A San Francisco VC told my client that they championed female founders, that their mission was to make it a more level playing field. My client was so thrilled after first and second the video call. The client shared the data room and after they had expressed a real interest in moving forward we asked to see the documents to review the closer terms. They kept giving exuses and it took 3 additional weeks before they sent the investment agreement and SHA. And then I reviewed the terms.
An aggressive 3x liquidation preference. Highly restrictive covenants and other control mechanisms. A focus on short therm sales figures that would leave the founder little room to prioritize long-term growth, even where that would benefit the business and its shareholders.
That negotiation illustrates why, at STG Corporate and Commercial Law, we look beyond the headline valuation. Here are five mistakes we help founders avoid.
1. Confusing ownership with what you get paid
Owning 60% does not necessarily mean receiving 60% of the proceeds when the company is sold. A 3x liquidation preference can mean the investor receives three times its investment before founders receive anything. Depending on the terms, the investor may then also share in what remains (so called participating pref. shares).
Always do a scenario analyzis of the payout at an exit - the so called waterfall - at different sale prices.
2. Giving away control without noticing
In that negotiation, the restrictions on running the business mattered just as much as the financial terms. Budget approvals, veto rights and binding targets can leave you accountable for performance while someone else effectively controls your decisions. And it can block you from having necessary flexibility when scaling the company.
Test the terms against the decisions you expect to make over the next year and make sure you have a grasp on what the investor, if you sign, may decide for you/the company in the future.
3. Assuming your shares remain yours if your role changes
Leaver provisions and vesting structures can require you to sell shares - including your own exisiting shares - at a low price, if you stop working in the business. These are not “standard provisions” that all look the same - on the contrary the trigger, the price and who controls your departure can vary and it all matters.
Ask what happens if the investor wants you replaced as CEO and you disagree.
4. Reviewing exit rights separately from the economics
An investor’s right to force a sale becomes particularly important when combined with a liquidation preference. An exit that delivers an attractive return for the investor may leave the founder with very little.
Check who can trigger a sale and what each shareholder would actually receive.
5. Overlooking personal exposure
Founder warranties and personal commitments can put more than your shares at risk. Understand what you are promising, how long that exposure lasts and whether liability is capped.
The company receiving the money and the founder carrying the liability are two different things and you need to be careful with personal exposure.
The bottom line
Our experience in M&A and investment negotiations has taught us to examine the whole arrangement. Individually, provisions may look familiar. Together, they can shift control, risk and value much further than a founder realises.
Have a term sheet on your desk? At STG Corporate and Commercial Law, we help founders and investors identify what matters, negotiate better terms and get investments moving. Get in touch while the key terms are still open.
Kat Strandberg, Lawyer
kat@stgcommerciallaw.com