Simeon Simeonov, the Founder & CEO of FastIgnite, has put together a nice Stock Option Vesting Calculator. It works just fine for stock vesting as well.
Sim is a dynamite entrepreneur who has also done a tour of duty as a VC so he knows the drill well. In the email he sent me about it he said it was inspired to put it together after reading several of the posts in the Term Sheet Series that Jason Mendelson and I wrote several years ago.
Sim – next up – how about a simple liquidation preference and exit analysis calculator?
Suddenly the blogosphere is talking about the need for a standardized first round term sheet. The latest iteration of this seems to have blossomed when TheFunded Founder Institute released a “Plain Preferred Term Sheet” (developed with WSGR). According to the article in TechCrunch, the goal is to (a) protect founders and (b) reduce legal fees. Kudos for yet another shot at this – between all the blog posts that have been written about this over the past few years, term sheets are no longer a mysterious thing to an entrepreneur.
However, let me suggest that the problem is not “the idea first round term sheet.” We now have a bunch of these – the YCombinator one, the TechStars one, the NVCA model docs, and several from law firms (WSGR did the YCombinator one, Cooley did the TechStars one.)
I think the focus should be on standardizing the docs and having a handful of fill in the blank terms for a first round financing. I’ve done my share of financings with a set of bullet points in email (I just proposed one today) and I’ve stated that the only things people should care about in the first round financing is (a) valuation and (b) the amount raised. That said, there will always be a handful of other things to argue about in a first round investment – most notably vesting dynamics, change of control issues, and option pool size (which is really just valuation). However, you should be able to do this off of a one page checklist that everyone understands.
But let’s get back to the real issue – standardizing the docs. I read through the protective provisions in TheFunded Founder Institute (TFFI) term sheet and they are a version that leaves a few things out that are important to me. I like a tighter version.
First is the TFFI version:
“So long as 25% of the aggregate number of Preferred shares issues in the financing are outstanding, consent of at least 50% of the then-outstanding Preferred will be required to (i) alter the certificate of incorporation if it would adversely alter the rights of the Preferred; (ii) change the authorized number of Preferred Stock; (iii) authorize or issue any senior or pari passu security; (iv) approve a merger, asset sale or other corporate reorganization or acquisition; (v) repurchase Common Stock, other than upon termination of a consultant, director or employee; (vi) declare or pay any dividend or distribution on the Preferred Stock or Common Stock; or (vii) liquidate or dissolve.”
Following is the standard we use in all of our financings:
“For so long as any shares of Series A Preferred remain outstanding, consent of the holders of at least a majority of the Series A Preferred shall be required for any action, whether directly or through any merger, recapitalization or similar event, that (i) alters or changes the rights, preferences or privileges of the Series A Preferred, (ii) increases or decreases the authorized number of shares of Common or Preferred Stock, (iii) creates (by reclassification or otherwise) any new class or series of shares having rights, preferences or privileges senior to or on a parity with the Series A Preferred, (iv) results in the redemption or repurchase of any shares of Common Stock (other than pursuant to equity incentive agreements with service providers giving the Company the right to repurchase shares upon the termination of services), (v) results in any merger, other corporate reorganization, sale of control, or any transaction in which all or substantially all of the assets of the Company are sold, (vi) amends or waives any provision of the Company’s Certificate of Incorporation or Bylaws, (vii) increases or decreases the authorized size of the Company’s Board of Directors, (viii) results in the payment or declaration of any dividend on any shares of Common Preferred Stock, (ix) issues debt in excess of $100,000, (x) makes any voluntary petition for bankruptcy or assignment for the benefit of creditors, or (xi) enters into any exclusive license, lease, sale, distribution or other disposition of its products or intellectual property.”
Details, but important ones. The protective provisions in the TFFI term sheet include the word “adversely” in section (i) – this is simply “lawsuit bait” if it ever comes to pass as an issue. I also want a protective provision to disallow increases in Common Stock. And – given the board size, I want a protective provision that doesn’t allow the board to be increased without my consent. Finally, I want a protective provision against making an exclusive deal or license for the assets – this is another way of selling the company out from under the investor.
Now, I guess I’ll negotiate on these, but I can’t imagine why anyone would struggle with any of this. Except for the lawyers. Remember – we are still in the term sheet – just wait until the lawyers expand this into the actual financing documents. I’m sure the WSGR lawyers might have a different point of view, as might my lawyers, or any other lawyer that looks at this. Or, if the WSGR lawyer is on the other side of the deal (representing the VC) he might have an issue with the TFFI version.
Standardizing the deal documents would solve a huge part of this. Also, if the lawyers acknowledged that they aren’t adding much value at this level (e.g. it’s a simple negotiation and a straightforward thing to document), you could get to a place where lawyers should be able to do this for a low fixed price (say, $10,000). However, this has to be done at the legal level, or you don’t really solve the fundamental issue. Sure – you theoretically can streamline the process by starting with a better “form” that has been “pre-negotiated” (e.g. take it or leave it), but until you standardize the legal stuff behind the deal, you are always going to have lawyers armed with word processors redlining things.
I’m not unhappy about the effort to simplify this – quite the opposite – I’m delighted even more people like TheFunded are getting in the mix. However, I encourage everyone, especially the lawyers, to recognize the value in standardization of the underlying docs (with the appropriate “fill in the blank negotiated terms”). I’m not sure how to get this to a standard point, but it’s got to be easier than figuring out if universal healthcare is possible and – if so – solving for it.
Fred Wilson has a nice post up titled The Ideal First Round Term Sheet. In it he describes the process of closing a financing using a standard set of Series A terms from Gunderson that he agreed to as part of the term sheet. In this case, the VC (Fred’s firm – Union Square Ventures) isn’t using a law firm. Fred states:
“I’d like to see this practice become standard in our industry. We need to lower the time and cost of raising capital. We need to eliminate a lot of bad terms that have caused a lot of harm (tranched investments, mutiple liquidation preferences, super pro-ratas, etc, etc). We need to converge on a set of standard Series A terms that everyone uses.”
I couldn’t agree more. Chris Dixon wrote a post titled Ideal First Round Funding Terms that Fred points to. I agree with almost everything Chris says, and especially agree with his assertion that you should “only negotiate over 2 things – valuation and amount raised.”
When my partner Jason Mendelson and I wrote our Term Sheet series in 2005, we had a lot of people thank us for demystifying the term sheet. Some time last year, both TechStars and Y Combinator open sourced their financing documents – TechStars were done in conjunction with Cooley Godward and Y Combinator’s were done in conjunction with Wilson Sonsini. On top of all of this, the NVCA (National Venture Capital Association) has had a set of model legal documents up on the web for a while (Jason was on the team that put these together).
So – there’s now no shortage of term sheet data (and forms) available. Now the trick is to get everyone to start using the same stuff. It seems like first round deals is a great place to start.
Ironically, if you read through all the various sets of documents with a fine tooth comb, you’ll find an interesting phenomenon – they are all slightly different. So – a next step is to get Gunderson, Cooley, and WSGR to standardize on one set. If there was truly a set of “first round docs” (for angel rounds, seed rounds, and venture capital rounds – whatever you want to call them) – life would be a lot better for entrepreneurs, VCs, and probably even the law firms since most first round deals are money losers for them even though they generally cost way too much.
We’ve funded a company called Brightleaf that plans to help with the document production part of this problem. But we also need leadership from VCs and law firms to realize that there really should only be two terms being negotiated in most first round financings – valuation and the amount raised.
Bambi Francisco was at TechStars Investor/Demo Day in Silicon Valley yesterday and did a short interview with me on how TechStars works.
Mom – please listen to at least the first 30 seconds as Bambi calls me a technology luminary!
In 2005, my partner Jason Mendelson and I wrote a long series of posts describing all of the parts of a typical venture capital Term Sheet. We started on 1/3/05 with a post on Price and finished up on 8/23/05 with a post on Indemnification and Assignment.
Of all of the stuff I’ve written over the past four years, my stats continue to tell me that stuff we wrote in the Term Sheet series is some of the most popular content on my blog. As I was writing my post I Blog, I Tweet, But Why I realized that many of you have started reading my blog after 1/1/06 so you might have missed this series.
We’ve seen this series used as the base for a number of college courses, we’ve been thanked by people all over the world for writing it, and we’ve been encouraged to publish a version of it in book form. Maybe someday we will get around to it, but for now it’s still relevant as an original web based life form.
For quick reference, following are the key posts:
While the 24 references are a bit dated (we might use Lost or Weeds this time around), I hope you will also enjoy (or at least forgive us for including) a little bit of Jack Bauer.
I love a good rant and Dave McClure has a doozy up titled VC’s & Tech Lawyers: Innovate, Automate, Simplify. Several years ago when Jason and I wrote our Term Sheet series, I often thought to myself (and often out loud) “why is this so complicated?” (ok – there were some adverbs used as modifiers in the sentence as in “why is this so X Y complicated?”)
In addition to a delicious rant, Dave has some good suggestions for all of us. Anyone doing a seed or light Series A round (< $1m) should read Ted Wang of Fenwick & West’s article Reinventing the Series A for some additional ideas.
In my first business, we didn’t have a line for EBITDA on our financial statement. We went straight to Net Income. We knew our cash flow from our statement of cash flows (and our bank account which we checked regularly since we were self funded.) We never talked about EBITDA, nor did we ever feel the need to come up with things like “Adjusted EBITDA.”
Now – I went to business school so I knew what an EBITDA was – I just didn’t care much about it at Feld Technologies because it didn’t matter. Cash mattered the most. Cash Flow mattered next. Net Income mattered a distant third (as long as it was positive every month – it got more important if it was ever negative, but it was still third.) The list continued. EBITDA was not on it. This was 1987 – 1993.
Earlier this week I looked at financials for a company I’m not involved in. Cash has been vanishing at an uncomfortable rate so I was asked by a friend who is involved in the company to dig into the financials to try to understand what was going on.
The first financial presentation I saw focused only on adjusted EBITDA. It was sort of defined, but not really very clearly (I didn’t know the dynamics of the elements of the adjustment well enough to have a good understanding at first glance.) Cash flow was buried in one of the back pages of the financials (and not explained in the presentation.) EBITDA wasn’t really visible; Net Income wasn’t really visible – it was all revenue and adjusted EBITDA.
Revenue was strong (it’s a good sized company – not huge – but nice growth.) Adjusted EBITDA is positive. Balance sheet cash is declining rapidly month over month. Hmmm. That doesn’t work.
I punted on the financial presentation (e.g. please don’t send me your explanation – just send me your cash flow statement, balance sheet, and income statement – by month for the last twelve months – as it comes out of your accounting system.) Easy to do – I had it quickly.
EBITDA is very negative. However, it’s still not as negative as the cash flow. This is an equipment intensive business so about 50% of the delta was “adjustments associated with customer acquisition”, 25% of the delta was capital equipment (CapEx) investments, and 25% of the delta was “other things that got rationalized as adjustments to EBITDA.”
Not only was adjusted EBITDA pointless, it completely obfuscated what was going on. However, the CFO of the company was spending all his time focusing his CEO and investors on adjusted EBITDA to explain how the business – while losing piles of cash – was really doing just fine on an operating basis “if you just didn’t count these couple of things.”
Last week the WSJ Journal has an article titled Profit as We Know It Could Be Lost With New Accounting Standards. There is a potential massive overhaul in financial reporting coming (the accountants and the AICPA will need something to do in 2008 now that everyone is finally figuring out how to deal with SOX) – you can see some before and after examples here. They are actually pretty interesting (as interesting as accounting gets – not up there with Lost or 24). However, the first step is banishing all of the “adjusted stuff” in the financials. Not helpful.
I’ve gotten to know David Cohen and David Brown through our work together at TechStars. DavidC and I have talked a little about Pinpoint (the company that the David’s co-founded) and I’ve had one meeting at ZOLL Data Systems (the company that DavidB runs that is a subsidiary of the company that acquired Pinpoint.) But I didn’t really know their story.
DavidB took some time off (left ZOLL but then went back.) During this time he wrote No Vision, All Drive. I love self-told, first person, authentic entrepreneurial stories (one of my favorites was The MouseDriver Chronicles.) DavidB did a great job of telling the Pinpoint story – starting at the very beginning – and sticking to the story rather than veering into the prognostication zone that so many authors of business stories feel compelled to go to.
Pinpoint (and subsequently ZOLL Data Systems) is one of the great sleeper stories in the Boulder software scene. They grew steadily from founding, survived the bubble gracefully, never raised any capital, and had a very nice exit when ZOLL acquired the company. DavidB’s tale will be familiar to any startup entrepreneur and is inspiring to anyone that aspires to start a company. The anecdotes about DavidC were hysterical and help me better understand one of my co-conspirator at TechStars.
I’m on a “read each Kurt Vonnegut book in order that he wrote them” (I’m on number two – The Sirens of Titan.) I’m putting a non-fiction book in between each Vonnegut book – No Vision, All Drive was a good choice.
Finally, Amy just wrote about our morning visitor if you want more “bear in the driveway pictures.” I still haven’t gone running and can’t figure out how to get my butt out of the house.
A blog reader (Sam from – well – somewhere) pointed out a critically important new set of accounting principles called SAAP that are a replacement for GAAP and are described on Long or Short Capital.