We recently selected our seventh class here at The Startup Factory (“TSF”). Assessing and selecting from 100 or more companies is always a challenge. It gets even tougher when we work with entrepreneurs who want to maintain something unusual about their company’s structure.
Part of the game in seeking and closing an investment is to make your company as “vanilla” as possible. Quality investors see a lot of deals. At both a conscious and sub-conscious level they are looking for reasons to say no. Thus our emphasis at TSF on your company having a legal structure that raises no questions and looks like the deals an investor has done before.
We do this in two ways at TSF. First, we work to create a “down the middle” set of investment documents. “Down the middle” means a number of things:
- The documents are fair to both TSF and the entrepreneur
- The documents protect TSF from key risks that we may encounter as an investor
- The documents set up the right incentive structure for both parties, and
- The documents will be viewed as professional and readily acceptable by future investors
Second, we work to make sure our deals include several elements that investors expect to see in a term sheet and the associated documents:
- Re-vesting of founder shares
- Preferred stock as opposed to common for investors
- Dividend rights
- Anti-dilution or price protection
- An option pool for attracting and providing incentives to future employees
At TSF, we’ve worked with several companies that objected to one or more of these features in their company. Sometimes the company has an alternative idea that it feels strongly about. In other cases, the founders object to a specific term like re-vesting their shares. Whatever the objection, it puts us in a difficult place as an investor.
If we accede to the request to modify the key terms of an investment we will make the entrepreneur we are negotiating with happy. But we will also likely make his or her route to later funding more difficult. This is because the value of having a “vanilla” structure is hard to overestimate.
Don’t standard venture capital documents change over time? Yes, they do but it’s better to try to adopt such innovations later in your company’s life cycle. Once you have traction, revenue and profitability your leverage to try such innovations will be stronger. Until then, vanilla is the flavor you want.