How to beat Venture Capitalists at their own Game Part 5


In Part 4 of this Series, How to Beat Venture Capitalist at their own game, I discussed some of the issues relating to the Deal Process.

In Part 5 I want to raise some of the issues relating to Deal Structure and why this complex area is a potential minefield for Entrepreneurs.


Why is this important?  VCs have done lots of deals and know of many legitimate ways to structure in downside protections and enhanced and prioritised returns in their favour. You need to understand exactly how the deal is structured to protect your own negotiating position.

Downside Protection

The VC’s starting point is to protect their downside as much as possible.  They will continually be evaluating downside scenarios and trying to ensure that their capital ranks as high up the list of company creditors as possible.  You need to understand this starting point mindset.

Yields and Premia

VCs will try to build in their returns into the capital instruments used in the deal as much as possible.  They will add interest rate yields to debt, convertible and preference share instruments. While some of these will be paid out, quarterly, semi-annually or annually, some of these will accumulate and only be paid out at the exit point but they will rank ahead of other investors.  Another technique is to attached redemption premia to some of their investment instruments.  You should understand the detail of these instruments and how they accumulate value for the VC.

Share Classes

VCs will use preference, convertible and debt instruments for the largest proportion of their capital to ensure that on exit, they are paid back this original capital first, ahead of the existing ordinary investors.  Once this capital has been paid back then the surplus is shared with all ordinary investors (which will also include their ordinary share interest).  This is about prioritisation and downside protection.  There may be no surplus to distribute to ordinary shareholders once they have been paid back

Investment Agreements

Venture Capitalists use investment agreements to give them additional rights or different classes of shares to do the same thing.  While they may not have a majority of the shares, these agreements give them a significant amount of control over the company and also protect their minority position.  These are complex agreements and it is important that your legal advisers are experienced in this type of deal.

Sharing the Pie

Throughout this process, you need to understand in detail how the pie will be shared out.  While the overall size of the pie may grow with time (as the company becomes more valuable and successful), the division of the pie is the important issue and you should have a spreadsheet that enables you to understand who gets what and under what valuation assumptions.

Not a Level Playing Field

In this deal, the VC will be using every tip and trick to slant the deal in his favour.  The investment and shareholder agreements can end up very one sided if you do not take a robust negotiating position from the start.  If you go in with good advisers and having done your homework you can end up negotiating a more balanced and fair deal.  While VCs will always tell you that they want to ensure that the founders and management teams are well motivated, they will still do their best to ensure that the deal is a favourable to themselves as possible.

In tomorrows final post in this Six Part Series, I will take up a discussion around the Value Added by the Venture Capitalist.

What Next?

Take a look at my FREE video Tutorial “How to Turn Your Great Idea into a Business” which is all about Starting a Business and Raising Capital.