Venture capitalists and angel investors can say they are founder-friendly. But their
“standard” term sheets and funding agreements may tell a different story.
Four attorneys with deep expertise in startup fundraising weighed in during a roundtable discussion with me, Eisaiah Engel, co-author of Founder Friendly Standard, a checklist for entrepreneurs to address all the “other” terms in a financing besides valuation and percentage of the company purchased. The attorneys shared their insights on what makes a term sheet founder-friendly, how “standard” term sheets compare to each other, and how to avoid mistakes when negotiating venture financing.
Y Combinator Safe, 500 Startups KISS, and other “standard” term sheets cannot claim they are founder-friendly, reveals study by 6 startup attorneys.
Nearly every hour of my spare time since May 2019 has gone into this research study to determine if “standard” term sheets really are founder-friendly. It feels amazing to be finished! Here is what we found.
Six attorneys analyzed 298 pages of legalese from:
Y Combinator Safes
500 Startups KISS notes
NVCA Model Legal Docs
Gust Series Seed term sheet
Sam Altman ‘Founder-Friendly’ term sheet
Y Combinator Series A term sheet
Compared to Founder Friendly Standard®, a framework for determining if a venture capital or angel investment deal is founder-friendly, the above “standard” term sheets and contract templates were on average:
A little more than a third (38%) founder-friendly as defined by being compatible with Founder Friendly Standard.
Just under a third (32%) founder-unfriendly as defined by being incompatible with Founder Friendly Standard.
Nearly a third (30%) silent on the issues in Founder Friendly Standard.
Founder Friendly Standard gives founders 24:1 super-voting equity. Here is the rationale behind it.
This weekend, I’ve been reaching out to startup influencers to coordinate a twitter campaign where we celebrate Indie Hackers, bootstrappers, customer-funding, and Zebras during the unicorn-obsessed Tech Crunch Disrupt conference in San Francisco, October 2 – 4, 2019. If you want to join us, we’re using the hashtag #DisruptVC.
One of the influencers I approached asked why Founder Friendly Standard gives founders a 24:1 voting advantage. The reason is to keep founders in control of their companies. Here’s an excerpt from the email:
Yes. There are lots of templates available, and you should start by retaining an attorney who represents founders. Your attorney may have a set of templates that you can have adapted to the Founder Friendly Standard.
After learning hard lessons about the tension between investors and founders, I teamed up with my former business partner, Dan Flanegan, and my former attorney, K. Adam Bloom, to create an open-source standard that you can attach to any bylaw agreement, term sheet, employment agreement, etc.
It’s called the Founder Friendly Standard. It has 17 sections that can lay common disputes to rest such as who gets to vote, who gets liquidation preferences, what is the scope of non-compete, etc.
Here are the top 17 tweets that illustrate points made in the book:
🤑 #startupgrind – solution to #VentureCapital liquidity problem = service providers to take a portion of their fees in warrants and swap 50% with a fund. The service providers would be earning client fees as their #diversified warrants appreciate. From my book, link in profile.
The data table below shows the odds of starting a High-Growth Company in each major city in America. This data serves as a baseline for the fund I’m modeling based on the book, Grays Sports Almanac for Venture Capital. I am sharing my research notes here so that you can incorporate this data into your angel investing or venture capital models.
Founder Friendly Standard and customer-funding can help founders avoid “No market need, Running out of cash, Not the right team,” and 7 more reasons startups fail.
The above graph shows the top 20 reasons why startups fail from CB Insights. I marked up the graph with green checkboxes to show which risk factors customer-funding (also called bootstrapping) can help you manage. Orange checkboxes denote risk factors that Founder Friendly Standard can help manage.
Risk Factor: No market need
If you’re bootstrapping, you’ll find out pretty quickly if there is no market need. Unlike your angel and VC-funded cohorts, you’ll be able to make fast pivots while they’re lining up their organizations’ change management strategies.
Risk Factor: Ran out of cash
If you are bootstrapping, you are financing innovation with organic cash flows. This is a key growth driver in the Credit Suisse Family 1000 research. If your company is controlled by its founders, you’re more likely to pace yourself, spending the money like it’s your own vs. your VC-funded competitors who are quick to spend (principal–agent theory).
Founder Friendly Standard v1.0 has been updated today. The new version of the standard is 1.1. Here is a description of the change:
Section 2.4 – clarifying language (in bold) has been added for companies outside of the United States. The section now reads: Due to potentially devastating tax consequences, the company tells individuals receiving sweat equity in the United States to consult with a tax professional about making an election under Section 83(b) of the Internal Revenue Code. Founders who live or pay taxes outside the United States are similarly advised to consult tax professionals about applicable local and national taxes.