netpreneur online conversation
is a Managing Director of SpaceVest, a
leading venture capital fund investing in companies that
capitalize advanced technologies. Mr. Parker was
President, COO, and a director of the
hospital information systems division of Compucare, a
healthcare information technology company. He also
served as a regional operations manager with Shared Medical
Systems Corp. Previously, he held progressively more responsible
management positions with the healthcare information systems
division of Technicon Instruments Corporation and with
Compucare. Mr. Parker received a BS in Biological Sciences
from Fairleigh Dickinson University where he also did
graduate work and conducted basic research in Human
Physiology. He received an MHA in Healthcare Administration
from The George Washington University.
the loop with ransom parker:
with VCs (and others)
July 2002, Ransom Parker, Managing Director of venture capital
firm SpaceVest, was a
special guest in The
Loop email list. He took questions from group members on
the topic “Negotiating With VCs (And Others).” Following
is a recap of that online conversation. Some posts have been
edited for length, clarity, flow, and topicality. The
complete, original posts can be found in The
Loop archives, which is accessible to all
What is the average length of the VC investment negotiation
120 days from first contact. 30 days from term sheet
In what major areas should a founder be prepared to negotiate
in the early days of a company?
Major areas will include reality-adjusted financial forecast,
pre-money valuation, size of the round, pre-money increase in
the unallocated stock option pool, option grants to current
management and other employees, liquidation preference,
anti-dilution provisions, Board size and composition,
preferred stockholder protective provisions, registration
rights, right of first refusal on subsequent securities
issuances, proprietary information and invention assignment
counsel should be brought in as early as practical. Such
counsel should be experienced in venture capital deals from
both the company and investor sides. The entrepreneur should
learn from counsel what to expect during and after the
negotiations. The founder should be careful to assure that
counsel represents the company and not the founder as an
Up until the VC funding deal is closed, entrepreneurs are on
opposite sides of the table from the VC. What are some
potential deal breakers from the investor's perspective?
Potential deal breakers can arise from any of the "major
areas" referenced above. The most frequent deal breakers
are driven by disagreements around valuation, the development
of a realistic financial forecast, and the strategic growth
plan for the company. If agreement on these basic points is
not reached early on, then it is not likely that a mutually
acceptable deal will come together.
What steps do entrepreneurs need to take to prepare for the VC
funding negotiation process?
Develop and present a realistic and well-founded plan for the
development growth of the company. Prospective investors will
focus on the reality of that plan based upon their own
information sources as well as those provided by the company
(e.g., customers, prospective customers, partners, industry
having passed these hurdles, the entrepreneur should prepare
him/herself to accept and embrace the notion of bringing in
external institutional investors. In consideration for the
capital and other value-add that comes with such investment,
the entrepreneur will sacrifice a certain degree of ownership
and control of the company. He/she should be prepared for
this, should believe that such changes are in the best
interests of the company, and should conduct the negotiations
What are the red flags to the investor that indicate that the
entrepreneur is not prepared to negotiate the funding deal?
Specific red flags include: delayed responses to basic
information requests; the company's
"over-protection" of customers, prospective
customers, partners, industry analysts from investor reference
calls; conditional agreement to basic deal terms; excessive
negotiation on minor deal points; objections to augmenting the
management team post-closing; and insertion of external
advisors directly into the negotiation process.
Who within the company should be doing the majority of the
negotiations for an early stage company? The CEO? CFO? General
The CEO. No substitutes.
Obviously VCs want their portfolio companies to be skilled
negotiators. What are the qualities that VCs look for to
determine entrepreneurs that will be good negotiators?
Realism. Responsiveness. Knowledge of deal provisions.
Appreciation that successful negotiation is not a
When a venture capitalist looks at investing in a business,
what due diligence would be typically undertaken to ensure
complete understanding of the market factors most important to
the success of the venture under consideration. Are there, for
example. specialized firms that assess the probable success
for a venture?
Venture capitalists tend to "triangulate" on a view
of particular market factors in judging the potential success
of a venture. Market impressions are assembled from among
other sources: the investor's own market knowledge and
experience; industry consultants who are current on market
dynamics; industry analysts who follow public and private
companies that address the market; and direct contacts with
other companies that address the market.
general market impressions are typically fine-tuned through
reference calls with the investee company's customers,
prospects and trading partners. The objective of these
conversations is to calibrate the answers to numerous
questions among which are the following:
To what degree does the customer concur with the
previously mentioned market impressions?
What are the key risk factors associated with the
market's development and growth?
How were the company's technology and product(s)
developed (i.e., in a development vacuum or in response to
specific customer requirements)?
What problem is the customer attempting to solve
by its use of the technology and product(s)?
How "painful" is this problem to the
customer? Is its resolution critical to the customer's own
Are the technology and product "mission
critical" or a "nice to have"?
To what degree are the company's technology and
product(s) designed and implemented to address the buyer's
critical technical and business requirements?
To what degree do the technology and product(s)
generate a quantifiable cost benefit and return on
investment (ROI) for the economic buyer?
What competitive and/or alternative solutions did
the buyer consider?
Based on the customer's evaluation of competitive
and/or alternative solutions, how difficult would it be
for a competitor to develop a competitive solution?
What were the key factors that drove the
selection of the company's product(s) versus competitive
and/or alternative solutions?
What other related products and/or services could
the company provide to the customer? Are these in the
company's product roadmap? Have customers had input into
the product road map?
there are a number of firms that provide such assessment
services, there is really no substitute for the investor's own
knowledge of the markets and direct inspection of market,
customer, and prospective customer impressions.
What should entrepreneurs look for (and expect) from investors
when it comes to participating in negotiations for the
portfolio company (for service providers, closing of sales in
pipeline, future rounds of investment, etc.)?
If the CEO/entrepreneur looks (and expects) investors to drive
the company's negotiations with service providers, sales
prospects, future investors, etc., then, in a way, he/she
could be perceived as abdicating to the investors an important
role that is normally expected of and reserved by the CEO.
That having been said, most institutional investors have a
wealth of experience in these areas that can assist the CEO in
investors are better utilized by the CEO in several ways.
Among these are:
introducing the CEO and company to service
providers, prospective customers and partners, and future
investors with whom the investor has had prior direct
experience in conjunction with other portfolio companies;
participating in developing relationships with
these third parties in his/her role as a Director of the
advising the company on alternative negotiating
strategies based on his/her prior working relationship w/
serving as a Board-level reference to third
parties as they conduct their due diligence on the
think it is important to recognize that service providers,
sales prospects, future investors, etc. generally tend not to
look past the CEO of the company when considering a potential
relationship with the company. Inserting investor/directors
into a lead position in such negotiations could cause the
third party to call into question the degree to which the
CEO/entrepreneur is, in fact, in control of the company and
able to deliver on whatever commitments may result from the
I've had several experiences at dot.coms that have failed
because of VC involvement. The VCs were looking to make their
10x - 100x return and create a billion-dollar company. The
VC's constant pushing on strategy points created an
unattainable business model and killed the (smaller but)
profitable company as well. After surviving that experience, I
feel that it was a VC strategy to force the billion-dollar
projections even if it meant probable business failure—the
"1 in 10 will make it and write off the rest"
attitude. (A side question: Was that an Internet bubble
anomaly or standard practice?)
a slew of questions result as we ponder VC involvement for our
Has this at all changed? Do VCs feel some
responsibility for inflating the business models of many
dot.coms? Have you re-aligned your projections on returns
or do you still want to see a billion-dollar market cap?
Yes, some people *do* say they had great VC
experiences. Where's that magical “VC guide” that
helps us make sure VC interest is aligned exactly with our
goals? Any specific questions we can ask of VC's to ensure
Looking back on the experience I feel that we
should have stood up to the VCs and pursued what we truly
believed in. Would you respect a management team that
didn't go in the direction you wanted to take things?
Would you continue to support them through a questionable
execution period where it wasn't clear whether they were
doing the right thing (and in fact you didn't think they
You've got a lot going on here! A few general comments may be
would caution you not to look for "standard
practices"; judge all VCs against what you believe those
practices to be; and then develop a strategy and set of
tactics against those assumed practices. If you do so, then
you will set your current goals and objectives against a set
of blended premises which are likely to be inaccurate.
VCs may feel some responsibility for "inflating business
models" so as to "see a billion dollar market
cap". We have not done so in our practice. We need not,
therefore, re-align our projections accordingly.
I suspect you are aware, there is no "magical VC
guide" that will assure alignment of interests.
Presumably, the investors who are on the receiving end of your
concerns did due diligence on your prior venture prior to
closing. What due diligence did you do on the prospective
your experience, I think you probably know the questions to
ask prospective investors to ensure alignment of interests.
The issue is not the questions; the issue is to whom should
you pose the questions. In your prior experience did you ask
the investor about his/her investment philosophy and practices
pre-closing? Did you calibrate the response with any of that
investor's portfolio companies? Did you conduct any due
diligence on the investor with service providers who would
have certain visibility into the investor's philosophy and
practices? Did you talk w/ any of those who you describe as
having had "great VC experiences?" If not, I'd
suggest you do so next time.
would respect a management team that did not go in the
direction that I wanted if the chosen direction resulted in
the growth and development of the company that the management
team represented it could achieve. If not, I doubt that I
would disrespect the team. Respect should be a foregone
conclusion for all of us. The issue here is that the
management team has an obligation to deliver the results that
it represents it can achieve. The investors have an obligation
to foster and enable such achievement. If the company and
investors have to continually work at developing mutual
respect, then something is seriously broken.
like the majority of VCs, support companies through
questionable execution periods. Few are the companies that
actually execute at or above the plan levels and in the time
frames that they originally project. If that is the case, then
it follows that we spend most of our time supporting these
companies. That's what we do for a living.
bit of direct and partially solicited advice: Get over it.
Move on. Develop an aggressive yet attainable business plan
and model. Select you investor partners carefully. Perform
against that plan. Forget the "bubble" and
opportunities "lost." Forget placing blame for
events in the past. Remember that it works both ways (i.e., it
has happened that companies disappoint investors!) There's
plenty of blame to pass around -- if that's how we'd prefer to
spend our time.
In one of your earlier answers, you stated that "The
founder should be careful to assure that counsel represents
the company and not the founder as an individual." Can
you share with me some examples of what you have seen and how
it affected things with counsel representing the founder and
not the company?
Take as an example the negotiation of an employment agreement
with a founder who is and will remain a member of the
management team. Typically the investor will submit its form
of employment agreement which is generally
"company-favorable." Certain key provisions will
take more conservative positions than those frequently desired
by the founder. Among these are: compensation, severance
provisions, length and terms of non-competition provisions,
change of control provisions, reassignment provisions, etc. In
the negotiation process it is natural for the founder to seek
the advice of company counsel on such issues. The effect of
this can be that counsel represents the founder as opposed to
the company. The impact of this can be that the negotiation of
the employment agreement begins to impact the negotiation of
the balance of the investment deal. Most investors would view
this as an undesirable complication. The most facile solution
to avoid such complication is for the founder to retain
separate counsel for the negotiation of such agreement.
Earlier, you also mentioned objections to augmenting the
management team post-closing is a red flag. I can understand
how that is a red flag, but how would you go about making sure
that you maintain some control over who they want to have join
the team? I have seen several deals where the VCs brought in a
new player to "augment the management team" that
created more negative trouble and disruption than anything
The best method of assuring agreement on new management team
additions is to do so pre-investment through the creation of a
full management organization development plan for the company.
All interested parties (e.g., current management, current
investors and current directors) should be involved in this
process. All should agree on the positions to be filled and
the desired qualifications of the candidates to be considered.
All should participate in the selection process depending on
the level of the position(s) to be filled. If the need for the
addition is identified post-closing, a version of the same
process should be followed. While there are few guarantees in
life, integration of new players has a much higher probability
of success under this scenario than under a "paratroop
As you stated in some of your answers to early questions,
valuation is often a point of contention between investors and
management. You also mentioned that investors tend to look at
a variety of sources to triangulate on valuation. Clearly,
many companies will derive their own valuation, perhaps
through their own methods, and their valuation conclusions do
not always line up with the prospective investor's view.
Assuming that both sides are dealing with reasonable and
rational sources for calculating valuation, when there is a
gap in valuation between the investors and the company, how
common is it these days to create a stepped valuation based on
performance hurdles that allows the company to benefit from
hitting projected numbers that may be higher than what
investors project (with obvious downside penalties built in,
It is best to focus my response on our investment practice
rather than on the venture industry at large. In a few select
cases we have incorporated such adjustments. As a rule we do
not favor them for several reasons among which are the
days there are several absolute facts with respect to the
private equity markets. One of these is that it is very
difficult for companies to complete venture financings across
the board. Venture Investors are being very selective. Market
conditions favor the investor not the company. As a result,
except in unusual situations, we simply do not see the need to
make such a concession. More importantly, the mere existence
of such an adjustment can cause the management team to make
strategic decisions that favor the short term versus long term
development of the company. Even more importantly, when the
time arrives to review the degree to which performance hurdles
have been, met one of the parties—investor or
management—is going to be displeased with the results of the
review. Either the investor or management will
"win." Both cannot. We believe that clear agreement
on valuation is best reached up front. The existence of an
adjustment indicates that the parties were unable to agree on
valuation which, in our view, is not a healthy predicate for
the balance of the investor/management relationship.
My experience is that many investors use common guidelines for
assessing a company's ability to hit its goals and to be a
long-term winner in their market. Such guidelines would
include team maturity, product maturity, market maturity, and
financial maturity. Depending on how a particular company
rates on the scale for each of these areas, an investor may be
more or less inclined to pursue an investment in the company
(all other investment factors of course being equal).
Question: Once the investment discussion has reached the point
of negotiating valuation, how much do the above factors impact
the actual valuation of the company and/or the strength that
the entrepreneur has at the negotiating table? (e.g. If the
company has an extremely experienced team, with a product that
already has a small core of loyal customers, and is serving an
underserved but large and attractive market, can valuation be
positively impacted in the eyes of investors and can the
entrepreneur reasonable argue for a stronger valuation based
in part on those factors?)
I think it is fair to represent that all of the factors that
you reference play into the valuation decision. It is very
difficult and a bit artificial to assume that one factor will
be weighted more heavily than another in every situation. Such
weighting is very situation dependent. After all of the
valuation analyses have been completed the investor then must
make his/her own experienced-based, subjective decision. At
that point the decision becomes more art than science.
like all of our venture brethren, spend as much, if not more,
time and energy assisting our current portfolio companies in
raising and closing subsequent financing rounds. In these
cases the shoe goes on the other foot! Aside from assuring
that the fundamentals of strategy and performance are in
place, the key driver in protecting valuation is not any of
the previously referenced factors. It is the company's ability
to secure competing term sheets! If the company is successful
in doing so, then competitive forces will serve the company's
As we wrap-up our first special guest appearance in The
Loop, I'd like to thank our friend Ransom Parker of SpaceVest
for generously giving of his time to share his insights.
Please feel free to send a quick note to Ransom
if you would like to thank him personally. Now we'll let him
get back to the negotiating table to do some deals.... For
more on this subject you can read our conversation in The Loop
and bootstrapping that led up to Ransom’s appearance.
Next week, Gina
Dubbé, Managing Partner of Walker Ventures, will join The
Loop to discuss issues in sales and customer strategy, ranging
from how to pick the right beta
customers, to assessing and integrating the best distribution