Just recently, someone asked me what it meant to “lead an investment round”. This was my reply:
1. The lead is generally the one with most to lose, or the most money in. It’s not always like this, but usually. Sometimes it ends up being the person who cares the most about the terms.
2. The lead negotiates the terms for the round.
3. The lead may or may not share the negotiation with the other investors. It depends on the situation. For example, a venture fund may not include angels’ opinions in negotiating. OTOH I’ve invested with one fund where they did include all us angels in the negotiation.
4. The lead is committed to the round and will most likely put in money first. Other investors will typically follow the lead’s move to sign the docs and transfer money into the startup’s account. So it’s a tremendous vote of confidence for investors who may be conservative or shaky.
5. The lead generally pays the lawyer fees associated with the negotiation unless it’s specifically called out in the terms that the startup will pay all the lawyer fees (ie. negotiation + financing). The lawyer fees typically aren’t shared amongst others like angels. There are exceptions like two big VCs may share some costs if they are working on the negotiation together from the investor side.
6. There is liability associated with being the official lead. For example, there have been rare cases where other investors have sued the lead investor where they may feel the terms weren’t negotiated well and there is some bad financial result because of it. So you should be aware of this and be concerned about it if you lead.
7. The lead generally sits on the board of directors since being on the Board of Directors since it allows them to watch their money most closely, and having the most to lose they usually want to do this. Not all financings have investor representation on the board, especially at early stage. Once you get professional investors involved it will most certainly be the case.
8. Only experienced people should lead. Someone who has done this many times is much better than someone who hasn’t. Experience gives you an edge in what to negotiate for and what to give on, and what really doesn’t matter. Otherwise you may not know what you’re doing. Even someone with a lawyer backing them up may not be enough; a lawyer will always argue for you first and so you have to know when that is appropriate and when it is not, meaning how investor friendly or company friendly do you want the terms to be and how to get there.
In the last few months, there have been a number of people whom I’ve tried to talk out of being entrepreneurs. I tell them it’s really a test to see if, after hearing about how hard it is, whether or not they actually still want to do it.
There are many who are newcomers to entrepreneurism. I think this is great. But I think most of the newcomers underestimate what it takes to start a company and make it successful.
So I let it all out. I tell them how it requires some serious soul searching about what kind of person they are. You have to be natural risk taker. You must be willing to throw all caution to the wind, because you never know what’s going to happen. You must be willing to throw away all levels of comfort in hopes of some huge gain later on. Are you OK with leaving your current job and its consistent pay, health insurance, and sense of direction in your life for a lot lower pay and the chaos that accompanies typical startups?
I talk about the time commitment. I talk about my early Yahoo days when there were just a bunch of us, and we worked our tail off for years. I talk about the long hours we spent building Yahoo back in the day, the stress, the do-everything-yourself mentality and the chaos of not knowing what’s coming next. I tell them about the fact that relationships have broken up due to training for Ironman, which even at its peak, doesn’t equate to time commitment spent at a startup and for a longer period of time. I go through the inevitable ups and downs that come with relationships and families of entrepreneurs; it’s not an easy place to be when your work and family demands collide.
I make them take a hard look at themselves, and I also gauge their reaction to what I say. I can see it in their eyes and in their replies if they are unwilling to give it up. My intuition is running high in sensitivity as I sense whether or not they have what it takes to go the extra distance to be a successful entrepreneur.
Don’t get me wrong; I am not judging what’s good or bad, but only what’s appropriate. I am not making a judgement call on whether you’re a good or bad person if you have or do not have what it takes to be an entrepreneur. For some people, it’s just not the right path to take. Yes it’s disappointing, but I think we need to be realistic that entrepreneurism isn’t for everyone. Or perhaps your life stage is now not the right time for a startup – for example, having a family and/or dependents, and/or a lifestyle which requires steady income may not make it appropriate for you to jump into a startup.
This is really important. We investors are betting on you to take our money and build something big with it. We are looking for those who are willing to do anything it takes to make something successful so that we all win, and that means sometimes driving yourself into the dirt and dealing with the stress of knowing that your bank account is about to run out and that if you don’t do something fast/creative/better, you’ll not be able to feed yourself or have a roof over your head anymore. This kind of passion/adaptability/drive for building a great company is what we’re looking for.
If you’re going to quit as soon as the risk is too high for your own personal livelihood, then it’s best that we just don’t start. It’s not positive for either of us. Find an occupation that allows you to live the life you want, at the stage you’re at now and be happy about that. Don’t try to start a company on the assumption that you’re going to just have the same kind of life you did when you worked at a bigger company.
One of the big problems I’ve seen over the last 3 years of angel investing and with entrepreneurs is that they will raise money and then compensation goes to near market levels for the people in the startup. They think that they can be in a startup and have their old lifestyle not be threatened. The reality is that startups are not a place where lifestyle can be guaranteed. This ranges from the “working lean and mean” philosophy (how can you pay yourselves market rates and still be lean?) to execution speed (you can’t work at speeds seen in large organizations; you’ll get crushed by other startups) to just the simple fact that the risk of failure is tremendous (you don’t get the comfort of stability in a startup that you would get at a larger more established company; that’s the price you pay for constant salary versus the chaos of a startup).
So if you pass my test, which is, after my whole tirade about the risks of startups and the downsides of what it’s like to be an entrepreneur, you are still fired up about being one, then more power to you. Let’s take this conversation further. But I am getting better at spotting hesitation, fear, and reluctance after hearing my speech. So let’s not kid ourselves in being somebody we’re not.
It’s sexy being an entrepreneur. The rewards are great. The upsides are what everyone sees, and nobody sees the downsides. Dealing with the downsides is where the rubber meets the road and where you’ll be tested sorely on whether or not you are a great entrepreneur. But if you’re not entrepreneur material, you’re not and that’s that, whether it’s your personality, life stage, or otherwise. You’re not a bad person; it’s just not for you and we should all just realize this, and not fool ourselves into thinking otherwise.
I was just talking to a new entrepreneur about a term sheet and I realized that trying to understand all those dang terms on a term sheet was super tough because of all the legalese there, and also it’s hard to know the implications of terms if you haven’t experienced them first hand. It took me 2+ years of investing to get to some basic understanding of the terms and I’m still not even close to being an expert at it.
Searching on Google, I found some excellent posts from Brad Feld that explains some of the basic terms in a more easily understood way. Here are links to them:
Information and Registration Rights
Drag Along Rights