Posted by Tom Foremski - August 24, 2009
Mike Arrington at Techcrunch has a great post on standard legal docs for startups that can save them as much as $50k in legal fees when taking investment monies. The Funded Publishes Ideal First Round Term Sheet.
The legal docs were prepared on the behalf of Andeo Ressi, founder of The Funded, a site that ranks VCs. They are designed to protect founders from some of the predatory terms used by VCs.
Mr Arrington, a former lawyer, writes:
The key terms include the elimination of participation with preferred stock, a 1x liquidation preference, and single trigger vesting acceleration on acquisition.
What this means: VCs try to increase returns by asking for large liquidation preferences. A 3x liquidation preference, for example, means the VC gets to take out 3 times his/her initial investment before founders and employees get anything.
...More importantly, participation is eliminated. VCs often ask for this. What it means: Participation rights means the VC gets to take a pro-rata share of money in a sale even after the liquidity preference. With it eliminated, the VC has to choose - either take their 1x liquidation preference or convert and share with common pro rata.
Mr Ressi writes that the documents will help correct "a misalignment of incentives."
Foremski's Take: It's amazing that it has taken this long for someone to produce standard legal documents that can be used by startups to protect founders from some nasty predatory practices that have caused a lot of bad blood over the years between founders and Silicon Valley VCs.
It's ironic that such legal papers are available now when there is very little funding at all! And because funding is rare, especially seed and Series A, and many startups are running out of money, there will still be many companies forced to take unfavorable founder terms. At least by having such documents available, the founders will know just how badly they are being screwed.
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