Growth5 Blog

Saturday, August 29, 2009

First Round Funding Terms

Chris Dixon covers Ideal First Round Funding Terms in this excellent post. Entrepreneurs should read his entire post. Here are the highlights (in bold):
1. Investors get either common stock or 1x non-participating preferred.
-Common stock makes financing easier down the road. I think some basic preferred is ok too and shouldn't prevent later investors. Later investors preferred should be as basic.
2. Pro-rata rights for investors. The right for all investors (including small angels) to put money in the following rounds.
-This is a great idea as the Angels are often taking all of the risk. They should have the right to protect against dilution as later investors realize what a great investment choice the Angels made way back when.
3. Founder vesting with acceleration on change of control.
-Founder vesting is important. Dixon recommends four years. That sounds like a good number. If the company is acquired all vesting accelerates to 12 months remaining - this gives the acquirer and the founder(s) 12 months to work together and see how it goes. If the Founder(s) are replaced upon acquisition, they vest fully. Dixon calls this the "double trigger".
4. Keep the first round docs simple, legal fees down.
-95% of the time the docs end up being mostly the same with or without months of negotiation and all sorts of legal posturing. Start close to where you will end up anyway and save the money.
5. Small board to start. One investor, one management and one mutually agreed upon independent director. If five board members are preferred, two investors, two management and one independent director.
- If you have the right three, a small board is better to start. Keeps you nimble, leaves room for board members in follow on rounds without the board getting too large and potentially less effective.
6. Founder / management salaries: subsistence level. Enough to not worry about money, but nothing more.
-If you have entrepreneurs who can't or aren't willing to take this level of pay during the seed/earliest stages, move on.
7. Small angels investing beside VCs should get the same economic rights (share price, warrants & pro-rata) but no control rights.
-Totally agree. Give the early risk-takers the same benefits as the VC/PE/Institutions that come in later. I also agree they shouldn't have control rights - you don't want your Angels blocking follow on rounds that are necessary, but they should be able to invest pro-rata in those rounds.
8. Option pool (10-20%). The chosen % should be based on a hiring plan, not just as a deal point.
-You want your management team to have "skin in the game" and benefit alongside their hard work. Some firms forget to plan for this and can't attract top talent. Yes it's dilutive, take the dilution early on and have the option pool in place, it will be worth it in the long run.
9. All other points (registration rights, dividends, etc...) should be standard NVCA terms.
-Sometimes all you need to do is show the founders these NVCA templates. Be patient, they will often come around. If they don't, move on.
10. Valuation & Amount Raised. These are the only two terms that should be negotiated. Everything else should be standard terms.
-Valuation is often in the eye of the beholder and is based on market conditions, how competitive the deal is, who the founders are, etc... I recommend focusing on the amount raised. What are the milestones that will create a significant bump in valuation for the next round of financing and how much money is needed to get there. Add some % multiple on top of that - Dixon recommends 50%. It always takes more money and more time to get there, so plan accordingly.

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