This week I had the privilege of being invited to speak at Harvard Law School in David Hornik’s term sheet negotiation class. David’s course is called Entrepreneurship and Company Creation and is one of the most popular elective courses at the school.
For those of you that don’t know him, David is a partner at August Capital and is a highly successful investor whose $9 million investment in Splunk is rumored to have returned $500 million to his limited partners. David is also the author of VentureBlog, the very first venture capital blog. The man is a legend.
The course covers a range of topics from company creation and formation to business planning and finance. In the term sheet negotiation class, he negotiates two sample term sheets with VCs. He does this to demonstrate which terms – valuation, size of the options pool, liquidation preference, anti-dilution protections, voting rights, board composition, and the like – are worth pushing back on and why.
I thought I would share my three most important takeaways from this experience.
There Is an Upside To a Billion Dollar Miss
In the class, David mentioned that he once turned down an invitation from Reid Hoffman to invest in Facebook at a $100 million valuation. He objected to the VCs lack of control over the exit, but more importantly, he thought the valuation was too high.
Although obviously a huge disappointment (Facebook’s market cap is currently about $230 billion), the reality is that the most successful venture investors have at least a few billion dollar misses and one ten billion dollar miss. The point of this is not to comment on an investor’s ability to pick winners but rather highlight that a good investor is in the flow. If you are consistently seeing the best deals you will inevitably miss some winners.
Rich or King? Many Prefer King
At the end of the class David asked the law students to incorporate all they have learned in the course and vote on which term sheet they would go with if they were the entrepreneur. Their choice surprised me. One term sheet had better founder economics but the investors controlled the board. The second term sheet had founder economics that weren’t quite as good but the founders controlled the board. The Harvard Law students overwhelmingly voted for the option where the founders controlled the board. Perhaps they placed a value premium on their control of the company. More fundamentally, they wanted to control their destiny.
Simple Is Best
The class also reinforced the importance of using standard vanilla terms with clean structure and fair governance in the base case. At Cue Ball, for example, when we issue a term sheet for a Seed or Series A deal, we like to use the standard NVCA term sheet with middle of the road options. Obviously, if an entrepreneur wants a higher valuation than we are willing to pay, we may bridge that gap with structure, but our strong preference in an early stage deal is to use the cleaner, simpler, terms. I would much rather put cash into the company than burn legal fees by reinventing the wheel for each new investment. This is clearly the way the industry has evolved and is continuing to move.
While this may not be good for Harvard Law School graduates going into corporate law, it is certainly good for all entrepreneurs.
Copyright 2015 Ali Rahimtula. All rights reserved.