This is another in a series of postings that relate to Fred’s and Brad’s various postings about venture capital funding. (Please note I have added an 11th item in response to a comment by Jack Sinclair, Return Path’s VP of Finance and my partner in crime on all transactions for the past five years.)

I think the most important part of the venture financing process is negotiating the term sheet. Although they’re only 2-3 pages long, term sheets contain summaries of all the critical aspects of a financing, and once they’re signed, the remainder of the financing process is significantly more “automatic.” Based on the financings I’ve seen and worked on – both as a VC and as an entrepreneur – my Top 10 (now 11) biggest takeaways for entrepreneurs are as follows (not in any particular order):

1. Get a good lawyer. I mean a really good one. Not just one who you are comfortable with and who is productive and doesn’t charge you too much (as Brad says, your wife’s brother’s friend’s neighbor), but one who knows venture financings like the back of his or her hand. They’re out there, many of them have worked on both sides of these transactions – for VCs and for entrepreneurs, and they can save your ass. No matter how many deals you’ve worked on, your lawyer has worked on more of them. Return Path’s lawyer, David Albin from Finn Dixon & Herling, is great if you need one.

2. Focus on terms that matter, otherwise known as Pick your battles. A typical VC term sheet will have at least 20 terms spelled out in it. There are only a few that really matter in the end, although you should at least make sure your lawyer is comfortable that the others are reasonable and somewhat standard. Spend time on valuation, the type of security, the option pool, Board composition, and your own compensation and rights.

2a (new). Sacrifice valuation for a clean security. Everyone always thinks that price/valuation is the most important thing to maximize in a deal. However, the structure of the security can be much more important in the long run. Whether the VCs buy 33% of your company or 30% of your company is much less important than having a capital structure that’s easy for an outsider to understand and want to join (e.g., investment banker or later-stage VC).

3. Always have a BATNA (Best Alternative to a Negotiated Agreement – a fancy way of saying Plan B). This is probably the most important piece of advice I can offer, and it extends to any negotiation, not just term sheets. If you have two or three VCs who are interested in funding you, I can guarantee you will end up with better terms from the highest quality investor in the group if you play the negotiation well. If you have one term sheet, you have zero leverage in your negotiation. Yes, you will spend 2-3x the amount of time on the process, but it’s well worth it.

4. Be prepared to pay up for high quality investors. There is a world of difference between good VCs and bad VCs (both the individual partners and the firms) that will ultimately have a lot to do with how successful your company can become. The quality of your VC isn’t more important than the quality of your product or your team, but it’s right up there. But – and this is an important but – you should expect to “pay” for quality in the form of slightly weaker terms (whether valuation or type of security). This is where having a BATNA really comes in handy.

5. Ask for references. Don’t be shy – prospective VCs are checking up on you…you have every right to do the same with them. Ask them for references of CEOs they’ve worked with. Ask them for a CEO they’ve had to fire as a reference. The good ones will give you the full roster of everyone they’ve ever funded and tell you to call anyone. The bad ones will give you two names and ask for time to prep them ahead of time.

6. Don’t let the VC get away with negotiating a point by saying “we always do it this way.” That’s just not true. VCs may have a preferred way of doing deals or handling a specific term, but every deal they’ve ever done is different, and they know it. If there’s a compelling reason for them to insist on a particular term, you have the right to hear it (if it’s important to you).

7. If you have multiple investors in the syndicate, insist on a single investor counsel and a lead investor. This is essential to (a) protect your sanity, and (b) prevent you from paying zillions of dollars in legal fees. You have to make the VCs stick to it, though – they can’t come back and re-trade the deal after it’s been negotiated. This is also helpful in getting a syndicate cooperating with each other and aligning the members’ interests, particularly if it has investors who have participated in different rounds of the company’s financing. Do expect to play moderator constantly throughout the process, however, to ensure that it goes smoothly.

8. Try do deal in advance with follow-on financings. When an investor doesn’t participate in a follow-on financing, it creates a total nightmare for you. Other investors will want to punish their wayward colleague and can create massive collateral damage in the process to common shareholders and management. Just as VCs will insist on something called “pre-emptive rights” (the right to invest in future financings if they want), you and your lawyer should insist on some protection in the event that one of your investors abandons you when you are raising more capital.

9. Handle the term sheet negotiation carefully. Whether it’s an initial round or a follow-on round, how you handle yourself in this negotiation sets the tone for the next stage of your relationship with the VC. The financing is the line of demarcation between you and the VC courting each other, and the VC joining your board and effectively becoming your boss.

10. Finally don’t forget to say thank you at the end of the process. Whether you send a formal email, a handwritten note, or a token gift, be sure to thank your VCs after a financing. They’re putting their butt on the line for your company, they’re investing in YOU, and they’re making it possible for you to pursue your dream. That deserves a thoughtful thanks in my book.

Sorry for the long posting. The next one or ones in this series will be on valuation, preferences, and “Venture Capital deal algebra.”

And here I am. In the middle of that “once.” Fred Wilson wrote a great posting by that title on his blog, and it has stuck with me. When I decided to start a blog, it was the first thing that came to mind as a main theme for the blog, so there you go. Only Once it is.

I’m not entirely sure why I’m doing a blog. Part of it is fascination with the newest corner of the Internet and its related areas like RSS (clicking on that link will get you the RSS feed of this blog). Part of it is to try out the medium and see how it might work for the hundreds of marketers and publishers who are my company’s clients. I suppose part of it is to generate some interest in my company, Return Path, which in my extremely biased opinion is one of the most interesting companies in the email services business.

My one hesitation about starting a blog is that the other part of me feels like blogs are a bit narcissistic, and I can’t imagine who on earth would want to read whatever it is that pops into my head. But I’ll give it a try and promise not to go overboard on the extraneous postings.

So, I will probably post periodically about experiences of an entrepreneur, of the one time I’ll ever be a first-time CEO. But I may also post on other things periodically that match my interests: book reviews, travelogs, Princeton, great wines, maybe even the occasional political commentary to prove to my predominantly New York friends that (a) not all Republicans are bad, and (b) not all Jewish New Yorkers are Democrats.

So, here we go…enjoy!

Keeping It All In Sync?

I just read a great quote in a non-business book, Richard Dawkins’ River out of Eden, Dawkins himself quoting Darwinian psychologist Nicholas Humphrey’s revolting of a likely apocryphal story about Henry Ford.  The full “double” quote is:

It is said that Ford, the patron saint of manufacturing efficiency, once

commissioned a survey of the car scrapyards in America to find out if there were parts of the Model T Fird which never failed. His inspectors came back with reports of almost every kind of breakdown:  axles, brakes, pistons — all were liable to go wrong. But they drew attention to one notable exception, the kingpins of the scrapped cars invariably had years of life left in them. With ruthless logic, Ford concluded that the kingpins on the Model T were too good for their job and ordered that in the future they should be made to an inferior specification.

You may, like me, be a little vague about what kingpins are, but it doesn’t matter. They are something that a motor far needs, and Ford’s alleged ruthlessness was, indeed, entirely logical. The alternative would have been to improve all the other bits of the car to bring them up to the standard of the kingpins. But then it wouldn’t have been a Model T he was manufacturing but a Rolls Royce, and that wasn’t the object of the exercise. A Rolls Royce is a respectable car to manufacture and so is a Model T, but for a different price. The trick is to make sure that either the whole car is built to Rolls Royce specifications or the whole car is built to Model T specifications.

Kind of makes sense, right?  This is interesting to think about in the context of running a SaaS business or any internet or service business.  I’d argue that Ford’s system does not apply or applies less.  It’s very easy to have different pieces of a business like ours be at completely different levels of depth or quality.  This makes intuitive sense for a service business, but even within a software application (SaaS or installed), some features may work a lot better than others.  And I’m not sure it matters.

What matters is having the most important pieces — the ones that drive the lion’s share of customer value — at a level of quality that supports your value proposition and price point.  For example, in a B2B internet/service business, you can have a weak user interface to your application but have excellent 24×7 alerting and on-call support — maybe that imbalance works well for your customers.  Or let’s say you’re running a consumer webmail business.  You have good foldering and filtering, but your contacts and calendaring are weak.

I’m not sure either example indicates that the more premium of the business elements should be downgraded.  Maybe those are the ones that drive usage.  In the manufacturing analogy, think about it this way and turn the quote on its head.  Does the Rolls Royce need to have every single part fail at the same time, but a longer horizon than the Model T?  Of course not.  The Rolls Royce just needs to be a “better enough” car than the Model T to be differentiated in terms of brand perception and ultimately pricing in the market.

The real conclusion here is that all the pieces of your business need to be in sync — but not with each other as much as with customers’ needs and levels of pain.

A friend of mine just emailed me and asked how I collect feedback from the Board after Board meetings. I have a good routine for this which I wrote about a little bit here but have since expanded.

First, we are disciplined about leaving an hour at the end of the board meeting for the following three things :

• Executive session – directors only, including me – sometimes I’ll have my CFO Jack come for a few minutes at the beginning, depending on the topics. The topics can be about people on the team, or things I’m concerned about that I didn’t want to talk about with observers and team present. I tee up any topics in a separate memo that I send only to board members when I send the main board book out. My board meetings are very inclusive – lots of team members and observers present, so it’s good to have this time available case the Board wants to talk more openly with me about something or ask questions they didn’t feel like asking with the broader group in the room.
• Closed session – I leave, so I give non-management directors an opportunity to talk about any issues related to me.
• CEO Debrief – I ask one director to take notes for me during Closed Session, then that person calls me back in to debrief anything.

All three of these are important, and it’s important to do them every meeting, even if you don’t have any specific issues to discuss. That way, no one freaks out (including you) if suddenly and unexpectedly, there’s a part of the meeting to which they’re not invited.

The key to this is really leaving time for it. Now that board meetings are often on Zoom, a lot of CEOs have shrunk the time to 2-3 hours to avoid Zoom fatigue, but that doesn’t usually leave a full hour for this end-of-meeting routine. Finish your main meeting, give everyone 10 minutes to breathe, then come back for the final three steps of the meeting.

Then, I use this form after every meeting, which was a suggestion from Fred a few years back (not here or here, though these are also really good posts he wrote on this topic). I sent it during Executive Session and ask people to fill it out immediately after the meeting while things are fresh in their minds.

Quick, easy, effective. You should never finish a Board meeting and have no idea how it went.