@Nitin Yes.

@Venkat
When entrepreneurs want a ton of cash to really go for it, the terms are fine. I just think they are overused terribly at the early stage with startup management who don’t really understand what they are buying into.

@Chris Yeh
The Preferred need protection but they don’t need control as a starting point of the negotiation. A 1X liquidity preference isn’t at all necessary. There are a hundred ways to solve that problem. Unlike @Saul Lieberman I think a co-sale right is much fairer to all parties than a liq pref.

The mechanism that I like best is a co-sale right plus an _expiring_ liq pref tied to a drag along, i.e. below a certain multiple of cash-on-cash return, the Preferred has a bunch of rights and a bottom line payout. Above that multiple, everyone gets paid solely proportional to share ownership and the Common rules the roost change of control decisions.

The reason to have a Preferred is to give out Common Stock options to new employees at a lower price than the investors paid.

Cap table spreadsheets get complicated and deal-specific very quickly, though I’d be happy to do a mockup to show some different concepts. Here’s one I did a while back comparing Charles River Ventures’ QuickStart funding model with a “traditional” VC financing.
(link)

And Kevin-

*Exactly*. It is 3x as hard/expensive to fix problems later than to get them right the first time around. Understanding the terms well is the first step toward a successful financing for all parties.

any chance you could throw up a google spreadsheet with some phony valuations and triggers that folks could play around with or something like that? it would really help to illustrate the points….

While there are some VC terms that are onerous, preferred stock and liquidation preference are absolutely necessary.

1) If the VCs own the same class of stock as the founders, and only take 30% of the company, the founders could vote out the board at any time based on holding a majority of shares. Without preferred classes of stock, VCs would always insist that founders give up more than 50% of their stock in the first round of financing.

2) If there were no liquidation preference, founders could make easy money by instantly liquidating their company after financing. For example, let’s say I raised $5 million on a $10 million premoney. The day after the close, I could liquidate the company and walk away with $3.3 million, leaving investors with a -66% return.

I agree that liquidation preferences of more than 1X are onerous, but a 1X preference is absolutely essential.