Ask YC: Advice after receiving seed funding offer?

https://news.ycombinator.com/item?id=196729

by stflory • 18 years ago

40 29 18 years ago

news.ycombinator.com

I recently learned that my co-founder and I have been offered seed funding from a VC. Our startup is working on a web app (I'm being purposely vague). The terms they are offering are a $25,000 investment with 70% common stock for the two founders, 10% common stock for themselves, and a 20% option pool, and they keep the right to invest up to 25% in the next round. They also propose a 3 person board - 1 of them, 1 of us, and 1 outside adviser.

How fair would you consider this offer, based on the information given? It is about what I expected, but I don't really have much experience -- most of what I know comes from attending Startup School. Also, are we allowed to make a counter-offer, or is that not really an option?

Thanks!

rms4• 18 years ago

It sounds like a terrible deal, but if you need the money you need the money. I'm curious what geographical area you are located in -- you'd never get something like that from a SV VC. Was this a verbal offer made quickly or do you have a term sheet?

These guys are offering a valuation half what YC offers, and they are proposing a board structure that gives them defacto control over the company board and the company. And they aren't YC.

Your response should be "how about convertible debt?" Convertible debt makes a lot more sense than setting up a board of directors that they control and it works out for everyone in the next round.

I would recommend reading http://venturehacks.com in its entirety along with pmarca's relevant blog posts. http://blog.pmarca.com/2007/06/the_truth_about.html, http://blog.pmarca.com/2007/06/the_truth_about_1.html, http://blog.pmarca.com/2007/06/the_truth_about_2.html, and more. After reading pmarca, you should be able to answer the question if you actually want to raise VC money or not. It only makes sense for a very specific type of company.

sabat• 18 years ago

Out of curiosity, what things make it such a bad deal? I can't figure out what particular elements are bad.

rms4• 18 years ago

the board seats don't reflect the magnitude of the investment

mikkom2• 18 years ago

The money they are offering is really awful. Also remember that the "outside expert" on the board is almost certainly controlled by them.

Also they have the second round defined because they know that $25k will not be enough and they will want to get more shares when you are in situation where you really need the cash.

dhouston• 18 years ago

http://venturehacks.com/term-sheet-hacks

start reading :)

pg2• 18 years ago

This doesn't seem like it could be a VC. A VC would not agree to be on your board for such a small amount of money. Do you mean an individual angel investor? In that case, it depends entirely who he is. $250k is a low valuation, so it is only a good deal if the investor is someone you really want as an advisor.

Though frankly, anyone you'd want as an advisor probably wouldn't want to be on your board for such a small investment, any more than a VC would. In fact, it's very anomalous for board composition even to be specified in such a small deal.

On the whole, smells bad. You might have to take the money at this low valuation if you don't have any other options, but push back about the board.

stflory2• 18 years ago

It's a VC, but this is a seed program of theirs.

pg2• 18 years ago

Really, a VC fund is going to put a partner on your board for a $25k investment? Is this a real VC fund, meaning they have at least tens of millions in outside investors' money?

I've never heard of a true VC fund doing anything like that before. Usually VCs look upon seed rounds (and for them a seed round means $100k minimum) as just a way to generate series A deal flow. So they don't care about the valuation or the board composition. At most they ask for right of first refusal on future rounds over a certain threshold. So it's weird that they seem to be trying to push so hard about such things so early.

I suppose I'd take the deal if it were a super-duper fund like Sequoia or KP. For most startups it would be worth giving them 10% of your co for nothing just to brag that you had them as investors. On the other hand, they'd never do something like this. And the fact that anyone is is ipso facto evidence that they're a bush league firm.

Obviously you can't mention the name here, but if you want to send me an email (my username at ycombinator) I'll talk to you about it privately. I have to deal a lot with VCs, so wildly novel types of VC behavior are very interesting to me.

rms4• 18 years ago

Compare to these VC seed programs with about the same dollar amounts:

http://www.hcp.com/summer/, http://www.lightspeedvp.com/summergrants.aspx

aneesh• 18 years ago

I know Lightspeed and Highland are VCs that have incubator programs, but neither of them takes any equity for it.

precipice• 18 years ago

That is a horrible deal. Run away.

bokonist• 18 years ago

The valuation isn't very good when you consider the option pool. It might not be completely awful though, depending on your background and means.

I agree with rms that it should be structured as convertible debt.

Push back hard on the board. 10% isn't enough for them to get that much power, and giving that away can make your life very difficult later on.

Generally, rights for the next round are pro-rata. That means the angel has the rights to put in enough money at the new valuation to maintain their position. It's rare to give rights to an angel to increase their percentage that much.

blader• 18 years ago

It's an absolutely awful and egregious to the point of malicious deal.

For a tiny investment, you are getting an overblown option pool, a 25% ROFR on your next round, and getting an investor leaning board.

When negotiating financing, you have to negotiate. In fact, not negotiating is a sure way of signaling that you don't know what you are doing. What you really want to do is to let the market price it out - you want a minimum of 2-3 term sheets to get a fair market value for it.

An actual, decent VC would just give you $25K as a grant.

mynameishere• 18 years ago

25K is what you get for about 1/3 a year of full time employment. Why not work weekends for 4 months?

edw519• 18 years ago

Or even a credit card while working full time on your startup. Normally I'd never recommend that, but for such a low amount, you can keep all your equity and control. A more realistic choice if you can plan the next event within a year.

omfut• 18 years ago

i understand the amount might be a big deal for u at this time. However, if you guys think long term. Its not a big deal. Since the amount is not big, i would rather raise the money from friends and family than going to VC Or ask for more money instead of $25,000.

Cheers, Omfut

aston• 18 years ago

Others have mentioned it, but definitely watch the size of the option pool.

http://venturehacks.com/articles/option-pool-shuffle

LPTS• 18 years ago

That's not an offer. That's a middle finger.

Flemlord• 18 years ago

Options - Is the option pool meant to go to yourself and the other founder? That isn't an unreasonable request, regardless of the size of the deal. Without that guarantee, there's nothing to prevent you from closing down tomorrow and taking your investor's money (less 10%). With my first startup, my partner quit after 24 months, and walked away with all his stock, despite the fact that it took two more years before we (I) sold the company.

Common Stock - Just because they're asking for common stock, doesn't mean they can't build additional terms into the investment agreement. The fact that they're asking for a board seat means they want rights beyond what common stock would normally grant them.

Conclusion - Irregardless of whether the ownership percentage is fair, $25k shouldn't be worth your time. Take the two months you'll burn getting this deal done and put it into developing your product. Also, just the least bit of legal shenanigans (and if it's a VC, there will be shenanigans), and you'll have to hire a lawyer which will eat into the $25k.

Now stop screwing around on Hacker News and build your product. ;) Wait until you have a working beta, with users and some press, then go get yourselves a real deal.

bberry• 18 years ago

Agree it's not a great deal... another way to look at it. Do you value your company at more than $250,000? How far does $25,000 get you before you need to raise another round (and then dilute further)?

ingenium• 18 years ago

Well, at least they don't drug test...

mattmaroon• 18 years ago

If you're ok with the valuation, I'd suggest negotiating a 10% options pool. Also say "we think the board should represent ownership" and give them at most one of them and two of you.

Be sure to have a lawyer look over any term sheets as well. And definitely don't pay any of the investor's legal fees out of your $25k.

My feeling is that this is shady. It's very unusual behavior for a VC to fund a company for so little, or to even want to sit on the board of a tiny company, let alone position themselves to potentially control it.

abijlani• 18 years ago

Here are few questions you should answer:

1. How far is 25k going to take you? Just to a prototype? A beta version? Basically you have to setup goals and objectives and if this money will help you get there.

2. If you answered to yes to number 1. Then once you get there how much would you value yourself then? Would it have been worth it to give up that % of the company to reach there?

3. What are the criteria for success? Will the VC help you get your next round of funding?

4. What else does the VC bring to the table? Relevant contacts? Better exposure?

tomh• 18 years ago

The board composition reminds me of the ArsDigita story: http://waxy.org/random/arsdigita/. Definitely a problem.

SwellJoe• 18 years ago

The deal is bad on all counts, as others have mentioned, but the board provision is simply horrible for seed level investment (actually, I would never accept a board provision like that for any level of investment).

You're effectively selling your company for $25k. You no longer own the company if the investors hold two seats on the board to your one (and if they get veto on who the outsider is, they definitely hold two seats).

You are always allowed to negotiate until paper is signed (or until you've shook hands on the deal), but it sounds like these folks are either testing your mettle or just hostile investors. Either way, it seems a little problematic.

Ask YC: Advice after receiving seed funding offer?

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