I'd like to hear more of your ideas regarding compensation for founders and employees of start-ups. I've been involved in a number of start-ups, and while I've had a great time and some amazing experiences, I've also piled up quite a few worthless stock options. Is there, do you think, an ideal way to balance compensation against incentive for early start-ups?
fred wilson
· 4 months ago
i agree with all of this chris. however, i think its fair for investors to get preferred stock, but plain vanilla preferred.
i really dislike super pro-rata rights. i had a discussion with another VC about that yesterday.
it's a really bad idea. i think i'll post about it
fred
chris
· 4 months ago
I agree investors putting cash in should get (1x non participating) preferred stock. I think it's fair. My main point was just against more than that. As an angel I'd do common but I think institutions are well within their rights to ask for preferred.
David Cancel
· 4 months ago
Fantastic post, generally agree with all of it.
Two sticking points, 1) acceleration for non-founders, 2) on the founders pay I agree but what happens when a startup goes years and several rounds before an acquistion. At some point ramen gets old and you want to prevent founders from leaving. Or do you believe startups should die before getting to that point?
Would like your thoughts on the above.
chris
· 4 months ago
Thanks, David. Re your first point - wouldn't you agree on at least double trigger for employees? Seems crazy to me that an employee can work for years for equity and then get fired right after an acquisition and not get fully vested. Single trigger is much more questionable.
I hadn't thought about your second point. When I think about startups I know in that position either the founders have left or the companies are break even to mildly profitable and the founders are taking better salaries - which at that point seems fair. I guess you'd have to take it case by case...?
Chris Yeh
· 4 months ago
As a serial entrepreneur and investor, I agree with most of what you recommend. The two points on which I differ are as follows:
1) I don't you can ever do a deal where all the investors get is common stock. That is as dangerous a misalignment as any; the day after the closing, entrepreneurs could liquidate the company and pocket 2/3 of the financing.
2) I agree on subsistence-level (e.g. $40K) salaries for seed round deals, but once a company raises a real A (e.g. $3 million) or is profitable, you should pay something closer to market.
a) It's unfair to ask founders to essentially lose money for an extended period of time.
b) The below-market salaries will distort your view of the company's profitability
c) Founders who actually have families will be priced out of the startup game. I have 2 small children, which means for cash flow purposes, $40K isn't subsistence, it's a cash hemorrhage.
Don't get me wrong; subsistence salaries are great for seed stage deals, and I did the same when I was at Ustream, but it was always intended as a super short-term (3-6 months) situation.
Tai Hsia
· 4 months ago
Great post, Chris.
Re: the ideal startup board, I think for early startups, it may not make sense to have two out of three directors who are not involved in daily operations. I completely agree that founders and team leaders who do crappy jobs do deserve to get fired but am more concerned about too much bureaucracy, politics, and chefs in the kitchen early on, when the startup needs to be dynamic and nimble.
Cheers, Tai
Brandon K
· 4 months ago
Great post. What's the average dividend you see?
Kindra T.
· 4 months ago
Great post, thanks to Fred Wilson for linking to it. The angel group I work uses boilerplate templates whenever possible to minimize costs and speed time to close. We are currently revisiting the templates in our continual effort to build better, longer term relationships on both sides of the aisles (companies and VCs). Would be great if all parties could get on board with thinking like that of the above.
Mark Essel
· 4 months ago
I think I understand the gist of what you are describing. And from my startup centric vision they look like a fair and fast way to do business. Can a great business philosophy like this become adopted by the VC community? I certainly hope so.
Any interest in a potential board member seat in a pre-corporate startup Chris? The initial thrust is in contextual advertising driven by user social media, with the user value point being 2-way personalized passive search (both real time and through standard search engines).
It's been challenging finding potential team members with zero dollars but it turns out relentless passion helps. I've got 2 web dev savy folks helping and a business strategy friend, an we're discussing the pattern matching/prediction problem with the ensemble winning Netflix team shortly (just gotta pick a good skype time)
Dean Collins
· 4 months ago
Hi Kindra,
A simple boiler plate template for most documents makes good sense.
I was planning on setting up a website for startups to access these boilerplate documents (not just capital raising but NDAs, Development/engagement contracts etc etc)
If you want to email any boilerplate documents you have the right to 'open source' to submission@NYalpha.com i'll add them to the library.
Cheers, Dean
Bob
· 4 months ago
A few of these are slanted towards the VC.
My guess is Chris doesn't work at "subsistence" levels. Neither should an entrepreneur. If you can work at subsistence levels, then you should reconsider funding.
Anything considerably less than market salary should result in increased founder vesting.
I have never seen the option pool taken out of the pre-money, and it doesn't make sense. These are used to recruit new executives down the road to increase the value of the company. These should not be dilutive only to the founders.
Vladimir Oane
· 4 months ago
I am surprised other terms can exist. All seem reasonable to me and my company is fortunate enough to have similar terms from our investors. One question though? What is the difference between founders vesting and good/bad leaving terms (if you leave in the first year you loose almost all your equity,a big chunk in the second year and so on). I guess is the same idea. Right?
Glenn Kelman
· 4 months ago
This is a great post. My only issue is with the percentage allocated to the pool: 10% - 20% may be standard -- I would argue it is 15% - 20% at least -- but if 10% - 20% is the standard, the standard is low. Imagine a 50-person company selling after three years for $50M; this isn't a fantastic outcome but it isn't an absolute dog either. The founders get 25%, or $12.5M; the 50 employees get 15% (the midpoint of your suggested range), which is $7.5M, or $150,000 each. If the first three employees get $1M and you have two execs who get around that too, then the other 45 get around $50K on average. That doesn't seem outrageous to me, but it does seem a little low, especially if people are working at subsistence levels of pay. Over three years at that level, an employee would give up more than $50K in cash compensation. Maybe my mistake is in assuming that 5 people besides the founders make a million, but I do think that the early, core engineering team thinks in those terms, and that early-stage execs -- the guy running sales for instance -- do too.
great stuff all round and thx for the content on founder vesting, especially the parts about acceleration on change of control, really puts the future into perspective.
John
· 4 months ago
Ever heard of a company retaining an S-Corp status post seed funding? We are in the process of seed funding, and are being pushed to go to C-Corp, but I hate C-Corps and would like to avoid such until a point where we would need to be for preferred stock or foreign investor reasons.
Jeffrey J Davis
· 4 months ago
Good post and very helpful info for potential early round founders.
My only inputs are that I tend to think option pool vesting for founders and senior leadership team should all trigger on change of control, but that normal vesting should have a portion time based and a portion performance based. Having an additional vesting carrot hanging out there in year 2 or 3 for hitting revenue or EBITDA goals can be a great motivator for a management team.
chris
· 4 months ago
John - I am not an expert on this but I think most institutional investors basically insist that you become a C-corp because their investors (LPs) require it because they don't want to be liable for taxes on profits. Most individual investors don't care and might even prefer a pass-through entity (S corp or LLC).
Matt Blumberg
· 4 months ago
I'm surprised you think all startup employees should have subsistence salaries. I guess it depends what you mean by that, but doesn't that cut off a pretty big swath of talent?
chris
· 4 months ago
Hey matt - Well, first let me clarify what I mean by subsistence salaries. If someone is a single parent with 2 kids and lives in a major city and doesn't have savings, subsistence to me might be >$100K. The point is enough to not have them spend time counting pennies but little enough that they make any "real" money on the equity.
Also I'm sure it varies by stage. I am thinking particularly at the seed stage, which is what I'm most familiar with. I'd expect at your stage you hire sales people etc at market cash comp prices and I expect that's the best strategy.
Andy Freeman
· 4 months ago
> Hey matt - Well, first let me clarify what I mean by subsistence salaries.
Shouldn't you also clarify what you mean by "employee"?
If we're talking about someone who has a significant equity stake (including options), subsistence salary makes sense. However, if we're talking about someone who has >1%, it's insane.
Let's do the math. Most of these companies will fail. Of the ones that don't, the vast majority will go for less than $100M. If the company "goes", that's $1M to our 1%er. Over five years, that's subsistence $200k/year. However, in most cases, it's $subsistence for five years. The expected value calculation is between those two end-points, but closer to subsistence than $200k.
There's a Dilbert about a company that thinks that it can find good engineers who can't compare salaries.
How many good engineers do you run into who won't do an expected value calculation?
Tom Klein
· 4 months ago
Nice post by Chris, but I have a few important tweaks:
1. Find a start-up lawyer, rather than a start-up law firm. Even at the firms Chris mentions, there are attorneys insensitive to start-up concerns. I practiced at Wilson Sonsini for 19.5 years before moving to Greenberg Traurig's Silicon Valley office. GT's Silicon Valley office has excellent start-up attorneys. 2. Cost. I believe that the quotes you will receive for Series A rounds will exceed Chris' estimate of $10K for both sides. However, there are ways to keep the fees modest. One way is to limit diligence and disclosures. If the company is a raw start-up, then there should not be much if any diligence. If the company has an operating history, has patents or applications, or has spun off from another company, then there may some form of diligence investigation. In life science transactions, it is typical for investors to do a "freedom to operate" analysis, which usually costs $5,000 by itself. Another way to limit costs is to make sure there is indeed an agreement at the term sheet level. Negotiating changes later in the process when the documents are largely completed adds to cost (just like change orders with a contractor; there will be additional fees). 3. Most US first through third tier venture capital funds will adhere to the basic terms Chris outlines. Foreign firms and angels usually have their own pet provisions, as do corporate investors. Expect deviations when not dealing with experienced U.S. venture funds.
chris
· 4 months ago
Hi Tom - Thanks for the comments. I'd generally agree with what you say. I'd definitely agree that the particular attorney matters more than the firm just as the particular VC does more than the VC firm. On fees I agree I'm being aggressive (on the low side) but think it's doable, especially if you agree to "standardization" as Fred Wilson suggests. I haven't done foreign deals - I expect your are right about that.
William Carleton
· 4 months ago
Chris, great post; I hope you've started something that leads to further standardization at the seed and Series A stages. I have to differ, though, where you recommend that entrepreneurs go with the "standard" startup lawfirms (and this is based on a single bad experience?). Not that there is anything necessarily wrong with them for being the conventional choice; Wilson lawyers at the Seattle office in particular in my experience have always been stellar. But there are plenty of us "non-standard" lawyers at small firms and boutiques who leverage past experiences working with startups, investors, in house, etc., who are passionate about entrepreneurs and whose counsel and advice may mesh better with serial entrepreneurs in particular who don't necessarily want to tread a prior path. Just saying.
Peter
· 4 months ago
Chris- I wholeheartedly agree with what you say. We recently had a discussion with another founder about the CEO compensation. I believe the right incentive is that the optimum is a mixture of fixed and variable. Fixed should be high enough so that they don't have to worry while the variable should be something around 20 to 30% and based upon specific goals for that period (usually one year). The variable should only come from the actual cash they were able to generate. Hence this is only reasonable when the startup is cash-flow positive. I believe success on the way should be rewarded. Interested to hear your opinion on that.
chris
· 4 months ago
Andy - I would hope all engineers do an expected value calculation. If they don't believe the company is exceptional, they shouldn't join.
Sachmo
· 4 months ago
This may seem like a dumb question, but how is the board / control rights usually structured in a first round term sheet?
It seems kind of unfair to me that an investor / VC can oust a founder, despite owning less than 50% of the company per say...
Bubba
· 4 months ago
This is a great piece. I'd have to agree that setting standard boilerplate terms and conditions makes a lot of sense, reduces time and cost, etc. I'd also agree that the vast majority of wasted time and energy in non-standard deals is usually around those points that have the lowest probability of impacting long-term value in success.
The only point of disagreement that I'd have with what has been presented is on founder comp. As it looks like I'm in the significant minority here, I'll just make the quick point and move on.
It's been my experience, over the past 18 years or so of investing in deals (and bringing in investments as well), that you get what you pay for, and the management team (particularly in a start up) is critical to the success of a venture. If you cap what you're willing to pay arbitrarily, then you're either investing in the wrong company, are investing in a company whose founder isn't necessarily critical to success, or setting a criteria that could lead to you not participating in a great deal.
I've personally seen few deals that the valuation (if the company was successful) was more important than the key people driving the company.
Maybe put another way, if an entrepreneur and/or his venture is so tenuous that he's willing to pursue it while eating Ramen, then maybe it might not be the right deal.... I don't know of too many of us in the VC community eating Ramen until we've hit our return hurdle to our investors...
Just some food (hopefully not Ramen) for thought...
Matt Mihaly
· 4 months ago
Bubba: If an entrepreneur is willing to pursue it while eating Ramen that doesn't speak to the quality of what he/she is working on. It speaks to his/her dedication to build something and not profit off it until it's created value for the investors backing it.
--matt
Steve Kane
· 4 months ago
Hi Chris. Nice post, but I do gree with the comments here about "substinence" pay. Do you believe partners and staff at VC firms should also receive substinence pay uintil/unless they get their "carried interest" (that is, until/unless they successfully "exit" their funds)? I can't really see any difference between the task of a founder and of a VC -- take venture capital dollars and turn them into venture capital returns. Yet VC partners and staff receive relatively huge (way above market) compensation simply as salary, and guaranteed for 7-10 years, no less -- guaranteed, that is, as long as their funds pay out flat, pre-negotiated, non-success-or-milestone-measured management fees.
Founders and entrepreneurs and startup staff -- and venture firm staff -- are compensated with a mix of cash and vesting equity -- why should the portfolio company human costs be viewed any differently than the funds overheads?
As I like to remind my many VC friends -- the person who is incompetent when negotiating with you for funding is likely to be incompetent negotiating with everyone else, too.
Steve Kane
· 4 months ago
Second comment -
The best way to standardize term sheets AND control legal costs would be to have VC pay their own legal bills
Its a bit unfair to view attorneys as the principal factor driving up legal costs -- having done a large nunber of delas, I can say the main reason legal costs balloon is that every VC in every deal expects to be able to have their own law firms review every word. And these law firms are under no pressure to keep it lean and mean -- they are not being paid by their clients (the VC firms) but rather by their clients opponent sitting across the table!
Imagine if VCs had to pay their own legal bills (and, um, isn't that what management fees were supposed to be for?) deals would quickly be near-standardized and attorneys would be under tremendous pressure to make it neat clean and fast (after all, a tsratup is a short term, small file client, but a VC firm can be a longterm, cash cow for a law firm.)
Even better, all that portfolio company funding money would (drum roll please) actually go to work in the portfolio company, and not to give VCs compensation raises (by freeing up management fees to pay bigger salaries.)
I know, I know. It's a crazy fantasy. But a guy's got to dream, doesn't he?
Bubba
· 4 months ago
Matt -
I apologize for perhaps not having been clear enough in the articulation of my view.
I'm not saying that an entrepreneur being willing to eat Ramen precludes the deal being of potential value.
I'm saying that in all the deals that I've done (good, bad, and indifferent) I've never seen a correlation between the value of the investment and what the founder is eating. The compensation to the founder needs to be FAIR and appropriate, and I don't think that arbitrarily setting this at some subsistence level is going to result in a better return profile for the fund and is more likely to deselect opportunities that could represent good return potential for the fund (as would ANY arbitrary parameter).
Put another way, as someone that has participated in a number of funds as an LP, the other standard terms that were presented in this excellent outline were thoughtful, articulate, and drive value. Were a fund manager to approach me as a prospective LP and tell me that one of their standard deal terms was that they would require a subsistence compensation plan to the founders of the company in which they'd invest, I'd show them the door. This, in my mind, would be akin to screening prospective deals out of a pipeline because prior investors had received too high a return in an up-round. I've seen this happen and have asked the same types of questions when these situations arise - "where in my financial return profile does what others have made prior to my investment show up?"
To make what Chris has put together (which is already extremely good) something great - I'd simply move founder comp to the "to be negotiated" column and move on.
Brad Parker
· 4 months ago
Chris - Fred Wilson pointed you out to me and I must say he was right. This is all part of the best advice I have ever seen for startups...
#39: I would hope all engineers do an expected value calculation. If they don’t believe the company is exceptional, they shouldn’t join.
One challenge is that this expected value changes every day, and you risk losing a key employee due to the natural gyrations of this number. I've lost good engineers in dark times, only to have things improve the next month. Paying more than subsistence gives you a bit of a buffer when a key engineer gets a call from a recruiter.
Davide
· 4 months ago
What about Liquidation Preference ?
Is it acceptable and what should be a fair ratio ?
Priceless post Christ, thanks for sharing your experience.
Best's
chris
· 4 months ago
Thanks, Davide. I strongly favor 1x non-participating liquidation preference.
Dan
· 4 months ago
Isn't it better if the investors take preferred stock? This way the common and strike price of options can be set much lower than the preferred valuation. If the investors take common would it establish fair value for the options strike price, which would otherwise be higher than one could price it with the preferred and common structure?
martin tobias
· 4 months ago
I can see this "ideal" term sheet was written by a founder with a huge chip on his shoulder. The problem is that these terms only work under "ideal" circumstances. That is friendly founder and investor (whatever kind). There are VERY few deals like that. The farther away from CLOSE FRIENDS the investor/founder are the more protections the investor will need. I have raised over half a billion dollars for various startups and invested personally over $20M of my own funds as well as funds as a partner at a VC firm. The right terms are those that get the deal done and correctly balance risk/reward at the time. The so called "un founder friendly" terms are in fact shifting the risk/reward scale over to the investor because they feel they need more reward for a higher risk. That is in many cases appropriate.
chris
· 4 months ago
Martin - Actually these terms were written by a founder who is also an active investor and who prefers these terms as an investor as well. I certainly try to only invest in people I trust but only a few are close friends.
I'd be curious which protections you think are important and missing.
Floost
· 4 months ago
Hmm... I read blogs on a similar topic, but i never visited your blog. I added it to favorites and i'll be your constant reader.
Pat
· 4 months ago
"Founder salaries - these should be “subsistence” level and no more."
I agree with the idea the that founders should be getting wealthy with customer dollars not investor dollars. That being said, my time is more valuable than your money. I can never get more time in my life. I must be able to recoup all my invested time and savings. My family's financial well-being depends on this. My extended family is poor and would not be able to help if my family suffered any major financial setback ( disability or death). Any investment offer that does not recognize these fundamental realities is not worth taking.
All Comments
i really dislike super pro-rata rights. i had a discussion with another VC about that yesterday.
it's a really bad idea. i think i'll post about it
fred
Two sticking points, 1) acceleration for non-founders, 2) on the founders pay I agree but what happens when a startup goes years and several rounds before an acquistion. At some point ramen gets old and you want to prevent founders from leaving. Or do you believe startups should die before getting to that point?
Would like your thoughts on the above.
I hadn't thought about your second point. When I think about startups I know in that position either the founders have left or the companies are break even to mildly profitable and the founders are taking better salaries - which at that point seems fair. I guess you'd have to take it case by case...?
1) I don't you can ever do a deal where all the investors get is common stock. That is as dangerous a misalignment as any; the day after the closing, entrepreneurs could liquidate the company and pocket 2/3 of the financing.
2) I agree on subsistence-level (e.g. $40K) salaries for seed round deals, but once a company raises a real A (e.g. $3 million) or is profitable, you should pay something closer to market.
a) It's unfair to ask founders to essentially lose money for an extended period of time.
b) The below-market salaries will distort your view of the company's profitability
c) Founders who actually have families will be priced out of the startup game. I have 2 small children, which means for cash flow purposes, $40K isn't subsistence, it's a cash hemorrhage.
Don't get me wrong; subsistence salaries are great for seed stage deals, and I did the same when I was at Ustream, but it was always intended as a super short-term (3-6 months) situation.
Re: the ideal startup board, I think for early startups, it may not make sense to have two out of three directors who are not involved in daily operations. I completely agree that founders and team leaders who do crappy jobs do deserve to get fired but am more concerned about too much bureaucracy, politics, and chefs in the kitchen early on, when the startup needs to be dynamic and nimble.
Cheers,
Tai
I certainly hope so.
Any interest in a potential board member seat in a pre-corporate startup Chris? The initial thrust is in contextual advertising driven by user social media, with the user value point being 2-way personalized passive search (both real time and through standard search engines).
It's been challenging finding potential team members with zero dollars but it turns out relentless passion helps. I've got 2 web dev savy folks helping and a business strategy friend, an we're discussing the pattern matching/prediction problem with the ensemble winning Netflix team shortly (just gotta pick a good skype time)
A simple boiler plate template for most documents makes good sense.
I was planning on setting up a website for startups to access these boilerplate documents (not just capital raising but NDAs, Development/engagement contracts etc etc)
If you want to email any boilerplate documents you have the right to 'open source' to submission@NYalpha.com i'll add them to the library.
Cheers,
Dean
My guess is Chris doesn't work at "subsistence" levels. Neither should an entrepreneur. If you can work at subsistence levels, then you should reconsider funding.
Anything considerably less than market salary should result in increased founder vesting.
I have never seen the option pool taken out of the pre-money, and it doesn't make sense. These are used to recruit new executives down the road to increase the value of the company. These should not be dilutive only to the founders.
I really believe this stuff.
http://www.techstars.org/2009/02/07/techstars-m...
My only inputs are that I tend to think option pool vesting for founders and senior leadership team should all trigger on change of control, but that normal vesting should have a portion time based and a portion performance based. Having an additional vesting carrot hanging out there in year 2 or 3 for hitting revenue or EBITDA goals can be a great motivator for a management team.
Also I'm sure it varies by stage. I am thinking particularly at the seed stage, which is what I'm most familiar with. I'd expect at your stage you hire sales people etc at market cash comp prices and I expect that's the best strategy.
Shouldn't you also clarify what you mean by "employee"?
If we're talking about someone who has a significant equity stake (including options), subsistence salary makes sense. However, if we're talking about someone who has >1%, it's insane.
Let's do the math. Most of these companies will fail. Of the ones that don't, the vast majority will go for less than $100M. If the company "goes", that's $1M to our 1%er. Over five years, that's subsistence $200k/year. However, in most cases, it's $subsistence for five years. The expected value calculation is between those two end-points, but closer to subsistence than $200k.
There's a Dilbert about a company that thinks that it can find good engineers who can't compare salaries.
How many good engineers do you run into who won't do an expected value calculation?
1. Find a start-up lawyer, rather than a start-up law firm. Even at the firms Chris mentions, there are attorneys insensitive to start-up concerns. I practiced at Wilson Sonsini for 19.5 years before moving to Greenberg Traurig's Silicon Valley office. GT's Silicon Valley office has excellent start-up attorneys.
2. Cost. I believe that the quotes you will receive for Series A rounds will exceed Chris' estimate of $10K for both sides. However, there are ways to keep the fees modest. One way is to limit diligence and disclosures. If the company is a raw start-up, then there should not be much if any diligence. If the company has an operating history, has patents or applications, or has spun off from another company, then there may some form of diligence investigation. In life science transactions, it is typical for investors to do a "freedom to operate" analysis, which usually costs $5,000 by itself. Another way to limit costs is to make sure there is indeed an agreement at the term sheet level. Negotiating changes later in the process when the documents are largely completed adds to cost (just like change orders with a contractor; there will be additional fees).
3. Most US first through third tier venture capital funds will adhere to the basic terms Chris outlines. Foreign firms and angels usually have their own pet provisions, as do corporate investors. Expect deviations when not dealing with experienced U.S. venture funds.
Thanks for the comments. I'd generally agree with what you say. I'd definitely agree that the particular attorney matters more than the firm just as the particular VC does more than the VC firm.
On fees I agree I'm being aggressive (on the low side) but think it's doable, especially if you agree to "standardization" as Fred Wilson suggests.
I haven't done foreign deals - I expect your are right about that.
We recently had a discussion with another founder about the CEO compensation. I believe the right incentive is that the optimum is a mixture of fixed and variable. Fixed should be high enough so that they don't have to worry while the variable should be something around 20 to 30% and based upon specific goals for that period (usually one year). The variable should only come from the actual cash they were able to generate. Hence this is only reasonable when the startup is cash-flow positive. I believe success on the way should be rewarded.
Interested to hear your opinion on that.
It seems kind of unfair to me that an investor / VC can oust a founder, despite owning less than 50% of the company per say...
The only point of disagreement that I'd have with what has been presented is on founder comp. As it looks like I'm in the significant minority here, I'll just make the quick point and move on.
It's been my experience, over the past 18 years or so of investing in deals (and bringing in investments as well), that you get what you pay for, and the management team (particularly in a start up) is critical to the success of a venture. If you cap what you're willing to pay arbitrarily, then you're either investing in the wrong company, are investing in a company whose founder isn't necessarily critical to success, or setting a criteria that could lead to you not participating in a great deal.
I've personally seen few deals that the valuation (if the company was successful) was more important than the key people driving the company.
Maybe put another way, if an entrepreneur and/or his venture is so tenuous that he's willing to pursue it while eating Ramen, then maybe it might not be the right deal.... I don't know of too many of us in the VC community eating Ramen until we've hit our return hurdle to our investors...
Just some food (hopefully not Ramen) for thought...
--matt
Founders and entrepreneurs and startup staff -- and venture firm staff -- are compensated with a mix of cash and vesting equity -- why should the portfolio company human costs be viewed any differently than the funds overheads?
As I like to remind my many VC friends -- the person who is incompetent when negotiating with you for funding is likely to be incompetent negotiating with everyone else, too.
The best way to standardize term sheets AND control legal costs would be to have VC pay their own legal bills
Its a bit unfair to view attorneys as the principal factor driving up legal costs -- having done a large nunber of delas, I can say the main reason legal costs balloon is that every VC in every deal expects to be able to have their own law firms review every word. And these law firms are under no pressure to keep it lean and mean -- they are not being paid by their clients (the VC firms) but rather by their clients opponent sitting across the table!
Imagine if VCs had to pay their own legal bills (and, um, isn't that what management fees were supposed to be for?) deals would quickly be near-standardized and attorneys would be under tremendous pressure to make it neat clean and fast (after all, a tsratup is a short term, small file client, but a VC firm can be a longterm, cash cow for a law firm.)
Even better, all that portfolio company funding money would (drum roll please) actually go to work in the portfolio company, and not to give VCs compensation raises (by freeing up management fees to pay bigger salaries.)
I know, I know. It's a crazy fantasy. But a guy's got to dream, doesn't he?
I apologize for perhaps not having been clear enough in the articulation of my view.
I'm not saying that an entrepreneur being willing to eat Ramen precludes the deal being of potential value.
I'm saying that in all the deals that I've done (good, bad, and indifferent) I've never seen a correlation between the value of the investment and what the founder is eating. The compensation to the founder needs to be FAIR and appropriate, and I don't think that arbitrarily setting this at some subsistence level is going to result in a better return profile for the fund and is more likely to deselect opportunities that could represent good return potential for the fund (as would ANY arbitrary parameter).
Put another way, as someone that has participated in a number of funds as an LP, the other standard terms that were presented in this excellent outline were thoughtful, articulate, and drive value. Were a fund manager to approach me as a prospective LP and tell me that one of their standard deal terms was that they would require a subsistence compensation plan to the founders of the company in which they'd invest, I'd show them the door. This, in my mind, would be akin to screening prospective deals out of a pipeline because prior investors had received too high a return in an up-round. I've seen this happen and have asked the same types of questions when these situations arise - "where in my financial return profile does what others have made prior to my investment show up?"
To make what Chris has put together (which is already extremely good) something great - I'd simply move founder comp to the "to be negotiated" column and move on.
Brad Parker
co-Founder
www.muzlink.com
One challenge is that this expected value changes every day, and you risk losing a key employee due to the natural gyrations of this number. I've lost good engineers in dark times, only to have things improve the next month. Paying more than subsistence gives you a bit of a buffer when a key engineer gets a call from a recruiter.
Is it acceptable and what should be a fair ratio ?
Priceless post Christ, thanks for sharing your experience.
Best's
I'd be curious which protections you think are important and missing.
I agree with the idea the that founders should be getting wealthy with customer dollars not investor dollars. That being said, my time is more valuable than your money. I can never get more time in my life. I must be able to recoup all my invested time and savings. My family's financial well-being depends on this. My extended family is poor and would not be able to help if my family suffered any major financial setback ( disability or death). Any investment offer that does not recognize these fundamental realities is not worth taking.