Tips On Venture Capital Deal Terms - Part Three

In Part Three we will be examining Venture Capital Deal Terms as they affect Management’s equity position and cash compensation. I conclude with a discussion about Exit Strategies.

When I represent a private company in a Venture Capital Financing transaction, I do my best to help them maximize their equity position and cash compensation. When I work on the Private Placement funding documents for a client I have been known to be quite creative to accomplish this goal. Read below and you’ll learn some of my ideas that you might be able to use to your benefit.

1. Always ask for a “Clawback”. Using a clawback provision allows the company to buyback shares from the investor at a minimum price if the company achieves a certain milestone. This gives you the opportunity of increasing your percentage of ownership and voting rights in the company. Milestones could be based on number of products sold, gross revenues or net profits.

Here’s an example: If you reach $4,000,000 in gross revenues in the second year after funding, then your company may repurchase 10% of the shares owned by the Venture Capita firm or Angel investor for a nominal value, like $.10 per share. The thinking behind this is simple. If you hit the milestones your company is doing great. If your company is doing great the value of the investor’s stock has dramatically increased and they may be willing to let you buyback a portion of their stock holdings.

2. Management Salaries. Management usually is underpaid the first 2 or 3 years of a company’s operation. Again, consider using milestones to allow for increases in management salaries. Investors today more than ever hate to see management waste money and pay themselves excessive salaries and bonuses. Investors would really like to see a responsible Management Team put their money where their mouth is. Have he employment agreement increase quarterly, semi-annually or annually based on gross revenues or net profits. Incentive based compensation is always looked upon favorably.

3. Exit Strategy. It is a good idea to include in your Deal Terms a discussion about your Exit Strategy. There are a number of issues to consider. Do the investors and management agree on the type of Exit Strategy to be used? Exit Strategies include reverse mergers, IPOs, acquisition by a competitor or buyout of the investors’ position by a large investor group. Maybe management has no intention of being a public company. If that is the case, then make sure the term sheet eliminates going public as an Exit Strategy.

Some Venture Capital Firms prefer a buyout or merger with a larger competitor. While other Venture Capital financing investors prefer going public or a reverse merger. Your Management Team should try to remain flexible. This way, you can keep your potential investors happy.

Tips On Venture Capital Deal Terms - Part One This section starts out with a discussion about when you should ask potential investors about "deal terms". We then go on to discuss using a separate Executive Summary to save them time screening potential investors and to protect confidential information.

Tips On Venture Capital Deal Terms - Part Two. This is a discussion of Venture Capital Deal Terms from two different perspectives, Business Venture Capital and Angel Funding. Learn some of the nuances of dealing with each type of investor.