Podcast Summary
Working with young startups is rewarding for lawyers like Becky DeGraw: Passionate lawyers prefer helping entrepreneurs grow businesses, and the relationship between lawyers and startups is unique with crucial legal guidance to avoid costly mistakes.
Working with young startups is rewarding for lawyers like Becky DeGraw, who have a passion for helping entrepreneurs grow their businesses. The experience is more enjoyable compared to working with larger companies or public entities. When Becky started at Wilson Sonsini, she discovered her preference for private companies, and her focus has been on early to late-stage private companies ever since. The relationship between lawyers and startups is unique, as investors may not always remember their early supporters. However, it's crucial for entrepreneurs to seek legal guidance to avoid costly mistakes early on. In their previous discussion, they covered the importance of choosing the right business entity and the significance of incorporating as a C corp for attracting investor funding. After incorporation, entrepreneurs should be aware of term sheets, which outline the terms and conditions for investment.
Term Sheet: A Sign of Serious Investor Intent: A term sheet is a crucial document in the investment process, outlining terms and conditions, and demonstrating an investor's serious intent.
A term sheet is a crucial document in the investment process that signifies the serious intent of an investor. It outlines the terms and conditions under which an investment will be made, including the valuation, specific rights, and the amount of money to be invested. The term sheet serves as a foundation for both parties to agree on the key terms before engaging lawyers and incurring additional costs. An investor preparing and presenting a term sheet demonstrates a high level of commitment and intent to invest, and failing to follow through can negatively impact their reputation in the investment community. The term sheet is usually standardized and serves as a starting point for negotiations.
Understanding the Importance of a Term Sheet in Venture Capital: A term sheet is a serious commitment in venture capital, and the diligence process ensures a successful investment by assessing the business model's viability and the company's legal standing.
In the venture capital industry, a term sheet is a serious and sacrosanct commitment. Founders and investors form a close-knit community where word spreads quickly, and a breached term sheet can negatively impact a company's reputation and future fundraising opportunities. The diligence process plays a crucial role in the decision-making process. Business diligence involves assessing the viability of the business model, while legal diligence focuses on the company's legal and regulatory standing. Discovering significant issues during legal diligence may lead investors to reconsider their investment, but minor issues are typically addressed and resolved before closing the deal. In summary, a term sheet signifies a firm commitment from both parties, and the diligence process is an essential step in ensuring a successful investment.
Investor due diligence: Protecting capital with thorough checks: Investors spend $2k-$5k pre-term sheet and $10k-$20k post-term sheet for series A round diligence. Verifying contracts, capitalization records, and employee signatures are crucial. Founders must prioritize diligence to protect investors' capital and avoid misrepresentation or fraudulent activities.
Thorough due diligence is a crucial aspect of securing funding for a startup, especially when dealing with larger investments. The speaker shares that their firm typically spends between $2,000 to $5,000 on diligence pre-term sheet and around $10,000 to $20,000 post-term sheet for a series A round. This diligence process includes verifying contracts with key clients, ensuring proper capitalization records, and employee signatures on confidential information and IP assignment provisions. Founders of seed or angel-funded companies may not have undergone extensive diligence before, but when dealing with larger checks, they must prioritize it to protect the investors' capital. The speaker shares an instance where a company claimed Google and Facebook as their top two clients but lacked formal contracts, which could have resulted in a significant loss for the investors. Fraudulent activities, such as unsigned IP assignments, are opportunities for cleanup work, but deal-breaking issues like misrepresentation of clients or contracts are less frequent, occurring approximately once in every 75 to 250 deals.
Being transparent with investors about potential issues: Founders should be upfront about potential issues, allow investors to assess situations, focus on term sheet economics and control, and create a pro forma cap table for informed decisions.
Transparency is crucial when dealing with investors. Hidden issues, such as lawsuits or past fraud, can lead to investors losing trust and backing out of deals. Founders should be upfront about potential issues and allow investors to speak with relevant parties, like lawyers, to assess the situation. When evaluating term sheets, founders should focus on both economic and control aspects. Pre-money valuations can be misleading, and founders need to understand the math behind the numbers, including outstanding convertible notes or options pool increases. Creating a pro forma cap table can help founders make informed decisions and avoid potential misunderstandings.
Managing Cap Tables is Crucial for Founders: Founders should prioritize managing cap tables using tools like Captable.io for efficiency, involve lawyers for proper implementation, and maintain good corporate governance to prevent costly disputes and ensure effective operations.
Founders of C to series A companies should prioritize understanding and managing their cap tables. This complex yet crucial aspect of startup finance can be daunting, but with the help of software tools like Captable.io, founders can maintain accurate cap tables more efficiently. By doing so, they become better negotiators and can avoid potential misunderstandings or disputes that could lead to costly legal battles. Additionally, involving lawyers early in the process can help ensure the proper implementation of control provisions and prevent potential missteps that could cost companies millions or even hundreds of millions of dollars down the road. While there may be some legal expenses involved, the potential savings far outweigh the costs. Furthermore, having good corporate governance, including a board of directors, is essential to prevent lawsuits and ensure the company operates effectively.
Importance of a three-person board for a Series A company: A three-person board, consisting of an investor, an independent, and one or two common share representatives, is crucial for a Series A company to learn governance and control provisions, ensuring growth.
Having a board of directors is essential for a company, especially when raising venture capital. The ideal board size for a Series A company is usually a three-person board, with one seat for the new investor, one independent, and one or two common share representatives. An odd number of board members is preferred to avoid deadlock situations. Boards help in learning governance and control provisions, which are crucial for a company's growth. Working with reputable firms, such as WSGR, can provide valuable guidance and education on these matters. As Steve Jobs once sought advice from both Larry Ellison and Larry Sunzini, it's clear that having experienced advisors can make a significant impact on a company's success.
Investing in expert legal advice: Seeking professional legal advice, even with added costs, is crucial for a solid business foundation.
Even though working with an experienced lawyer like R.D. Graw at WSGR.com comes with a higher cost due to his partner status, the value and knowledge gained from the experience are worth the investment. The conversation highlighted the importance of seeking expert advice in the legal aspect of starting a business, even if it means incurring additional expenses. R.D.'s expertise and insights provided the interviewee with valuable information, ensuring a solid foundation for their startup. This conversation underscores the significance of investing in professional services to ensure business success.
