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Article Four – Common Ground January 24, 2010

Posted by Lawrence Lenihan in Uncategorized.
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The common ground here is fairly straight forward: the VC and the entrepreneur need to engage and agree on mutual expectations PRIOR to signing a termsheet.  Easy advice, but hard to do!  Why?  Because it is against human nature to seek out unpleasantness and disagreement (at least it is against most humans’ nature!).  These are not the most pleasant conversations.  The VC is trying to sell the entrepreneur and vice versa.  In addition, there is love in the air – both sides are really excited about this future relationship, so why do or say anything to spoil it?

If spoiling it is asking for the honest truth, spoil it now, because it will be a lot more painful when it spoils later.

Ask these questions and make sure both sides understand the answers, actions needed and consequences of not achieving:

  • Where and on what is the money going to be spent?
  • What definable and measurable objectives and milestones will be reached as a result of this investment?
  • What will we learn and by when will we learn it?
  • How much future funding will be needed and when will it be needed?  Who will fund it?
  • What happens if the answers we discover are not positive and objectives are not met?
  • How does the company report progress?
  • What is the VC’s commitment if the company meets its expecations?  How can he/she demonstrate that the commitment can be kept?  Does the VC have the authority?  Has the firm given the commitment?  What happens if the VC is not there at the next milestone?
  • At what value will future funding be secured?  Based on what?

These questions seem straightforward, but they’re not.  It is a hard and uncomfortable discussion, but you need to talk about them and not simply hope they are the answers  and commitments that you want, but, rather, they ARE the answers and the commitments you expect.  And, because human minds are frail things that often “misremember”, a confirmatory email is not a bad idea either.  Why not a contract?  You could, I guess.  But my take on it is that unless there is a real contractual commitment (like a future funding at a specific price), there are so many ambiguities, that you would spend months in contract negotiations.  Moreover, these contracts would be difficult to enforce anyway.  If you need somebody to have a contract to fulfill an obligation, you have the wrong partner anyway!

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Comments»

1. Caroline - January 25, 2010

Wow…such a crucial list of questions. This totally captures the most important points of discussion between a VC and an entrepreneur. Printing this out now!

2. Colette K. Young - February 3, 2010

Great posting; I have a few questions. My past experiences have all been sole proprietorship, therefore I have not had to worry about contracts with any part of a management team. Do you think it is a good idea to dive in with contractual commitments between the TMT team, before we start the production of a business? More specifically, deciding on how to break up the business according to who owns what, do you think we should award shares based on deliveries? Clearly, when you seek funding, all this will go out the window but until we reach that point, is this important?

Lawrence Lenihan - February 6, 2010

Good questions. I don’t think you are asking about employment agreements, but I’ll address it anyway. The founding team typically puts an agreement in place around the vesting of stock that they own. That way, if one of the founders were to leave for greener pastures early on, he/she would not participate in the future upside of the company to the degree that the others would. This is very fair although it has caused many an argument.

Now, I think your question is along the lines of a “pre-nup” agreement for a founding team. In technology or tech-enabled types of businesses there usually is not much to take away if there is a break-up. Maybe a desk or chair or something like that! However, at times, I have seen direct ownership of a piece of technology by one of the founders. In other words, the intellectual property is owned by an individual(s) and not the company (Skype is a great example of this). We would never fund a company where this arrangement existed after funding and would cure it before funding (or not fund). Others might feel differently. But, since the company is so early and tenuous in its development, in this case, it would make a lot of sense for the creator of this technology to keep it prior to funding as it was his/her direct non-cash contribution to the business.

The most effective way to address this I feel is ownership. If you contribute more, you get more. If you wrote a check, you would get more ownership. So if you contributed technology, the same should hold. I understand though that prior to a VC funding, the outcome of the enterprise is more uncertain, so the contributor would want to ensure that he/she retains title in the event of the company’s quick demise.


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