Tuesday, December 13, 2005

Badly behaved VC - series 2

I am attempting to keep track of bad behaviour by venture capitalists as and when my work day causes me to be exposed to such an instance. Today was one. Pre and Post option pool scams. Yes - i am now convinced that they are not sophisticated negotiating postures, they are scams. They are scams because they create a shift in control from the entrepreneur to the investor, through employment agreement rights, firing for cause, and so on. The age-old - 'we need a seasoned executive to take this to the next level' is often times a lie. It should read 'we will dump you the entrepreneur and replace you with 'friendly to us MBA XYZ', your options that have not vested will be given to him / her, and we the investors won't get diluted' - Eureka. Term sheet particulars such as this need to be exposed, so that abstract permutations that an entrepreneur can't possibly see in these clauses are explained in the real light under which they are created. the 'we are the entrepreneurs VC' mantra should be the first red flag. If a VC has more fear than greed built in to his / her assesment of an investment, buy debt. Dont try and build a company.


At 12/13/2005 04:01:00 PM, Anonymous Isaac Garcia said...

When you say "Pre and Post Option Pool Scams" are you referring to the point of negotiation when the questions arise of: "how much to allocate for option pools" and "who takes the dilution (the entrepreneur, the vc, or both)."

Paul Graham suggests that these types of conversations fall to the wayside when VCs and Entrepreneurs adopt his theory of 'VCs buying out Founders Shares." (While this sounds great in theory, I'm not sure how realistic it is.)

In the end, shouldn't the contract/term sheet be about clarity, instead of clouded terms that either party can hide behind?

Seems like "clarity" stops alot of chicanery early in its tracks.

At 12/13/2005 06:00:00 PM, Blogger marks ramblings said...

The likely tactic is that the VC will argue pre-term sheet for the need for a large pool - stating the need for rounding out the team etc - some of which is absolutely prudent path to pursue - the first issue comes when they then claim that the pool must be x% post and not pre.

In nearly every case, the VC will argue for post pool of X - meaning the entrepreneur takes the additional dilution.

Another flag here is to look at the post money share % be wary of a share allocation to one additional executive that could put the VC over 50%.

To your point about clarity - i have heard several VC's try the "our term sheet is very simple - only 2 pages" angle. Sure enough, only two pages - but remember its a non binding document, the merger equivalent of an LOI.

Thus we arrive at the 're-trade' phase. claims of "i was not aware of this" or the risk profile has increased since we have done more 'digging' - all concluding in a price, options, board make up or other significant change to originally agreed terms.


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