An April 11 post at VentureBeat provided some good guidance on generating a term sheet for a seed-stage investment from an angel investment. While reviewing it, I was reminded of recent stories I’ve been reading about founders demanding, and getting, part of their equity stakes purchased by investors at closing rather than simply taking the dilution most had come to expect from investment rounds.
In most deals, founders taking some of their personal risk out of a company can lead to a misalignment of purpose with the investors. If too much cash is provided to the entrepreneur, reducing his ownership stake, he may not feel as compelled to stay focused on driving value in the company. The rationale being used by investors to allow this is that they don’t want their founders to become unfocused by unpaid mortgages and kid’s college bills at home. My instinct tells me that each circumstance will be different and should be evaluated. In general, though, I’d rather structure an incentive based combo of salary, bonus and stock options for the founders, keeping them both focused and bankruptcy-free at home.
But that isn’t the point of this post. My point is that if this is even being talked about let alone acquiesced to by investors, I’d say that founders are gaining power in the marketplace. The equilibrium point might be swinging into a sellers market where competition is heating up for deals. Investors, starting to worry more about fear than greed, are beginning to agree to terms unthinkable 6 months ago. The slow boil up of valuations are symptomatic of this as is the buoyancy of the stock market and an uptick in M&A. Getting an equity takeout at the beginning of the investor relationship is like a reverse liquidation preference! Founders are getting their 1x today. How’s that feel Mr. 3x Participating Preferred-venture man? 🙂
So if you’ve been trying to raise an angel round of funding and getting the s-l-o-w undue diligence of investors waiting for you to run out of money, here are a few “easy” steps to take to fire up your deal closing. The times, they may be a-changing in the market for angel and seed stage investment. If you’ve launched and bootstrapped your way through the darkness of the past three years, and have managed to survive and start to build some presence in the marketplace, you just might have outlived the wolf at the door.
1) Bootstrap your way to building the beginnings of a valuable company. (Obviously there are several sub-steps to this one, but that is the subject of another post or two).
2) Begin “socializing” your business plan with as many investors as you can. Seek people who have been in your business. Get one or two interested in investing at a rough set of terms.
3) Craft a term sheet. I wouldn’t include terms that allow you to take you out of the business, but the importance of this step is to create a sense of urgency, especially if you’ve had a few investors kicking the tires for 6, 12 or 18 months. They have no urgency to close an investment with you, unless there is an urgency! If you’ve got some soft interest for $100,000, make the round a $500,000 round, but reserve the right to close it at $100,000. And put a time frame on it. You should plan to close on a round in a few months. It is important to start with steps 1 and 2. It is quite difficult to talk about closing a round when you’re completely bluffing. Don’t ever completely bluff.
There is an excellent framework for a term sheet here at Series Seed. Build yours with the terms you’ve generally roughed out with those early potential investors. Circulate the term sheet with other potential investors in a professional and courteous way. Don’t lead with the term sheet. Lead with an executive summary and make sure an investor is interested in you and your business first. The goal of doing this is not to create an ultimatum, but to simply create some sense of forward motion. The investor needs to make a decision, and they may decide to say no. But at least you’ve gotten them moving.