Monday, February 26, 2007

Startup Financing: What's Overdone and Other Matters

Over coffee this morning, a client and I discussed transaction strategy - that is, how to get his deal closed with maximum efficiency but minimum damage to the goodwill between him and his new investors. We've been through several rounds together, so we have similar views about what issues are critical to founders and and what issues are not.

Here are our lists:

Terms on which far too much time is spent:

1. Registration rights (Some VCs still require these in early stage companies, although mercifully this is a declining trend)
2. Board composition ("It's an emotional issue. Focus on your other rights." - client)
3. Protective Provisions (Unless they fall outside normal parameters and could potentially scuttle the current business plan)

Terms where not enough time is spent:

1. Representations and warranties - Many VCs (or their lawyers) take the position that all risk- including the risk of the unknown - is on the company, and as a result, require that the company make breathtakingly broad representations about the business. These kinds of terms are typical in later stage financings, where the issuer has made prospectus-level disclosure (and done the due diligence to back it up). I often wonder why it's reasonable to make early stage companies provide the same thing. A balance needs to be struck between what is an appropriate amount of disclosure (and risk) to be born by a new company and your VC's needs.

2. Founder employment agreements - Too many founders allow themselves to receive less severance and other benefits than they would otherwise have received had they been newly hired to the same company. As I've indicated in a prior post, this agreement is where a significant set of your rights resides, thanks to the pro-employee laws in Ontario. They should not be negotiated away lightly.

3. Indemnities - Although it is not the norm, there are still some VCs in the northeast who believe that founders should back their company with a personal guarantee of sorts, in the form of an indemnity. I'll post more about that tomorrow.