MAP Accelerator Program — Week 12
With two public holidays shortening last week, there was only one main session on venture capital.
Venture Capital
We’ve already had plenty of sessions on investment and venture capital, but as always, there’s a few aspects in it that haven’t been covered yet by the others. This session was focusing a little bit more around the mechanics of an investment round.
Especially in the super early stage of a startup, setting up proper investment terms can be expensive and difficult, since uncertainty is at a maximum. Under these circumstances there are two similar investment instruments that can be set up with a few pages of legal contracts and with a great deal of flexibility. They are called “convertible notes” and “SAFE” (Simple Agreement for Future Equity). In essence, the investor gives some money to the startup, but doesn’t receive equity just yet — instead it just receives a promise of future equity at a better price than the future valuation when further capital is raised. This postpones the valuation question/decision to a later point in time, which can be quite handy for investors and founders — especially in the very early stages.
The main difference between SAFE and convertible notes is that the convertible notes are a type of loan and accrue interest, which will be converted into equity as well, when the second investment round is executed. Usually these two tools come with much better conditions for the investor — i.e. the investor receives more equity for the same amount of investment than a later investor, because they took on more risk early on.
A later investment round, like a Series A, usually comes with a term sheet, a market valuation (company value) and a small booklet of legal documents. The legal costs of these investment rounds can grow quite big, depending on the complexity of the investment deal. Investors will often ask for a board seat, and the startup founders need to be careful about how much equity (% of the company) they give up and how many board seats they hand out. Board seats will grant some level of control over critical decisions of the company to the investor — as a startup founder you usually don’t want to get outvoted by your investors. On top of the board seat, investors usually will also ask for veto-rights on liquidation events. This is primarily to protect the investor from the founders selling the company below market value or at a loss to the investor.
The obvious conclusion is that you should pick your investors carefully and negotiate the terms properly. I think especially startups that are desperate for investment money sometimes have to throw these considerations over board and end up with investors that — in the long run — can be difficult for the company to deal with and cause major hick-ups. In an ideal world, you want an investor who knows your space, but trusts your execution. They can be very powerful advisers / mentors. They will be part of major decisions, but you are still are calling the shots. You are grateful for their trust and investment and willing to give them their fair share — but not more. All this can be achieved by smart negotiations and in the ideal case both parties get a fair deal and benefit from each other (win-win).
