Good morning, everybody. Welcome to Episode #13 of the #thinklikealawyer (Think Like a Lawyer) Small Business Vlog. My name is Bradley Bailyn, and I am a small business attorney here in New York City. I am very proud that we finally made it to 13 episodes and that’s in large part due to the likes and positive comments and shares and support and feedback that I’ve been getting from so many people, particularly Glen and Marisol this week. Thank you so much for being involved and supportive and helping me to come up with new ideas to make this better and better. So with that being said, let’s get right into what we’re going to talk about today.
There are entrepreneurs who sell their business for 5, 10, 20, 50 million dollars and are sitting on Craigslist looking for a job. How does such a thing come to happen? Well, I’m going to explain to you the five or six tips that you really need to know to potentially work with a venture capital firm without getting killed.
Tip #1: Don’t Use The VC Firm’s Preferred Attorney
The first thing I want to discuss with you right off the bat is that venture capital firms typically have their own attorneys they like to work with. I don’t recommend that you do that. Why is that? Just think about it for a minute. The law firms are making probably hundreds of thousands of dollars a year in business from these particular venture capital firms.
If your business is successful and one VC wants to work with you, there’s probably 99 other VC’s that want to work with you. So if you get spooked, you’ll jump ship in a minute. And it’s so competitive that whatever your problem is, somebody else will probably give you whatever it is that you want. So are they going to bring up the things that I’m about to bring up? I would say not a chance. And there’s going to be a lot of things specific to your deal that obviously I cannot talk about on this video because I don’t know what those things are. But an independent attorney will tell you about that. The VC’s lawyer probably will not.
Tip #2: Make “Off The Table Money” A Requirement
First thing that the v.c will probably never discuss with you is “Off The Table” money. When you take venture capital, you are going to bind your company in many different ways that you’re probably not going to like, as well as binding yourself personally in multiple ways. And we’re going to talk about what those ways are. But bottom line is, in exchange for you losing your ability to sell your business for a two times valuation or a four times valuation and keep all of the money for yourself that you’ve earned… and to start multiple businesses and run multiple businesses at the same time that you’re running this one, you are entitled to ask for something called off the table money.
Venture capital firms do not like off the table money at all. Off The Table money means they give you money right now just as an inducement for you to do the deal. So maybe they are going to put five million dollars in. You’re going to say, OK, a million goes to me, a million goes to my partner and three million dollars is going to go into the business. That’s not helpful to the venture capital firm, but that’s very helpful to you because what if you’re bound in this thing for 5 or 10 years and then it doesn’t do well. Now you’ve just lost five or 10 years of your life. And for what purpose? Or you don’t hit your earn out number so you don’t get any money. The venture capitalist gets plenty of money and you lose.
There’s many ways that you can lose on these deals. So one of the ways that you can hedge your bets a little bit is with off the table money, maybe two out of three VC firms are not going to want to do off the table money. But I’d say one out of three will consider it because they realize that they have to do it.
Tip #3: Heavily Negotiate Your “Terms Of Employment”
Next is what are the employment conditions that they’re going to obligate you to? Usually they’re going to tell you that you cannot be CEO or otherwise involved in any venture other than the venture that they are currently investing in. That maybe wonderful if that’s how you do things, but it may not be because you may be the kind of person who sets up systems and processes and is capable of running five different businesses at the same time, sometimes with multiple partners and being obligated to only work full time for one company… you may find that stifling of your creative process and too limiting on your ability to hedge your bets against one particular business failing. And you may not be OK with it or you may be OK with it, but only for a period of one year or two years. So understand, this is going to be an issue and it’s going to be something that you should think about sooner rather than later.
Tip #4: Be Very Conservative With Earn-Outs
Next thing, this is a real painful one. Earn outs. A lot of times the v.c firm is going to have the position that they need to make a certain multiple on their money. If they put in two million, they either need to make back five times their money or 10 times their money, or whatever multiple. And they don’t want you getting any money until they’ve made back the multiple that they are seeking to make for their investors. That may be a ridiculous, completely unreasonable multiple.
For example, maybe they put in two million and you’re going to find someone who’s willing to pay twelve million dollars for it and you’re going be like, oh, this is fantastic because I’ve got thirty thousand dollars in the bank so we can sell for 12 million right now. I can be safe for the rest of my life. I’ll go out and I’ll start five more businesses and I’ll wait to sell each one for one hundred million dollars. But I’d like to exit my first business at a six times valuation multiple and I’ll be very comfortable. The VC may say that makes us look bad. We need a 10 times or 20 times multiple, and if we are forced somehow to exit earlier than that, then you don’t get anything.
Tip #5: Don’t Indirectly Lose Control Of Your Company
Next thing, board control. This is a real sticky one. Sometimes they’re going to insist that they have a majority of the votes on the board. Other times they’re going to say, oh, no, we leave you in control of the board, but they’re going to put restrictions into your corporate documents that effectively put them in control of the board. Particularly, they’re not going to want you to have control over employment decisions and they’re not going to want you to have control over compensation. In other words, those are the two things that affect you. They may want the ability to remove you as an officer or a director or whatever position you may hold from the business. And they may not want you to have the ability to set your own compensation. And those may be two of the most important things to you, because if you’re going to be employed there for five years, if you’re going to be bound for five years and they want you to become the head of product development and not the CEO, and they’re going to want your salary to be capped.
Whatever the number is… one hundred twenty thousand dollars a year plus some kind of a bonus… You might be like, heck, no, I’m not going to agree to that. So that’s going to be a very thorny issue. I’m telling you right now, you may want to discuss that sooner rather than later if you’re not willing to give up any board control. If they have to believe in your abilities as a CEO, then you need to be straight about that. Right off the bat is that you are going to remain the CEO. They’re going to say to you, well, just because you’ve been successful getting the company to two or three million dollars a year or whatever it may be or, you know, a million, five million users, that doesn’t mean that you have the experience or the capability to get the company to the next level to 5, 10, 20 million dollars to 50 million users. And maybe you’ll say they’re right. You do whatever’s best. Or you may say, I am going all the way and I’m not okay with anything else. And so just make sure, you know, ahead of time what your limitations are.
Tip #6: Negotiate Investment Amount(s) And Timing
You should pay attention to access to funding. A lot of times, even when you get the venture capital, they don’t just write a check for ten million dollars and then give you control over it. What they do is they give you almost like a line of credit and then they have the discretion to release payments or not release payments depending on how they feel things are going. So, you know, the logic for that is if you get sued, it makes you a less attractive lawsuit target because they are just not going to put the money in because they just don’t want to lose it. But you may feel that something needs to be negotiated to provide lawsuit protection without giving them the ability to just not make the investment that you’ve negotiated… to require you to perform 100 percent… to be bound by everything… while they have the discretion to perform at the 5 percent level or a 10 percent level or whatever it is they choose to do.
Again, these are things you’re not going to see until the very end and you’re deeply in. But these are things that really should be part of your term sheet right from the very beginning. Finally, if you’re going to do business with anybody, you want to speak with their references. And it goes for venture capitalists as well as it goes for anybody else. You want to speak with other companies that they’ve recently funded and see whether they feel the venture capitalist has been more of an asset or has been more of a liability.
Some are much more of a liability than an asset because they don’t share your vision, they don’t share your goals, they don’t share your values. They’re just 100 percent profit oriented. They may be bullies – or not. They may be the most helpful people in the world. And it may be that they’re willing to give you less off the table money and a little bit lower valuation. But they bring so much value to the table that they’re absolutely the people that you want to work with. So that’s definitely something that you need to take into account.
All right. Well, I think that that’s it for now. Please like or subscribe to this video on whatever platform you may be watching or listening to it on. And as a standard disclaimer, this is just a video. I don’t know what your circumstances are. The facts of every case are different and this is purely for information and awareness purposes only. Do not rely on anything you hear in this video to make life changing important financial decisions. Thank you and have a wonderful day.
