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What is Negotiable in a Venture Capital Deal?

Congrats, You Got a Term Sheet

You have done the hard part and you now have a term sheet from a VC in hand.  While you are not funded just yet, you should be congratulated because this is a real validation of your business.  As it should be, the term sheet itself is non-binding on either the VC or your company as to the obligation to close, so, even if you sign it as drafted, neither your company nor the VC are required to close the deal. That closing will be subject to coming to agreement on full “definitive” contracts and whatever due diligence the VC wants to continue to do on the company (and what you may elect to do on the VC firm). That does not mean the contents of the term sheet are insignificant.

The term sheet outlines the many key terms of the investment deal. It is not intended to cover everything that will arise in the actual binding contracts, but it should have all the “major” items included. The signed term sheet is the map for the attorneys to use in drafting the contracts. To the extent that a major issue comes up later in the deal that was not addressed in the term sheet, or there is a material change in terms after the term sheet has been signed, one party or the other is probably going to be a bit perturbed.  So the point is, it is in everyone’s best interest to get the term sheet right now so problems do not arise later. Stated differently, don’t expect to sign the (mostly) non-binding term sheet and then raise big issues or changes later. This will quickly create “deal fatigue” and either kill the deal or create bad feelings with your new shareholder. Negotiate the major terms before you sign the term sheet.

What VC Terms are Not Negotiable?

So if you must negotiate the major terms now–before you sign the term sheet, what terms are really negotiable? It is easy to find an “expert” or lawyer that says “everything is negotiable” and in some theoretical world, that may be true (if your company is a “unicorn”). However, in the real VC world, many terms are simply non-negotiable realities of accepting VC money. With very, very few exceptions, if you are taking money from a real VC,

  • if your company is not already structured as a corporation for state law purposes and a “C Corporation” for tax purposes, you will need to convert
  • the stock issued will be preferred, not common
  • there will be a liquidation preference
  • assume board representation for the preferred class
  • assume the company will be required to indemnify the board designee and obtain D&O insurance
  • assume defined “major decisions” will require the consent of the VC
  • assume that founders will need to sign noncompetes where enforceable and other documents in favor of the company
  • you will need to enter into a Management Rights Agreement with the VC

This is clearly not an exhaustive list but merely examples.  If you do not enter the negotiation understanding certain realities, you will look amateurish and have less chance of successfully negotiating the items that are negotiable. Further, there is no reason not to be aware. If you have a term sheet from a traditional VC for “Series A” preferred stock, look at the annotations for the NVCA’s template term sheet. If you do not understand those annotations, find an advisor that does. If your advisor or attorney does not know what a Management Rights Agreement is when you ask them, find another advisor. A lawyer that does not even know what a Management Rights Agreement is may be a fine lawyer, but they by definition do not know VC deals and cannot properly advise you as to market terms. Representing many investment funds, I cannot tell you how many times I encounter lawyers that are advising company founders on VC deals but they have no background to properly advise their own clients on what to expect and which terms are “market.” The outcome is that the founders end up worrying about issues that are not particularly important and the transaction becomes more expensive because it extends lawyer time wasted on arguments you will never win. The result will be the same, and you will have simply wasted money, stress and time in the interim.

It does make it a bit more difficult that some firms have their own “third rail” issues that are non-negotiable for that particular firm. Do your research on the VC firm on the Internet. In conducting your own due diligence on the VC, ask them for references in the form of management contacts from companies in their current and former portfolios. While they will naturally provide those with the best relationships, ask those founders what terms were and were not negotiable with that firm. In my experience, they will share this intel.

Alright, So What is (or should be) Negotiable?

There is a list of terms, some of which have real economics behind them, that should always be fair game in my mind for negotiation. These include:

  • Valuation (within reason but if you are nuts on valuation, that probably would have been flushed out by the VC before the term sheet stage)
  • Liquidation preference multiple (if it is anything except 1x, negotiate!)
  • Participation (participating or not, caps?)
  • Vesting schedule for founders (if it is being imposed or extended, its is negotiable at least as to time)
  • Dividends (any, amount, cumulative?)
  • Registration Rights (at least as to type)

In summary, do your own research, use knowledgable advisors and attorneys and get the major terms fully negotiated before you sign the term sheet without raising things that will never be successfully changed. It will make your deal more likely to actually close and will start your relationship with the VC off on the right foot.

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Browsewrap Bingo: Are Your Terms of Use Enforceable?

browsewrap photo

By Mark R. Mohler

If your business has a website, there is a good chance you have posted Terms of Use and a Privacy Policy that you expect to act as contracts that govern users and the use of your site. If you use our site, you are stuck with our terms, right? But are your terms of use worth the pages they are displayed upon? A recent California court ruling suggests that they may not be enforceable at all. Terms of Use and privacy policies that do not require the user to take any action to affirmatively accept those terms fall into a category of Internet contracts commonly referred to as “browsewrap” agreements. E-commerce is virtually built upon this practice. Browsewraps are distinguished from “click-wrap” or “click-through” agreements where the user must actually click a button such as an “I Accept” button or take some other action in order to proceed with the use of the site.

Browsewrap is everywhere

If you are like most website owners, your posted terms of use are accessible only by hyperlinks somewhere on the pages that people actually use. In fact, your UI/UX people have probably intentionally buried these unattractive links down near the footer of page because no one likes to cloud your customers’ screen with something as boring and unproductive as legal “boilerplate.” You even know from your site analytics tracking that few people actually ever click on those links anyhow. Mission accomplished! But that is where the problem lies: courts do not like to enforce “contracts” that people do not read or at least take some action that puts them on notice that they are being bound to the terms.browsewrap hyperlink

That is exactly what happened to Proflowers.com in the case linked above: the court found that the terms of use hyperlinked on the page were unenforceable and threw them out. While I seldom recommend reading published cases for practical business advice, this case actually goes through details on the site design and you may find some of the details frighteningly similar to your own site layout. Have your web designers read it.

A Practical Alternative?

Now I realize that the volume of use on any moderately successful website generally eliminates the possibility that you can efficiently enter into a traditional contract with every single user. For traditional high-volume Internet contracts, a “click-wrap” format, where a user must click a button accepting key terms is much more prudent than a browsewrap link. Even if your user does not actually read the terms, courts are less inclined to side with users that realize they are being bound by terms but still refuse to read them. Just posting the terms of use on a page that no one ever visits is a different matter.

Understand that even the “click-wrap” format is not a guaranteed way to form a binding contract. Click-wraps have been successfully challenged as well. Take additional actions to make it clear that users had an opportunity to see and review the terms. Ideally, the site features should require a user to scroll through the entire agreement before the “I Accept” button can even be clicked. That makes it all the more difficult for your users to argue that they did not realize what they were clicking. Never limit the time that a user has to read the terms being accepted. Make the terms as easy to understand as possible. As an additional best practice, try to emphasize the most important terms in your online contracts in order to make them highly visible. For instance, placing LIMITATION OF LIABILITY provisions in an “all caps” format and perhaps with bold and underlined fonts makes it all the more difficult for users to claims that they never saw the terms. Let your UI/UX people use their creativity on making those key terms as obvious as possible. Let them know that the goal is to make the terms more obvious and more understandable–not to bury them. Still, expect challenges to enforceability.

Is a Standard Agreement All That Impractical?

Finally, consider whether you ought to have good, old-fashioned written and signed agreements for at least some users or some functions of your business. Written and signed contracts will not be scrutinized in the manner that browsewrap and click-wrap agreements are scrutinized. I find that many website owners actually want to enter into truly binding terms with only a small subset of users that are actually buying products or services. With this subset (at least where the dollar amounts or terms are particularly important) a written signed contract may make sense. Acceptable e-signature formats make exchanging electronic contracts and signatures very efficient.

I see many companies that want to use a click-wrap format because they really want to create a sense of high volume demand for their products or services in situations where they could easily obtain written contracts during the early stages of their business. They want to create the perception that they are a much bigger company that could not possibly enter into thousands of written contracts. That is a business decision but it should be made with the knowledge that click-wrap agreements, and even more so browsewrap agreements, may not be enforceable when push comes to shove. Strongly consider a measured approach in your efforts to balance usability with enforceability.

Business Law - Complex Transactions - Venture Capital Law - Technology Companies - Startup Law - Mergers & Acquisitions - Fund Formation - Private Equity - Social Enterprises

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