agreement. The most important thing is to know who you are talking to.
Employment matters also require care and the assistance of a specialist lawyer.
The three best places to incorporate a company are Delaware, the company’s home state, or the venture capitalist’s home state.
Delaware corporate law is clear, business-friendly, and familiar to most U.S. lawyers. It has only two drawbacks: you may have to comply with two sets of corporate laws (your own state’s and Delaware’s), and you may have to pay more taxes.
Most investment banks will require you to incorporate in Delaware before helping take the company public.
U.S. law provides that only wealthy and sophisticated individuals may qualify as accredited investors eligible to purchase shares in a private company.
U.S. law provides that if you do not file an 83(b) election within 30 days of receiving company stock, you can lose the opportunity to realize the profit from selling the stock and may have to pay three times the amount of tax otherwise due.
In the past, the board of a private company could determine the fair market value of its Common Stock, and the IRS would accept it. As a result, the stock price used as the exercise price for employee options was generally only about 10% of the price of the Preferred Stock in the previous fundraising round.
Later, the IRS introduced tax rule 409A, imposing huge penalties for inaccurate option valuations. This made a great deal of money for 409A valuation firms, and valuations generally rose to 20% to 30% of the Preferred Stock price. That made the floor for monetizing the options—the exercise price—more expensive, leaving employees with less upside than before.
Ironically, tax revenue comes from corporate profits, yet this tax rule actually reduced the IRS’s revenue.
Finished reading on Dec 4, 2019
Feld’s guide arms you with the legal and financial literacy needed to survive the negotiation table, protect your equity, and secure the capital required to grow. But surviving the term sheet is only half the battle. Once the money is in the bank, the real test begins: building something people actually want.
To ensure that your hard-won capital isn’t wasted on building the wrong product, Startup Science maps out the next critical phase, providing a rigorous, step-by-step methodology for validating your market, building the right MVP, and scaling your business without burning through your runway.