Book review: Venture Deals by Brad Feld and Jason Mendelson

Whether you are an investor or entrepreneur, the book “Venture Deals” by Brad Feld from the Foundry Group and TechStars and Jason Mendelson, also of the Foundry Group, serves as a reference for those who are involved in fundraising.

While venture deals can be complex depending on the context around the players (entrepreneurs, angel investors, venture capitalists, lawyers, investors syndicate and mentors), the term sheet and other structures which are required, this book serves a good overview of the subject but one has to bear in mind that it’s very US-centric, and not everything is applicable here in Southeast Asia.

Nevertheless, the authors in “Venture Deals” set up the whole book by focusing on two key things which matter in actual term sheet negotiation – Economics & Control. Economics refer to the return the investors ultimately get in a liquidity event, for example acquisition of the company via trade sale or an initial public offering (IPO).

Control refers to the mechanisms which allows the investors to exercise control affirmatively over the business or to veto certain decisions which the company can make that might not favor the investors. The books starts by explaining each player’s  perspective and how they view the piece of the fundraising action.

While most of the book is dedicated to the term sheet as a piece of legal documentation that dictates the economics and control of the entire deal, the authors also elaborate on the perspectives of the different stakeholders, particularly the entrepreneur and the investor.

The book explains the economics and control of the term sheet well. On the economics side, the authors discuss the price, liquidation preference, pay to play, vesting, employee pool and anti-dilution in detail.

A significant amount of time is spent on explaining how some of the terms can confuse the different players on the venture deal. In understanding control for the entrepreneur against their investors, they elaborate on control mechanisms such as board of directors, protective provisions, drag-along rights and conversion.

In measuring valuation —  how much a company is worth, most entrepreneurs can get caught in deciding whether it is pre-money or post-money valuation. Other side issues involving in the term sheet are also discussed, for example, proprietary information and inventions agreement, founders’ activities, and no-shop agreement.

The most important part of the book, which I often urge startup founders to think about, is the capitalization table where they work out how their ownership of the company would change before and after financing. In Asia, a lot of founders are very reluctant to discuss this because of its sensitivity.

What’s worse is that they don’t have a scientific way to actually determine the implications when they speak to investors. In the book, the question is well-posed — “What will I own if a VC invests X in my company at Y valuation?”

They used an example and guided the reader through the process. Even if the founders are friends, having a capitalization table before negotiating with investors is vital. Otherwise, you end up in a situation which you live to hate: Working for someone with the title of an entrepreneur.

The remaining part of the book explains how venture capital firms and their fund structure work, but it applies strictly to the US. This section is probably important to Asian readers as well, as long as they map the differences in business structures, incorporations and even tax rates within individual countries in Asia. But it’s a good starting point for those involved in the investment side of things.

Brad Feld provides a chapter about negotiating with investors, and he gives the following advice: (a) Achieving a good and fair outcome, (b) not destroying personal relationships and (c) understanding the deal you are making and that includes your ownership, the value of the company and the conditions involved in the term sheet. It helps a lot that the authors did make suggestions to which terms are negotiable and which are not.

At the end of the day, everyone’s experience in fundraising is different, depending on the geographical context you are in. However, this book will offer you basic working knowledge and also help you understand the process. It’s good to learn the ropes because someday you might move from being an entrepreneur to an investor.