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Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, 2nd Edition

ISBN: 978-1-118-44361-3
272 pages
December 2012
Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, 2nd Edition (1118443616) cover image
A full revised edition of the Wall Street Journal bestselling book on startups and entrepreneurship

As each new generation of entrepreneurs emerges, there is a renewed interest in how venture capital deals come together. Yet there is little reliable information focused on venture capital deals. Nobody understands this better than authors Brad Feld and Jason Mendelson. For more than twenty years, they've been involved in hundreds of venture capital financings, and now, with the Second Edition of Venture Deals, they continue to share their experiences in this field with you.

Engaging and informative, this reliable resource skillfully outlines the essential elements of the venture capital term sheet—from terms related to economics to terms related to control. It strives to give a balanced view of the particular terms along with the strategies to getting to a fair deal. In addition to examining the nuts and bolts of the term sheet, Venture Deals, Second Edition also introduces you to the various participants in the process and discusses how fundraising works.

  • Fully updated to reflect the intricacies of startups and entrepreneurship in today's dynamic economic environment
  • Offers valuable insights into venture capital deal structure and strategies
  • Brings a level of transparency to a process that is rarely well understood

Whether you're an experienced or aspiring entrepreneur, venture capitalist, or lawyer who partakes in these particular types of deals, you will benefit from the insights found throughout this new book.

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Foreword xi

Preface xiii

Acknowledgments xix

Introduction: The Art of the Term Sheet 1

1 The Players 5

The Entrepreneur 5

The Venture Capitalist 6

The Angel Investor 8

The Syndicate 10

The Lawyer 11

The Mentor 13

2 How to Raise Money 15

Do or Do Not; There Is No Try 15

Determine How Much You Are Raising 16

Fund-Raising Materials 17

Due Diligence Materials 23

Finding the Right VC 23

Finding a Lead VC 25

How VCs Decide to Invest 26

Closing the Deal 28

3 Overview of the Term Sheet 31

The Key Concepts: Economics and Control 32

4 Economic Terms of the Term Sheet 35

Price 35

Liquidation Preference 41

Pay-to-Play 47

Vesting 50

Employee Pool 54

Antidilution 55

5 Control Terms of the Term Sheet 61

Board of Directors 61

Protective Provisions 63

Drag-Along Agreement 68

Conversion 70

6 Other Terms of the Term Sheet 73

Dividends 73

Redemption Rights 75

Conditions Precedent to Financing 77

Information Rights 79

Registration Rights 80

Right of First Refusal 83

Voting Rights 84

Restriction on Sales 85

Proprietary Information and Inventions Agreement 86

Co-Sale Agreement 87

Founders’ Activities 88

Initial Public Offering Shares Purchase 89

No-Shop Agreement 90

Indemnification 93

Assignment 93

7 The Capitalization Table 95

8 Convertible Debt 99

Arguments For and Against Convertible Debt 100

The Discount 102

Valuation Caps 103

Interest Rate 104

Conversion Mechanics 105

Conversion in a Sale of the Company 107

Warrants 108

Other Terms 110

Early Stage versus Late Stage Dynamics 111

Can Convertible Debt Be Dangerous? 112

9 How Venture Capital Funds Work 115

Overview of a Typical Structure 115

How Firms Raise Money 117

How Venture Capitalists Make Money 118

How Time Impacts Fund Activity 122

Reserves 124

Cash Flow 126

Cross-Fund Investing 127

Departing Partners 127

Fiduciary Duties 128

Implications for the Entrepreneur 128

10 Negotiation Tactics 129

What Really Matters? 129

Preparing for the Negotiation 130

A Brief Introduction to Game Theory 132

Negotiating in the Game of Financings 134

Negotiating Styles and Approaches 136

Collaborative Negotiation versus Walk-Away Threats 139

Building Leverage and Getting to Yes 140

Things Not to Do 142

Great Lawyers versus Bad Lawyers versus No Lawyers 145

Can You Make a Bad Deal Better? 145

11 Raising Money the Right Way 149

Don’t Ask for a Nondisclosure Agreement 149

Don’t Email Carpet Bomb VCs 150

No Often Means No 150

Don’t Ask for a Referral If You Get a No 150

Don’t Be a Solo Founder 151

Don’t Overemphasize Patents 152

12 Issues at Different Financing Stages 153

Seed Deals 153

Early Stage 154

Mid and Late Stages 154

Other Approaches to Early Stage Deals 155

13 Letters of Intent—The Other Term Sheet 157

Structure of a Deal 158

Asset Deal versus Stock Deal 161

Form of Consideration 163

Assumption of Stock Options 164

Representations, Warranties, and Indemnification 167

Escrow 169

Confidentiality/Nondisclosure Agreement 170

Employee Matters 171

Conditions to Close 172

The No-Shop Clause 173

Fees, Fees, and More Fees 174

Registration Rights 175

Shareholder Representatives 176

14 Legal Things Every Entrepreneur Should Know 179

Intellectual Property 179

Employment Issues 181

State of Incorporation 182

Accredited Investors 182

Filing an 83(b) Election 183

Section 409A Valuations 184

Authors’ Note 187

Appendix A: Sample Term Sheet 189

Appendix B: Sample Letter of Intent 209

Appendix C: Additional Resources 217

Glossary 221

About the Authors 229

Index 231

Excerpt from Startup Communities 237

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Brad Feld has been an early-stage investor and entrepreneur for over twenty years. Prior to cofounding Foundry Group—a Boulder, Colorado-based early-stage venture capital fund that invests in information technology companies all over the United States—he cofounded Mobius Venture Capital. Prior to that, he founded Intensity Ventures, a company that helped launch and operate software companies. Feld is also a cofounder of TechStars and has been active with several nonprofit organizations. He is a nationally recognized speaker on the topics of venture capital investing and entrepreneurship.

Jason Mendelson has over a decade of experience in the venture capital and technology industries in a multitude of investing, operational, and engineering roles. Prior to cofounding Foundry Group, he was a managing director and general counsel for Mobius Venture Capital, where he also acted as its chief administrative partner overseeing all operations of the firm. Mendelson was also an attorney with Cooley LLP, where he practiced corporate and securities law with an emphasis on representation of emerging companies in private and public financings as well as mergers and acquisitions.

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