Want to Know How VC’s Calculate Valuation Differently from Founders?

Posted on Jul 22, 2010 | 113 comments

Want to Know How VC’s Calculate Valuation Differently from Founders?

Back in 1999 when I first raised venture capital I had zero knowledge of what a fair term sheet looked like or how to value my company.  Due to competitive markets we ended up with a pretty good term sheet until we needed to raise money in April 2001 and then we got completely screwed.  It was accept the terms or go into bankruptcy so we took the money.  Those were the dog days of entrepreneurship.

But the truth is that I didn’t really understand just how screwed I was until years later when I finally understood every term in a term sheet and more importantly I understood how each term could actually be used to screw me.  Things like “participating preferred stock” in legalese unsurprisingly never actually call out, “hey, this is the participating preferred language.”  We got a 3x participating liquidation preference with interest (not participating with a 3x cap, but 3x participating.  Ugh. I explain the difference later in the post or you can click through on this link above for an explanation).

Back then VentureHacks didn’t exist.  Brad Feld hadn’t written his seminal “term sheet series” and The Funded hadn’t yet been created.  And for some strange reason entrepreneurs didn’t share this information.  Other founders, “as a privately held company we don’t disclose our valuation.”  Me, “dude, I’m not a journalist.  I just want to figure out what a fair valuation is.”  I figured all the VC’s talked so we should. Duh.

I don’t feel that as a VC sneaking in nefarious terms into a term sheet that the entrepreneur doesn’t understand is a good way to build a long-term relationship nor to build a long-term reputation but this does happen and more frequently than we all would like.  I’ve started from day one trying to build total transparency into my process with entrepreneurs.

This starts with understanding how VCs and entrepreneurs often see valuation differently.  And no prizes for guessing which side of the table really understands the right answer.  I’m not sure I really even need to write this at length because Nivi absolutely nailed the topic in his article “The Option Pool Shuffle.”

When I went to raise money in 2006 I thought I knew every term in a term sheet but somehow I still got a bit duped by the option pool shuffle.  I had several term sheets and one of the leading term sheets had an option pool of 40% in it.  I couldn’t understand why they wanted so many options until a friend pointed out that this just lowered their “true” pre-money valuation (they also asked for some sharp elbowed terms in the deal).

I turned them down.  They were nonplussed.  They couldn’t understand how I could turn them down when they considered themselves the leader in my field and they had worked so hard to get the deal.  I told them that True Ventures had stuck to their brand name and submitted a totally clean term sheet.  No gotchas.  No option pool shuffle.  No hidden terms.  So they agreed to match True’s term sheet.  I thought to myself, “OK, they were willing to F me when they thought I had no idea what I was talking about . Now that I do they’re willing to accommodate?  Gee, if they treat me like this in good times I wonder how they’d treat me in bad times!”

So to make sure it never happens to you, as a loyal reader of this blog and hopefully an occasional watcher of This Week in Venture Capital, I recorded a video session with my colleague Kelly Hwang on how VCs calculate valuations and he’s created a cap table spreadsheet you can download from DocStoc to plug in all of the terms and you can watch the video here and/or read the text summary below.

How VC’s Calculate Valuation: We walked through a standard deal where you raise $1 million at a $3 million pre-money valuation leading to a $4 million post money valuation.  The math works out that the investor owns 25% of the company post deal ($1 million invested / $4 million valuation) and assuming 1 million shares, each share would be valued at $3 / share ($3,000,000 pre-money / 1 million shares = $3 / share).  Investors own 25%, the founders own 75%.  NOTE: In the video I talked about how VC’s and entrepreneurs decide the total number of shares at the first major funding round and why it’s often a high number.

But this example above is all entrepreneur math, not the VC’s.  The VC assumes you’ll have an option pool.  That’s normal.  You’ll need to hire and retain talen to grow your company.  Those options need to come from somewhere.  The more senior members you have (say you already have a CEO, CTO, VP marketing, VP Biz Dev, VP Products) then the less options you’ll need and vice versa.  Industry standard post your first round of funding will be 15-20%.  I say “post” funding because you’ll need more than this amount pre-funding to get to this number after funding.  We walk through this in the video.

So taking the same fund raising round and assuming that the VC wants the options including before he or she funds (and before is totally standard) then the math works like this: Assuming a 15% option pool post funding then you need a 20% option pool pre funding (because the pool gets diluted by 25% also when the VC invests their money).  So your 100% of the company is down to 80% even before VC funding. Normal.

The VC’s $1 million still buys them 25% of your company – it’s you who has diluted to 60% ownership rather than 75%.  The price / share is actually $2.40 (not $3.00), which is $3,000,000 pre-money / 1,250,000 shares (because you had to create the 250,000 share options).   Thus the “true” pre-money is only $2.4 million (and not $3 million) because $2.40 per share * 1 million pre-money outstanding shards = $2.4 million.

Note that the term sheet you get will still say, “Pre-Money = $3 million” and there won’t be anywhere in the term sheet that says “true Pre-Money” or “effective Pre-Money” – that’s for you to calculate.  So let’s start calling the term sheet listed pre-money valuation as the “nominal” pre-money valuation.  Luckily you all now have the spreadsheet to download that will calculate both for you.

Term Sheet Overview:

The second most important economic term in the term sheet other than price is “liquidation preference.” This states how the proceeds from a sale or dissolution of the company will be distributed.  Investors will always want to get their money out of the company before founders, which in the case where the company is sold for a low price is fair.  You almost certainly will have liquidation preferences if you raise VC so don’t worry about having them.

But not all liquidation preferences are equal – we discuss all this in the video – some can have a “multiple” on top of them such as a 2x liquidation preference, which means that investors get 2x their money before founders get anything.  In an early round of investment where there is not an extremely high price relative to normal valuations this is anything but benign.

More likely what you’ll see if you have an aggressive term sheet is “participating preferred” stock.  This means that investors get their money back AND they get to share in the proceeds.  If you’ve raised $6 million in total and still own 40% of the company and sell for $10 million (not a great outcome but it happens) then with participating preferred investors would take $6 million off the top and then 60% of the remaining $4 million so the founder’s take would be $1.6 million (.4 * $4 million) and not $4 million. Note that it might be even less than $1.6m because liquidation preferences often have interest calculated on top of them.

VC’s in early rounds will argue that “participation” is simply downside protection and if you sell for a lower price they should get more of the proceeds.  While true, the problem I have is that any terms you have in your early stages will certainly be asked for by future investors in your later funding rounds so all of these terms pile up when you’ve been through 3-4 rounds of funding over a 5 year time frame.  And by the time most companies get to an exit (which despite what you read on TechCrunch about all the high-profile early exits the most realistic case is still 8-10 years) often the founders own very little of the economic upside.  This is a shame.

Privately some early-stage VC’s talk about participation helping them to “juice their returns” on smaller exits.  This is silly talk.  I don’t imagine any VC seriously makes money by having tons of small to mid-sized outcomes and therefore “juicing” to me is delusional. I think VCs make money by investing in 20-25 deals and finding 2-3 outliers that drive extra-ordinary returns.  And those are often done by the best and smartest founders who have enough knowledge to know which VCs are juicers and which aren’t.  You reap what you sow.

I also won’t say there is never a time for “participating preferred” but it tends to be in later-stage rounds and particularly in the case where the founders are getting an exceedingly high valuation relative to the norm.  In those cases there are all sorts of mathematical reasons why participation might make sense.  These are edge cases.

But for founders stuck in this negotiation about participation or not with VCs the most standard compromise is “participation with a cap” which is usually set at 2-3x their investment.  This means that participation truly only applies in downside scenarios and once your exit outcome is above a certain price investors would still be better off converting to common stock and not taking their preference.  I prefer to see no participation but this is a good compromise if you can’t get a straight 1x liquidation preference.

After valuation in the video we went through Liquidation Preferences, Board Seats, Protective Provision, Voting Rights, Drag Along Rights, Redemption, Anti-Dilution and a few other key terms.  We spend a lot of time on them in the video but frankly we could have done a 3-hour session.  If I get demand from people after this video to do a deeper dive on term sheets we will.  Heck, maybe we’ll even invite a lawyer on to do it with us!

  • Joe

    Excellent post. You can spend years on this stuff in b-school or law school – many of us have – but people just need to know how to start a business and not lose their shirt before the product is even off the ground. Unfortunately for many entrepreneurs, reading a term sheet is no more interesting than reading the latest volume of the Federal Register.

  • http://bothsidesofthetable.com msuster

    And most lawyers will tell you what the terms mean but not how they can be used to screw you, how to negotiate them or what is the “norm”

  • http://www.jasonwolfe.co.uk/ Jason Wolfe

    This is a hugely valuable post. I've long been convinced that a simpler way of processing the “ownership” of a new venture is needed, and I think this helps make that point more strongly than I ever could.

    The big challenge for me, and I don't know of a good answer, is how to come up with that initial valuation. How much is an idea worth? I guess it's what someone is willing to pay, but it often feels that there's a huge discrepancy between the “buyer” and the “seller”.

    Thanks for sharing.

  • http://market.io Vivek Sharma

    Great stuff here. I was clueless about many of these in my first startup. I've seen VCs float these terms to get a sense of how green you are to the VC way of doing things. 1x liquidation preference and non-participating preferred seems like a pretty clean starter.

  • http://twitter.com/ilmago Il Mago

    Terms in a term sheet are always a matter of negotiation. There's a saying “you can pick any valuation you want, but I pick the terms.” So valuation and terms need to be taken as a whole as part of reaching a deal. Sometimes it is more beneficial for entrepreneurs to have a higher valuation (less dilution) understanding that in case the company does not do as well as expected some of the terms may become “painful”, sometimes the reverse is true.

    It is true that VCs issue many term sheets while entrepreneurs only see them once in a while (so they are at a disadvantage) but good VCs will always make sure that entrepreneurs understand all the terms in the deal. The times I have dealt with entrepreneurs that did not know enough about term sheets I made a point to educate them. There's nothing worse than people feeling they “got screwed” after the fact. Life's too short and when things go well everyone can win.

    Also keep in mind that all these terms typically disappear if a company goes public (there should be a forced conversion) and in case of a sale at a low valuation entrepreneurs should ask (and typically get) a carveout (an allocation of proceeds not contemplated in the original terms). After all companies are bought (also) because of the team, and the team should be motivated to complete a transaction.

  • jrh

    In real life, when an acquistion happens at a low valuation, the participation terms are a starting point for negotiating, not the final answer. All the owners have to agree, after all, as under Delaware law a fairly small minority of shareholders can challenge the deal in court. In this case a judge can do more than change the split of the proceeds — she can determine that the total price was too low and force the acquirer to pay more. So disputed transaction basically don't happen, and founders who are being totally screwed can easily tank a deal, even if they don't have enough seats to control a board vote.

    Most acquirers have no interest in paying off the VC, but lots of reasons to incent the team. At low valuations, the acquirer often tries to weight the deal towards earnout, new options, etc., that can be excluded from the VC's particiation. The actual deal terms on participation serve as a good bargaining chip for the VC — they can cut a deal with the founders, by appearing to give up something.

    In the end, the real question is whether you trust your investors, and whether they will behave decently and try to do right by everyone when the time comes. Many VCs, probably most, will not behave well. But some are good people, and those are the ones to go with, no matter what the term sheet says.

  • http://www.participate.com Alan Warms

    Mark –
    As both an entrepreneur and an investor I don't really agree with you on participating preferred. The way I look at – if someone writes a check in a private company with zero visibility for liquidity – they are looking to get 5-10x their money. That's what they're in the deal for, and why they wrote the check. They're taking a much bigger risk (than say buying Apple stock) and expecting a commensurately higher return. In the example you quote above, if they sell for $10MM, and the investors didn't have participating preferred, they would get their money back and the entrepreneur would make $4MM. So the investors make zero dollars for their investment, and the entrepreneur makes a nice windfall – not life changing – but certainly impactful. Not sure why that is fair either — and even with a coupon not sure why it makes sense.

    Like I said, I am an entrepreneur also — and I always give participating preferred. I feel that for my investors it gives them the maximum chance to earn a return regardless of the size of the outcome. If I do a good job running my business, I'll get taken care of also. I think the earliest investors need that term almost more than anyone, as they are taking by far the biggest risk.

    The other thing I like about the term is the value it has in setting expectations. Even in a scenario where you have say $4MM in pp ahead of you – when you raise the next big round – you now very clearly understand the hurdle you have to overtake to make the incoming money worth it.

  • http://giffconstable.com giffc

    I love that you, feld, venture hacks and others take the time to write posts like this and de-fog a stressful, complicated topic for the entrepreneur.

  • newcardeal

    Mark, what about creating a fixed number of shares and allocating those shares to new investors and employees. For example, I am thinking of creating 1M shares for my company. Say the seed investors get 25% of the company, then they get 250k shares. Any new hires get shares from the remaining 750k shares I own. Wouldn't this make it much easier to manage the valuation long term and short term? The effective share allocation could be 10M as well. That way, new investors get shares from the existing pool rather than creating new shares. What do you think of such a strategy?

  • http://bothsidesofthetable.com msuster

    We'll just have to agree to disagree on this one but I understand your point of view.

  • http://roachpost.com/ Eric

    Story suggestion. How do you calculate valuation in the first place? That strikes me as much harder than a digestion of terms. Not that the article does not hit a home run in that regard. Thanks.


  • Jason M. Lemkin

    Mark I'd be very interested in a follow-up story on this point why is “why do VCs scrap for nickels?” Seems to me like you only two things matter: (1) the triples and home runs and (2) getting your money back on deals that aren't going to make it. I think (2) helps quite a bit and I've noticed the top VC firms somehow always find an exit even for their dogs, while the third-tier guys don't. My question though is why bother over anything else besides (1) and (2), when you can end up with disgruntled founders and unhappy deals. In my last company, for example, it was a cash acquisition so anything went (vesting, etc, out the door in all-cash deal). There, some of the investors wanted to cancel the unvested options of a small number of rank-and-file employees and consultants to retain an extra $50k for themselves, which represented less than 0.08% of the deal to the VCs, but was material to these guys. It was a huge fight. My question is — Why is their (VCs') DNA trained this way? It isn't so in my experience in private equity, in my very limited experience, where they take care of people on deals where they do well. Why does the VC industy make VCs act this way? A simple example is extremely hostility to evergreen option grants by so many VCs. I must be missing something.

  • http://bothsidesofthetable.com msuster

    won't work. new shares have different rights associated with them and investors will want to negotiate those. can't fight the system – just need to be informed on how to work with it.

  • http://sisyph.us/ ErikSchwartz

    Great post. I wish I had read it 4 years ago.

  • http://bothsidesofthetable.com msuster

    Valuation = whatever an investor is willing to pay. Investors want to own 25-33% so it can be determined by how much you raise. That said, early investors know how much they want to invest and what the norms are by stages. There are huge variances (and prices go up and down dependent on market conditions), but general guidelines on valuation:

    angel: sub $1m
    seed $1-$2.5 pre
    A round: $2-5 pre. Up to $7-8m for super experienced entrepreneurs
    B round $7-12m pre. Outliers can be $20m pre. EXTREME outliers (see: FourSquare) can fetch crazy prices.
    C round: 100% dependent on company performance

  • http://bothsidesofthetable.com msuster

    You're not missing anything. I always tell people, “if your VCs are being aggressive now (before they've invested in you) just imagine how they'll act when it comes time to split the pie.” There are a lot of bad actors out there that are short-termist in mentality. Luckily with the Internet reputations spread more easily and some people are smoked out. We both know some very bad actors – we've discussed as much at lunch. But people who aren't “connected” can still see stuff on The Funded or ping people on Twitter, Facebook for input.

    Still, there are a lot of good people in VC. You just need to know where to find them.

  • http://bothsidesofthetable.com msuster

    Yeah, I wish I had read it 10 years ago! 😉

  • philsugar

    As a follow up to a follow up, I'd love to know what's the SWAG on how much the non big exits really matter on a good fund….what is the highest percentage of an overall fund that gets returned by these deals?

    Scrapping for nickels does happen and I always wonder if its a partner thing…i.e. I better look tough in front of my peers, because it really does make you look shitty, when you're screwing a rank and file employee that's busted their butt makes a tenth of your salary and you're trying to screw them. The answer I've always heard is “I have a fiduciary responsibility” which is why that made it into my “screw you euphemisms” post.

    That being said I know that Mark can't talk for other VCs…but some really like to play the game with sharp elbow…its what they like.

  • thiernofall

    This episode was very informative and unfortunately SAD as well.
    For a group professionals who's entire existence depends on investing in innovation, it is just disheartening that you guys fail to innovate within your own environment.

    With this many rules and fine prints it is as if investors are not frankly trying to help companies succeed. Please invest in simplifying the investment process, the language, eliminate the fine prints.

    Mark, you seem pretty different so you should be one of the guys leading this change in the industry.

  • Roko

    This episode was very informative and unfortunately SAD as well.
    For a group professionals who's entire existence depends on investing in innovation, it is just disheartening that you guys fail to innovate within your own environment.

    With this many rules and fine prints it is as if investors are not frankly trying to help companies succeed. Please invest in simplifying the investment process, the language, eliminate the fine prints.

    Mark, you seem pretty different so you should be one of the guys leading this change in the industry.

  • philsugar

    I really agree with you on the participating preferred. I know that you have to look a terms from a purely dis-passionate viewpoint, its all a numbers game, just run the spread-sheet.

    I can't get my head around participating preferred. You want your cake back and then you get eat it to? Sorry that one I really just take personally. Also some of the “control” issues that get floated I really take personally. As somebody points out if the entrepreneur fights they can't be enforced as it will kill a deal.

    And yes I agree there is an edge case where the founders raise a ton of money at a high valuation and take a bunch off the table, but if you're in that position you better be getting some better advice than here.

    Which brings up a point. I'm sorry but everyone that says I wish I read it before seriously must have had a bad lawyer. Sorry. Mine went through this me right up front with three scenarios..low, medium, high exits….here is what is going to happen.

  • philsugar

    As you point out you really needed the money it was that or dead. Even if you knew would you have taken the money?

    Something that I never see discussed are bridge rounds……they take sharp elbows and elevate them into a knife fight

  • http://walkercorporatelaw.com Scott Edward Walker

    Mark – Great post and, I am happy to report that, unlike “most lawyers,” my firm does indeed sit down with entrepreneurs and walk them through every term in the term sheet – and we do discuss how they can get “screwed.” In fact, my colleague has actually created proprietary software which she uses to create spreadsheets/models showing how the purchase price is distributed (i.e., the waterfall) in the event of an M&A exit. I also note (as I’m sure you’ll agree) that more important than the terms is the investor. Indeed, I’ll recommend going with an investor like Sequoia even if their “pre” is lower and they request some sort of participation (versus a higher pre and no participation from a “B” investor). Cheers, Scott (@ScottEdWalker)

  • http://roachpost.com/ Eric

    Thanks, very informative. Still can't get over quora getting 84 million…

  • Al

    Mark, I don't think anyone took you up on your offer to do a deeper dive – but I know it will be extremely helpful so please do a deeper dive. Dave Young, Scott Alderton or Scott Walker would all be great choices :)


  • http://twitter.com/yegg Gabriel Weinberg

    I generally agree with everything you've said, but I want to press one point and get your opinion on it. As I've tried to explain in my blog, I think there is a case for 2x non-participating in a small, but growing angel niche where I exist. Namely:

    > decent probability >=50% of never needing to raise VC money
    > very small round, <=300K, so the aggregate preference is low (600K max)
    > no interest or other economic terms (dividends, etc.).

    I think in that case the follow-on risk is much lower because there may not be VC and if so, you can argue that the aggregate is low enough you can start from scratch. The ability to argue that is of course dependent on leverage and situation, but I don't think it is a complete non-starter as everyone reflexively says.

    From the investor side, it does protect against the small exit case. And in particular for the smaller new angel investor, who can't go into 30 deals and get that outlier, in the small exit they make a modest return to enable them to make more angel investments. That is, it doesn't move their overall portfolio IRR needle, but it enables them to get to 15-20 deals instead of 10-15, which a) may get them to that more of an outlier and b) allows more entrepreneurs to be funded.

  • http://www.leftbraintorightbrain.com/ Scott Carleton

    Excellent post!

    I'm glad to be starting my entrepreneurship life during a time where open communication is deemed best for all. The VC/entrepreneur blog world is an unbelievable resource.

  • Shafqat

    Great post… We just raised our seed round, and posts like these (especially Venture Hacks) meant we were absolutely prepared to discuss all of these details with our investors. Understanding the option pool shuffle was probably the biggest win we had – and Nivi's post brilliantly guides you through the process of negotiating the option pool (hint: show a reasonable hiring plan!). I can tell you that it works.

  • http://blogs.fluidinfo.com/terry terrycojones

    Hi Mark

    Nice post, thanks. It's nice to see someone (partly) on the other side of the table who gets it and wants to say so publicly. I also liked Nivi's post. I ran into the above issues when writing code ~7 years ago to manage an options plan, and it has bugged me ever since.

    Fred Wilson posted about this subject back in November, and received lots of comments. Here's one of mine http://www.avc.com/a_vc/2009/11/valuation-and-o… which I still stand by (it's as you say above).

    The wriggle to avoid (what seems to me to be) clear and unambiguous thinking and alignment of interest in this issue is for the VC to argue that the options pool is implicitly priced into the deal, and that's just the way it is. I don't like that line of argument, as I find it *much* less explicit. It feels like a post-facto rationalization of something that has always been wrong. The way to fix it is to do it properly, with sunlight and clear examples. So…. thanks. I hope my examples in Fred's post seem clear too.

    Too bad we didn't get to meet when you were in Barcelona (Tyler Crowley sent an intro). In the meantime, we managed to get funded http://blogs.fluidinfo.com/fluidDB/2010/05/24/a


  • NY Media Exchange

    Thanks for the post…like many entrepreneurs, I got screwed by guys who have done this a million times. Keep up the great work.

  • philsugar

    I agree that the options shuffle is just a valuation issue, but there is one thing that I never liked and that is that while the option pool comes out pre-money when the money for the options come in, the post money people share that money.

    I.e. if you have a company that is valued at $10M and issue 15% options, when the company sells the option holders have to put up $1.5M. That should only be split by the people that essentially paid for those options.

  • http://www.mattbartus.com/ Matt Bartus

    Good thing to keep in mind is that while option and valuation are intimately related as you point out, from the entrepreneur's perspective it's better to get a higher valuation than a lower option pool, because the VC bears the entire effect of the higher valuation. The VC would rather have the lower option pool, because when they increase it post-money, they are only pro-rata diluted. Also, if those options are never actually granted, the dilution was not actual dilution.

  • http://twitter.com/JohnnyFontana John Fontana

    I think thats always an issue for a company without traction. A couple of my responses would be 1) The Entrepreneurs- if they are strong and experienced than they have a better chance of getting a good valuation. 2) The Investors- the more they understand the space, the better chance you have of getting a good valuation. If you have a SaaS and they have never invested in or been involved in a SaaS business before, they may not see the value of your business model.

    Im sure these are somewhat obvious answers, but I think they play the largest role at an early stage.

  • http://charliecrystle.blogspot.com/ Charlie Crystle


  • Kai Mamand

    You are asking the entrepreneur to take on lots of downstream complexity (for the 50% of entrepreneurs who will need to raise on follow-on rounds) for a fairly small amount of money. If I were raising <= $300K and you asked for a 2x non-participating beyond ending the negotiation I would encourage my friends to avoid meeting with you so as not to waste their time i.e. you are killing your deal flow.

  • indus

    Great stuff. Well narrated.

  • Phil Black

    Hey Mark,
    Great post and I appreciate the nice mention you give to True. As the author of the True Ventures term sheet that you mention, I would add that it was an easy decision for us to make in presenting you with that term sheet. We were a new firm back then, but we have always said that we wanted to create a venture firm that Founders could trust. You had an excellent option in selling the company at that time which you took, but it has been a real joy to see you “on the other side of the fence” as a venture capitalist who is not afraid to shine a bright light on the issues that are important to Founders. It's great to be a co-investor with you.
    Phil Black
    Co-Founder, True Ventures

  • http://twitter.com/ravipratap Ravi Pratap M

    Mark, this is an excellent post, thanks for sharing all the gory details and for creating the DocStoc spreadsheet to help us first-time entrepreneurs out.

    I'm an entrepreneur based out of Bangalore and although much of what you write about applies here in India as well, I wonder if there's enough knowledge about what kinds of terms are offered by VCs in India.

    Thanks again.

  • http://www.eval-source.com Erpscmanalyst

    Great post, hugely helpful.

  • http://bothsidesofthetable.com msuster

    re: “the right investor” I'd agree with you 100%. Now we can have an offline debate about who the “right” investors are.

  • http://bothsidesofthetable.com msuster

    Lot's to discuss here but quick points:

    1. few companies ever IPO any more so that should never be a planning assumption
    2. It's totally true that you can get a “management carve out” in low outcome situation. That's a future post. BUT … you never want to rely on that. And you can never be sure your investors will be honorable.
    3. Very few VCs walk entrepreneurs through the intricacies of a term sheet. Sure, they walk people through the term sheet but never every term and how it can be used if they're unhappy with things down the line for any reason. Lawyers need to do this.
    4. Team often has leverage. Sometimes they do not. I prefer people be protected a priori.

    But … good points all. Thank you.

  • http://bothsidesofthetable.com msuster

    True but leverage rests with the person who has the stronger position legally to start with. Trust me.

  • http://bothsidesofthetable.com msuster

    I don't have the actual data so if anybody does they should feel free to chime in. But in my anecdotal experience 2-3 deals in any portfolio return the majority of any fund. We had one deal from our last fund that returned $320 million. It was across 2 funds but $270m went to our shareholders in a $365 million fund. And that fund will do VERY well. It is in the top 5 performing funds nationally in its vintage. Outsized portion of the returns will be from 5-6 deals out of 30 or so.

  • http://bothsidesofthetable.com msuster

    Brad Feld and Fred Wilson led the way.

  • http://bothsidesofthetable.com msuster

    What are you talking about! I wrote a whole post on the subject!

  • http://bothsidesofthetable.com msuster

    I think many guys have started. YCombinator, Foundry Group, Union Square, Founders Fund, etc.

  • http://bothsidesofthetable.com msuster

    Thanks, Al. Will do.

  • http://bothsidesofthetable.com msuster


    I've read your stuff on many occasions and normally agree with most of what you say. But I'm diametrically opposed to this point. Here's the reason: your “harmless” 2x (“it's only $300k so only $600k in liquidation preference) makes the next round investor ask for the term and then the B round asks for it. It snowballs.

    Entrepreneurs: start with a clean term sheet and fight like hell to keep it that way from day one until exit (or at least through the A & B rounds).


  • http://bothsidesofthetable.com msuster

    Yes, it does. And Nivi deserves a medal of honor.

  • http://bothsidesofthetable.com msuster

    Yes, sorry we didn't meet. I was there for an MBA reunion so it was hard to sneak away.

    re: your comments on Fred's blog – I'm afraid I don't agree. When I put $3m to work for 25% of your company I don't expect to then get diluted by 15% afterward to create an option pool. I expect that the founders did this when then set up the company. But it's important to me that the founders understand this rather than being tricked.

    re: funding – congrats. Hope all is going well.