Startup investment terms

Investment terms appear as a recurring discussion topic in the Nordic startup and VC community. I was recently invited to join a panel discussion hosted by the Norwegian Venture Capital Association to discuss terms in the Norwegian market, which served as a catalyst for sharing our perspective on terms generally with more details and context.

See also a video of the panel discussion (in Norwegian) at the end of the post.

Key principles

Alliance Venture follows a few key principles on investment terms, which we believe align well with best practices in the market. Furthermore, we believe that these principles benefit ourselves, as well as founders, co-investors, and all stakeholders targeting successful outcomes and investment returns. The key principles are:

• Founder-friendly; Experienced VCs understand power law returns and that winning high-quality deals drive returns. The most critical component of high-quality deals is the founders. Founder-friendy terms are table stakes to win deals with high-quality founders, thus simply good business sense. On a more fundamental level, VC investing is minority investing, where we bet on and ride with the founders. In this context, it is critical to give the founders the incentives, tools, and control to execute efficiently for success.
• Standard-based; There is a multitude of benefits to using standard document templates for investments, including helping alignment on standard/fair terms, removing process friction/cost, faster process, leveling the playing field between founders and investors, and educating/maturing the ecosystem. Both founders, investors, and the ecosystem benefit from standards.
• Compatible; Achieving meaningful ventured returns, ideally unicorn outcomes, typically require lots of capital and multiple funding rounds. Building a good foundation of terms and documents helps facilitate this trajectory. Thinking about compatibility with later-stage investors from the start is a core component of this foundation. While this unsure success in itself, it certainly helps avoid friction and misalignment downstream. Utilizing standard documents has a beneficial, but intended and inherent compatibility effect.
• Context-adapted; Standard documents and compatible terms are good fundamental principles, but unfortunately there is no single, uniform, and global standard. As an example, the ideal documents and terms for a startup aiming to raise international venture capital may be different from a startup looking to raise funding from Norwegian investors and ultimately list on the Oslo Stock Exchange. This means that good/right documents and terms are often context-specific, and it makes sense to look ahead at the ideal/likely path to choose wisely. We are proud of our track record for investing and syndicating outside our home markets and look to multiple standard documents to ensure that whatever we choose is standard, compatible, and context-adapted to target the ideal trajectory for each investment.

Standard documents

Being a Nordic VC investor and fans of standardization we decided to back the pan-Nordic standard StartupTools when it was established a few years ago, as it provides us with a single standards framework for our home markets. With our partnership with StartupLab and Norwegian roots we also support the standard document templates from StartupLab/SANDS. This one is widely used in Norway, and the SLIP template is particularly useful and tax-efficient for incentivizing early employees thru equity in Norway. Our preferred choice is therefore context-specific. Furthermore, since many of our portfolio companies operate outside our home markets, we track and use standard documents from multiple geographies, staying true to the context-adapted principle. Below is a table showing the various standard documents we rate as high-quality and relevant to consider depending on geography and context.

While we are fans of standard documents, there are exceptions to using these out of the box. If high-quality agreements with the right terms are already in place for new investments, there is no need to reinvent the wheel. There may also be situation-/context-specific concerns that need to be catered for thru modifying standard docs or using custom docs. Even when standard templates are not used, they serve a purpose for benchmarking fair and good terms.

No Go Zone — companies and reputations are at risk

The vast majority of experienced VCs in the market are well aligned on fairly standard and founder-friendly investment terms, understanding that this is better for both returns and the ecosystem. This does not mean that it is the only or a uniform approach in the market. I have been surprised to see that a few experienced investors in Norway, who should know better, have presented term sheets with off-market and aggressive investment terms even during the last 12 months. I would have expected these days to be gone. When facilitating funding and fundraising workshops for founders and startups over the years, I have shared a list of off-market terms that founders should not accept and are bad signals about investors’ intentions or investment practices; terms indicating investors to be “sharks” or “vulture capitalists”. The “No Go Zone” list contains the following elements:

• >1x preference; more than the money back as a liquation preference
• Participating pro-rata; liquidation preference in addition to pro-rata share of upside at liquidation
• Full-ratchet anti-dilution; the most aggressive form of anti-dilution
• Super pro-rata; right to invest more than pro-rata in follow-on rounds
• Option investing; small investment + large investor call option to invest a larger amount in the future —i.e. a way to repackage super pro-rata
• Excessive dilution; pricing under “market” with the effect of diluting founders/teams, making external fundraising later very difficult

In my view, proposing terms from the No Go Zone puts an investor’s reputation is at risk. A likely consequence is getting shunned by high-quality founders and co-investors, thus damaging long terms returns. Furthermore, such terms are counterproductive, as they tend to lead to problems, friction, or accelerated punitive terms in any potential follow-on funding round and thereby putting the company at risk.

The standards docs listed above are useful for benchmarking and catching off-market terms proposed by investors. There are also datasets that can help calibrate and call out overaggressive terms, mostly in the US, where there may be minor context-specific differences. The trends data from Cooley at Cooley GO is one such good, updated, and open dataset.

Intended take-aways

By sharing our perspectives on key principles, standard agreements, and no-go terms we wanted to go on the record with what Alliance Venture stands for in this context. We hope this helps founders “decode us” to have even better discussions/negotiations in the future. We also hope that sharing more details and resources in this post provides useful content to other stakeholders in the Nordic ecosystem regarding terms and investment practices.

Videos content

See video below from panel discussion (in Norwegian) on investment terms in Norwegian VC hosted by the Norwegian Venture Capital Association in February 2022. Thanks to Ellen Amalie Vold, CEO of the Association, for moderating the discussion, as well as Monika Inde Zsak of Wiski Capital and Gisle Østereng of StartupLab for being great panelists and discussion partners.

See video below for a discussion on term sheets and terms from Bifrost Talks hosted by Nordic Innovation House Silicon Valley in June 2020. Thanks to Andreas Börjesson from Synch Law for being a great discussion partner.