When VCs and Angels look at deals, there are some initial things they look at. The team, the idea and they begin to roll around in their mind if the team can execute the idea. A favorable impression gets a second meeting.
The due diligence that starts rolling out in subsequent meetings will be crucial to whether the business gets funding or doesn’t. For most VCs and Angels, they prefer a “clean deal”.
Clean can mean a lot of things to a lot of different people. Once I was talking to a VC about this and he said, “I love angels because of all the risk they take. They get in early. They write checks. They make connections. But, I hate them because they tend to screw up deals.”. By that he meant they put all kinds of terms on their term sheets that try and protect their investments-but they wind up doing lots of harm to themselves and VCs shy away from the next round of financing.
Some terms are as simple as requiring a board seat. Angels need one early-but it’s questionable if they need one later. Board observation or information rights ought to be enough depending. Other terms might be in the way participation rights are stated. There are all kinds of ways to structure terms. Brad Feld has a series of posts on term sheets. It’s really important that your attorney understand what angel financing and venture is all about. If they aren’t experienced, don’t use them.
If you are an entrepreneur, and the financier you are working with starts putting all kinds of different structures and terms into the deal, walk. Find someone else because it’s probably not going to be worth all the hassle. The next round of financing will spend a lot of time, and money, undoing all the knots so why start in the first place?
When you first take money, a lot of time it’s in convertible debt notes. Fine with me (as long as they are capped). Make sure every investor invests in the same note, with the same terms. That saves a lot of time and headaches in the next round. If each early investor has different terms, later stage investors have a lot more to sort through. Many times, different early investors will want some different things. What you will have to do is get all the investors in that early round to agree to all the same terms. It might mean going back and forth a bit, but if they are good investors they should make the process painless. They should also be able to clearly explain why they need what they are asking for. Transparency is good. The messier it is, the slower things will move.
The other piece of advice that I would give entrepreneurs is that when things start to move past the second or third meeting, sign a term sheet with the financier. If they don’t have one, either force them to come up with one-or walk. You will save yourself a lot of heartache.
Clean cap tables and clean terms are everything in entrepreneurial finance. It helps build trust between parties, and makes everything go more smoothly-including the operation of your business. Bad terms and messy cap tables will blow deals up-even if it’s a good idea and the team seems like it can execute. By the way, for many investors, bad terms are a sign that the team doesn’t know what it’s doing.