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"It's hard to see why all these quirks make any sense, except fooling naïve entrepreneurs"
Adeo Ressi’s on a mission to save entrepreneurs from the “atrocities of investors.” Yesterday, he published his “ideal term sheet”— an attempt to standardize VC deal terms that’s getting a lot of play in the WSJ, TechCrunch, Fred Wilson, and Chris Dixon. Among the key provisions are the elimination of participation with preferred stock, a 1x liquidation preference, and single-trigger vesting acceleration on acquisition. See TC for a good breakdown of what these mean.
Turns out Adeo, who is the founder of The Founder Institute, has backers in the Academy. "A standard term sheet is a great idea,” says Ola Bengtsson, Assistant Professor of Finance and Entrepreneurship at Cornell University, whose research focuses on differences in how U.S. VC contracts are structured. “My work shows that there is so much variation in deal terms (based on founder experience, VC experience, lawyer experience, geographical location) and at the end of the day it's hard to see why all these quirks make any sense, except fooling naïve entrepreneurs.” In an email, Bengstonn said he examined almost 2000 real contracts from 2006 on, and concluded the following:
1. Experienced/Reputable VCs use FEWER (!) investor-friendly deal terms. This result is surprising because these VCs are likely to have better bargaining positions - my results show they use that to get more shares but not more investor-friendly terms.
2. Deal terms are less investor-friendly in California, and in particular in Silicon Valley. Also, VCs who are located outside California but invest a lot in California, syndicate with California VCs and are located geographically closer use less investor-friendly deal terms. This suggests that there is regional "culture" or style in VC contracting.
3. Entrepreneurs who hire more expert lawyers sign contracts with fewer investor-friendly deal terms. Simple story is that these lawyers warn entrepreneurs that many deal terms may give VCs significant payoffs and power. Interestingly, the impact of lawyers is less for experienced entrepreneurs - suggesting that such entrepreneurs already learnt their lessons.
4. Many deal terms interact in complex ways. Protective provisions (covenants) are less common when VCs control the board but more common when the VCs have other investor-friendly deal terms. This is not a random pattern and can be explained by the needs of different investors varying across financing situations.
Embedded is an interview with Adeo conducted a month ago, focusing on his most recent project, the Founder’s Institute, an incubator that trains new entrepreneurs, helps them find funding, and participates in investments. Around 7:30, he mentions that he had “Wilson Sonsini draft from scratch the best operating agreements possibly in the history of operating agreements" to give the founders in the institute.
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