Making European Venture Capital a Little More Human
TL;DR: Say goodbye forever to signaling risks, bloated Term Sheets and crazy Due Diligence checklists
Over the course of the last 10–15 years, Europe’s VC ecosystem has grown up tremendously. Ten years ago you could still count the number of high-quality European VCs on one (or maybe two) hands. London was the only city with a decent funding ecosystem, while most other places were dominated by lousy investors. And when I say “lousy” I’m not referring to “no value-add”. It was worse than that. What I mean, and this might surprise people from Silicon Valley, are investors who shamelessly leveraged their power, lack of competition, and the inexperience of founders to command “sweat equity”, charge founders for services, buy 50% of a company for a hundred thousand Euros, push through 3x participating liquidation preferences, and so on.
Fast-forward ten years. The increasing competition from a flurry of new European players, as well as American VCs who took interest in Europe, has worked wonders. Brazen terms are a thing of the past, and most of the investors active in Europe today understand that in order to be taken into consideration by the best entrepreneurs, they must do more than doing no harm (although that is important, too).
In spite of all of these important improvements, many (if not most) founders still feel like raising venture capital is a pain in the butt. A survey that we did some time ago revealed that being left in the dark, i.e. not knowing where you are in the process, as well as not understanding why a VC has passed, is what sucks most about fundraising. However, many founders also mentioned term sheet negotiations, due diligence, and legal paperwork as additional sources of stress. Another thing that causes many founders to worry is the uncertainty of whether existing investors will participate in the next round and the associated signaling issues, i.e. the problem that potential new investors may read lack (or just uncertainty) of participation by people with inside information as as bad sign.
Today we are excited to announce three new initiatives that we hope will make fundraising a little less stressful for entrepreneurs. To borrow a phrase from Typeform, we hope to make European venture capital a little more human.
1. We will do our pro-rata in your Series A, period.
Starting with our current fund (PNC IV) and with immediate effect, we will always do our full pro-rata in Series A rounds. If you raise a Seed round from Point Nine, you get a guarantee that we’ll also participate in your A round. There it is, our promise that’s signed, sealed and delivered. :)
Given that the “graduation rate” from Seed to Series A is only around 30%, it’s not surprising that raising an A round is an important milestone for every founder. It’s no wonder that founders don’t sleep particularly well until their Series A money has hit the bank account. The Seed-to-A graduation rate across our portfolio is fortunately MUCH higher so far 😉, but to further minimize the anxiety associated with Series A fundraising, we decided to take one topic — participation of the Seed investor — off the table. Founders have enough things to worry about. Now there’s one less.
Where’s the catch? There is no catch. Really. That’s the point. 😍 The only disclaimer that we’d like to add is that the financing round must be a legitimate Series A, which for the purpose of this pledge we’d like to define as a €3–12M equity investment led by a new investor who takes at least 50% of the round. In other words, a €100k check by an existing investor is not a Series A, and neither is a €1M grant from the government. 😉 On the other end of the spectrum, if you’re raising a €50M Series A from Softbank (first off, go back and ask for more! LOL), our fund size will prevent us from doing our full pro-rata — but in that case it doesn’t matter because you’re 🔥hot🔥 and don’t need our c̶h̶a̶n̶g̶e capital anyway.
2. Here’s our term sheet, ready to be signed.
We’ve always been big fans of simple term sheets. If a term sheet is longer than two to three pages, chances are that 90% of the provisions are aimed at situations which almost never occur. When they do, most of the VC’s money has most likely been flushed down the toilet already and can’t be pulled out again, no matter how deep you dive into the legal sewage system. We never understood why we should spend any brain power (and legal fees) on trying to slightly improve our odds of getting some money back in a 0.1% probability situation. This is especially true in an industry where success is almost completely dependent on positive outliers! Fortunately, our long-time legal counsel, Tilman Langer, is completely aligned on this with us, which was one of the key reasons why we’ve recently brought him onboard full-time as our in-house General Counsel.
Don’t get us wrong, there are a couple of important basic protective rights that we do need, too. Founder vesting, a simple (non-participating) 1x liquidation preference, pre-emption rights, customary information rights, co-sale rights, and a few other things are important to ensure alignment of interest between the founders and Point Nine. We obviously have fiduciary duties towards our Limited Partners (LPs), but fortunately our LPs are all cool people who understand that as a VC, moving fast is much more important than optimizing for some edge cases.
To further simplify term sheet negotiations (and with the goal of taking another topic off the table) we decided to publish the template that we’re going to use from now on.
It’s almost identical to the term sheet template that we’ve been using for most of our investments in the last years, but it comes with a few small improvements (e.g. to make it compatible with various jurisdictions).
Publishing our template doesn’t mean that we’re not willing to discuss modifications on a case by case basis if there are good reasons for doing so. What it means is that from our end, we commit to using this template and to not ask for anything fancier.
3. Our simplified Due Diligence (DD) checklist
If you think that long contracts can cause founders a lot of pointless work, just wait until you’ve seen a 10-page DD questionnaire. :-) I’ve seen DD checklists in early-stage deals asking founders for a “description of all current research and development projects, including the current status of all projects and the number of man days to complete them”, “recommendation letters for all senior staff members”, “press clippings of the last 12 months” and dozens of other items.
I recently asked Tilman why Due Diligence checklists often contain many dozens of items, many of which seem to be irrelevant, as I was honestly wondering if we’re missing something by not asking more DD questions. His answer was:
“Traditional” DD requirements have been developed mostly by large corporations and private equity investors purchasing mature businesses and with the assistance of advisers paid by the hour and therefore incentivized to maximize the effort. While the basic idea is to identify material risks and problems in the business already prior to signing binding documentation, the exercise has somewhat developed a life of its own with many DD items simply serving “tick the box” purposes without material impact on the “if” and “how” of the transaction. Still in many areas quite extensive DD makes sense for most “traditional” acquisitions, where the purchase price is to a large degree a reflection of existing revenues, earnings and assets rather than the potential of the relevant product and growth expectations. This is the key difference to (most) early-stage venture investments, where the main value drivers are the business idea and its potential as well as the founding team.
Here you have it, with the official stamp of approval by our General Counsel: Huge DD checklists for early-stage VCs are by and large BS. With that in mind, I asked Tilman to take a look at our DD checklist, see if anything was missing, and remove anything that’s not needed.
Question on the above? Suggestions for other ways to make European VC more human? Let us know!