What are common VC deal structures and how do they affect your startup? (2024)

The investor wants to become your partner and help with his capital, contacts, and experience. Compared to other forms of capital entry into a company, taking equity involves more time due to creating and signing a shareholders' agreement. However, it has undeniable advantages, as all parties know exactly where they stand - what rights and obligations they have and how key issues are resolved. A good Investment Agreement is a mark of quality that investors of subsequent funding rounds will appreciate. The startup also gains confirmation of the company's valuation, often not provided by instruments like CN or SAFE.

I think that equity financing is a prevalent and effective method for startups to secure funding and fuel their growth. It involves selling a portion of the company's ownership to investors in exchange for capital. The valuation of the startup determines the amount of equity relinquished for a given funding amount.Benefits of Equity Financing:- Access to Capital: Equity financing provides startups with the necessary resources to expand their operations, develop their products, and acquire new customers.- Strategic Partnership: Equity investors often bring valuable expertise, industry connections, and mentorship to the table, fostering long-term strategic partnerships.- Validation and Credibility

The pricing rounds entail setting a definitive valuation for the company. Commonly adopted as startups mature and seek larger investments, pricing rounds involve critical negotiations with investors, including discussions on crucial topics such as liquidation Preference.

Equity Financing:Structure: Investors purchase equity in the form of common stock, often at a negotiated valuation.Impact: Dilutes existing ownership but provides investors with a direct stake in the company. Equity financing is common in later-stage rounds and allows investors to participate in the company's success.

Convertible notes are a type of short-term loan that can be converted into equity during a priced round. These notes often carry an interest rate and have a defined maturity date, necessitating conversion within a stipulated timeframe. Convertible notes prove valuable when quick funding is imperative and a clear valuation is yet to be established.

Convertible Notes:Structure: Convertible notes are debt instruments that convert into equity at a later financing round.Impact: Provides a quick way to secure funding without immediately determining the valuation. The conversion typically occurs during a subsequent funding round, with the note converting into preferred stock at a discount or with a cap.

Convertible Notes provide a great deal of flexibility in terms structuring the transaction viz., parties can commercial agree to the following:1. Fixed discount or discount waterfall based upon when the next funding occurs;2. Valuation Floor;3. Valuation Cap/Ceiling;4. Formula for Valuation in case next round does not occur by the agreed long-stop date;5. Redemption (full or partial) option, if any.

SAFE (Simple Agreement for Future Equity):Structure: Similar to convertible notes, SAFEs are a form of convertible security. They do not have a maturity date or interest rate.Impact: Offers a streamlined and standardized approach to fundraising. The SAFE converts into equity during a future financing round, usually at a discount or with a valuation cap.

A popular startup choice, SAFE stands out for its simplicity and expediency. It essentially pledges future equity to investors to be acquired upon the occurrence of a priced round. This flexible option is particularly advantageous for nascent startups. The 2018 version introduced post-money convertible security, with the standard being the post-money Valuation cap.

Different VC deal structures offer perks but also penalties, know how they shape control, ownership & your exit options. The right fit means maximizing what matters most -fuel for growing your baby into a gamechanger

Structure: Investors purchase preferred stock, which comes with specific rights and preferences not available to common stockholders.Impact: Provides investors with greater control and protection compared to common stockholders. Preferred stockholders typically have priority in liquidation events and may have veto rights on certain corporate actions.

Startups meticulously determine their financial needs and manage potential investor ownership expectations by working backward from their ultimate objectives. Striking the right balance is imperative, raising capital to fuel growth while avoiding excessive equity relinquishment. The funding landscape is diverse, offering a spectrum of options to entrepreneurs.In essence, understanding the nuances of each empowers founders to make informed decisions aligned with their long-term goals. While each funding method has its advantages, founders must navigate potential drawbacks. Consulting with experts and aligning choices with long-term objectives ensures a strategic approach to funding that propels startups toward sustained growth.

VC deal structures vary widely so study up front. Communicate clearly with investors how their proposed terms influence your planning and strategy. Compromise and candor pave the best path to mutually beneficial agreements.

Both founders and investors have to understand what the cap table looks like and is likely to look like from first raise to exit.Not everyone that sits on that cap table has equal rights, realistically most investors would expect preferred equity i.e. senior to common stock simply given the high risk nature of VC as an asset class and potential of how many factors such as dilution, strategic investors, employee option pools, changes to business landscape, ability of the founder to execute can impact an investor’s outcome. These can be preferred at the outset itself as a priced round or a note that converts or a safe.

Liquidation Preferences:Structure: Specifies the order in which investors and other stakeholders are paid in a liquidation event.Impact: Can protect investors by ensuring they receive a return on their investment before other stakeholders. Higher liquidation preferences may result in less distribution to common stockholders.Anti-Dilution Provisions:Structure: Protects investors from dilution in future financing rounds by adjusting the conversion price of their securities.Impact: Mitigates the impact of down-rounds on existing investors but can result in increased dilution for founders and other common stockholders.

It's crucial for founders to carefully review and negotiate these deal structures to align the terms with the company's growth plans, valuation expectations, and long-term objectives. Seeking legal and financial advice is highly recommended to navigate the complexities of VC deal structures and ensure that the terms are favorable for both the startup and its investors.