VC Terms That Can Hurt Your Company (Part 2)

This article delves into the world of venture capital (VC) terms, specifically highlighting clauses that can pose risks to a company's future. It emphasizes the importance of understanding and negotiating these terms effectively to protect a company's interests.

Limited Exercise Period for Stock Options

One of the most controversial aspects of VC terms is the limited exercise period for stock options. When employees leave the company, they often have a short window (typically 3 months) to exercise their vested options. This can be a difficult situation for employees, forcing them to make a significant financial commitment.

• Employees are required to pay the strike price to acquire the shares.
• This can create a substantial tax liability.
• It is argued that options should be exercisable over longer periods, allowing employees to benefit from the company's eventual success.

Multiple Liquidation Preferences

A multiple liquidation preference gives investors a multiple of their invested capital back before any distribution to other stakeholders. This can be a major hurdle for a company.

• Investors are prioritized in receiving their money back before founders or other shareholders.
• While it may be necessary for a company to secure funding, it is crucial to negotiate these terms carefully.
• The author emphasizes that simpler terms are preferable to complex structures that prioritize investors' returns.

Cumulative Dividends

Cumulative dividends, which accrue over time when they are not paid, can add a significant financial burden to a company. This is not common in most venture deals.

• The interest on these unpaid dividends can quickly compound, leading to a larger liability for the company.
• These clauses may be acceptable as part of a larger deal but should be carefully assessed.

The Trap of Complexity

Complexity in VC terms can create confusion and slow down decision-making. This is a significant risk that can hinder the company's progress.

• Complex terms can make it difficult to understand the cap table and the allocation of equity.
• The author advises that simplicity is key and that focusing on business execution is more important than complex legal language.

The Importance of Legal Counsel

The author stresses the importance of securing legal advice from experienced lawyers who understand VC deals. This advice is crucial for protecting your company's interests.

• You need a lawyer who can identify potential risks and provide guidance on negotiation strategies.
• This is not a service that can be outsourced; you must actively participate in understanding the terms and asking questions.

Understand What You Are Signing

It is essential to understand the terms of the agreement thoroughly. Don't rely solely on your lawyer's advice.

• Read through the documents carefully. Ask questions about anything that is unclear.
• Understand the risks associated with the terms, both to your income stream and ownership.
• Be prepared to push back on terms that you feel are unfair or disadvantageous.

Standard Terms Don't Exist

VC terms are not standardized, and each deal should be negotiated individually. Do not assume that all VC deals have the same terms. Every situation is unique, and you need to negotiate carefully to protect your company's interests.