Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist is the definitive guide to venture financings. This book is for anyone who wants the insider's guide to raising money, negotiating deals, and to know what really makes venture capitalists tick. Don't believe us? Check out these recommendations:

In my entrepreneurship class at Stanford, the number one topic is venture financing -- how it works and how (or even whether) to get it. There are no two better people to coach an entrepreneur through the venture process than Brad Feld and Jason Mendelson, and next to in-person guidance this book is the next best thing. I am planning to make this required reading for my class at Stanford. - Heidi Roizen, Fenwick and West Entrepreneurship Educator, Stanford University Technology Ventures Program A must-read book for entrepreneurs. Brad and Jason demystify the overly complex world of term sheets and M&A;, cutting through the legalese and focusing on what really matters. That.s a good thing not just for entrepreneurs, but also for venture capitalists, angels and lawyers. Having an educated entrepreneur on the other side of the table means you spend your time negotiating the important issues and ultimately get to the right deal faster. - Greg Gottesman, Managing Director, Madrona Venture Group The adventure of starting and growing a company can exhilarating or excruciating.or both. Feld and Mendelson have done a masterful job of shedding light on what can either become one of the most helpful or dreadful experiences for entrepreneurs.accepting venture capital into their firm. This book takes the lid off the black box and helps entrepreneurs understand the economics and control provisions of working with a venture partner. - Lesa Mitchell, Vice President, Advancing Innovation, Kauffman Foundation Venture Deals is a must read for any entrepreneur contemplating or currently leading a venture-backed company. Brad and Jason are highly respected investors who shoot straight from the hip and tell it like it is, bringing a level of transparency to a process that is rarely well understood. Its like having a venture capitalist as a best friend who is looking out for your best interest and happy to answer all of your questions. - Emily Mendell, Vice President of Communications, National Venture Capital Association I would highly recommend .Venture Deals. to any entrepreneur, venture capitalist, student, or casual reader who wants to get the .true scoop. on how venture deals come together and what the venture capital landscape truly looks like. The authors are not only veterans of the industry, but are willing to share their unvarnished views of what venture is all about. The reader will not find the insights shared here anywhere else. And, perhaps best of all, the authors write in an easily readable, casual style that makes the book quite fun to read. - Craig Dauchy, Cooley LLP Feld and Mendelson pack a graduate level course into this energetic and accessible book. The authors. frank style and incisive insight make this a .must read. for high-growth company entrepreneurs, early stage investors, and graduate students. Start here if you want to understand venture capital deal structure and strategies. I enthusiastically recommend. - Brad Bernthal, CU Boulder, Associate Clinical Professor of Law - Technology Policy, Entrepreneurial Law My biggest nightmare is taking advantage of an entrepreneur without even realizing it. It happens because VCs are experts in financings and most entrepreneurs are not. Brad and Jason are out to fix that problem with Venture Deals. This book is long overdue and badly needed. - Fred Wilson, Union Square Ventures I've been reading and loving Brad Feld's blog for years. He's one of my favorite venture capitalists on the planet. I'm delighted Brad and Jason have written the definitive book for entrepreneurs seeking to learn about raising and going through the venture capital process. - Bijan Sabet, Spark Capital

Today’s great post is from Bilal Zuberi @ Lux Capital. In it he asserts that Friends Don’t Let Friends Have a Lazy VC/CEO Relationship. I see this play out so many times in so many ways that – while it seems obvious – it’s an important reminder to all entrepreneurs who hear their friends complaining about their relationship with a VC.

Oh – and make sure your VC has a sense of humor. For example:

I love it when David Hornik – one of the very first (maybe the first) VC bloggers writes a post. Today’s is Want to get funded? Get an introduction! So simple, yet so often overlooked or ignored.

The punch line – it’s the transitive property that we learned about in elementary school math:

So how do you get funded?  Step one — get an introduction.  Find someone you know who can introduce you to the person you want to pitch.  The closer your relationship with the person making the introduction, the better.  And the closer that person’s relationship with the VC the better.  I’ve written about this before and described it as “borrowed credibility.”  If you are being introduced by someone who has credibility with the VC, and you have credibility with the person making the introduction, you will have credibility with the VC.

I learned about this in elementary school math class — it is called the transitive property:

if

A has credibility with B

and

B has credibility with C

then

A has credibility with C

And as a corollary to the traditional transitive property, (1) the stronger the credibility between A and B, and (2) the stronger the credibility between B and C, (3) the stronger the credibility between A and C.

If you don’t follow VentureBlog, you should. It’s the original.

Tom and Tony of tastytrade talk with Brad about Foundry Group, Techstars and Bootstrapping…

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Reid Hoffman, founder / executive chairman of LinkedIn and partner at Greylock has started blogging. Well – he’s started writing long form essays on a blog that my understanding is will come out about once a month.

The first post is If, Why, and How Founders Should Hire a “Professional” CEO. It is outstanding and I expect Reid’s blog should be on your must read list. My only complaint is there are no comments open – I’d encourage Reid to engage with people reading this, rather than just lecture to us!

Related articles

• Reid Hoffman strikes a blow at the cult of the founder. Is he right?
• Founders Hiring “Professional” CEOs to Run Their Company
• If, Why, and How Founders Should Hire a “Professional” CEO

Q: When building a financial projection model for a pitch to VC’s, should you include future rounds of funding in the model or simply show what measurable goal you are trying to achieve with the current round you are seeking?

A (Brad): It depends on the stage of the company. But first, it’s important to understand how a VC is going to look at your projections in the first place.

• Early and pre-revenue: Investors are going to be most interested in your near term burn rate and how long their money is going to last. Focus on putting this information front and center – don’t hide it. Recognize that your revenue is totally speculative so the “base case” is going to be zero revenue.
• First product in the market, < $100k / month of revenue: Revenue matters here and the projections out into the second and third year will give a good indication of how you are thinking about the ramp of your business. However, if your revenue is modest, a smart investor is going to look at your gross margin also. If you are a recurring revenue business, the month-over-month growth – both of revenue and gross margin, is going to be important.
• Meaningful revenue, > $1m / quarter: You have entered the zone in which you have a real business and likely can have a credible growth plan out three or more years.

Now, in every case, a VC is going to be interested in how long the current round of financing is going to last. In early cases, they are going to focus on cash / monthly-burn-rate. In later cases, they will factor in some amount of revenue and gross margin projection, but likely discount both, viewing you as being overly optimistic on revenue as well as the gross margin percentage.

Then, building off of this, they will be interested in how much additional money you think you will need to get cash flow positive. They’ll calibrate this against whatever your current plan is. The earlier the life of your company, the more skeptical the VC will be of any projections of revenue, and any time horizon greater than one year.

Update: I just noticed a twitter comment that said “I would suggest that it should take you up to their expected exit as that is most definitely their primary concern.” While some investors may ask for this, it’s the exception as most rational investors will want to understand what it takes to be cash flow positive. It’s impossible to predict the exit as there are too many variables at play, including the notion that you can’t force an exit. However, you can run a business indefinitely without additional financing if you are cash flow positive. So I’d assert that showing the plan getting to cash flow positive is much more important than showing the plan getting to an exit.

Q: On page 105 of the second edition of Venture Deals under Debt Conversion Mechanics, you state: “Therefore, having outstanding debt (that doesn’t convert) can be a bad thing if an entrepreneur ever gets sideways with one of the debt holders”. I infer this to mean that convertible debt cannot bring about the same bad results. Is that correct? How can the company trip conversion so that debt holders cannot enforce these bad results?

A (Jason):  Convertible debt only automatically converts (normally) under two circumstances:  One, the company completes a financing of X amount or two, the debt holder elects to convert.  We’ve never seen convertible debt where the company can unilaterally convert the debt, thus the caution around getting sideways with a debt holder.

Q: What is the best path to take if a VC which has invested in my company closes down, but we have not exited and are still operating profitably ? What happens to the LLC entity that was formed at the time of investment?  Do we ask the VC for our shares back or buy them back at a discount? 

A (Brad): First, you need to understand what actually happened to your VC firm. There are lots of specific points in time to consider. Let’s start with two magic milestones – year 5 and year 10.

1. The VC is outside their five year investment period. Most VC funds have a five year investment period. This is the time frame in which they can make investments in new companies (those that they haven’t already invested in.) However, most funds last 10+ years and can be extended for many more years. In this case, even if a fund is outside of its investment period, it can still make follow on investments in your company.

2. The VC is outside their ten year fund period. As mentioned above, most funds last for 10 years. However, they often have two, one-year automatic extensions, resulting in a 12 year life. Beyond 12 years, the fund can continue to be extended to operate with approval from the fund’s investors (the LPs). Many funds end up operating for 15 – 20 years.

Now, in each of these cases, you’ll have two situations – the VC firm has raised a new fund or it’s hasn’t. If it has, then the firm itself is still “in business” even if the fund that has invested in your company is getting older. If the firm has raised a new fund in either case, then you have nothing to worry about. However, if the firm hasn’t raised a new fund by year ten, it’s like to be considered a zombie firm.

Now, these zombie firms may still be operating, managing their existing investments, but not making new ones. As time passes, and a firm clearly is not going to raise another fund, most of the partners move on to other things.  And this can go on for a long time as long as there is at least one partner from the VC firm still engaged in managing it.

Ultimately, we come back to your question. What if the firm actually shuts down, either because the LPs won’t continue to support additional extensions, or the remaining partner doesn’t feel like continuing to manage things. There are a few different options.

1. Distribution of shares to a liquidating trust: In this case, the equity in your company held by the VC fund now belongs to a completely passive entity that is simply going to exist until the shares become liquid, either through a sale or an IPO.

2. Distribution of the shares to the LPs: Similar to #1, but you now pick up a whole bunch of new shareholders in your company, who were there LPs of the VC fund. No one really likes this option – LPs don’t want private company shares, the companies don’t want all the new shareholders, and the VCs likely have no upside after the distribution. 

3. Managed liquidity of each company: In this case, the VC will sell off each company in whatever manner he can at the point of time, either via a secondary sale to another investor, or a sale of the shares back to the company. By this point, VC funds typically have two kinds of companies in them – ones that are worth something and ones that are worth nothing. The graceful VC knows the difference and behaves appropriately. The non-graceful VC tried to squeeze blood out of rocks.

Regardless of the situation or outcome, there isn’t a simple, straightforward one. This is compounded by the complexity of VC / LP relationships, private company dynamics, and the optimism of many investors that “something good will come in the future”, more formally known as “maintaining option value.”

Q: Where can I get some good starting salary information for a SaaS startup?  I need the information for CEO, CFO, CIO, CINO, Director of Sales. How much should the starting salaries vary for a startup with $5 million vs $10 million gross revenue?

A (Brad):  First of all, you can find a great deal of info on structuring employee compensation right here on Ask the VC. We have posted about this topic many times in the past and have often covered specific aspects in great detail – take a look at the Compensation archive. Although many of the posts found within the archives relate to the question, the few listed below are a targeted to your question.

• What are typical compensation numbers?
• Compensation In A Very Early Stage Company
• Compensation In A Very Early State Company – Follow Up Question

The CompStudy report, written by Harvard University Professor Noam Wasserman, is also extremely good. It’s a yearly report on the current equity and cash compensation within private companies. Noam also has an excellent book related to startups (but not to compensation) titled The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup.

The numbers we list here on Ask the VC or those found within published market reports are based on average market data and should therefore be used as a general guideline. Many variables like the company’s age, current revenues, profitability, geography and others all come into play when structuring compensation packages.

Finally, I have a belief that most of these compensation studies have a frustrating survivor and reporting bias that tends to cause the numbers to be inflated. So, use them to calibrate, but not justify, your numbers.

Q: In our startup we have 4 founders, two of whom are not full time.  We’ve all put in a good sum of cash thus far.  The two founders with the least equity happen to be the two tech founders.  Some of us feel that we made a mistake when allocating shares in the beginning – there is one founder in particular who does not do any work, and he has the second-most equity (the split goes like this: 32%, 26%, 10%, 7.5% with the rest for employees + advisors).  To me, it seems like any outsider would see this as a big disparity and wonder what happened, but one of our guys (Mr. 32%) seems to think that if we can get funding, the VC will correct this wrong.  I’m rather doubtful of that – what VC will want to fund a team that didn’t have the foresight to motivate the biggest contributors and keep them interested?  I’m looking to convince him that we need to fix our own mistakes before pursuing funding.  Am I off base?
 

A (Brad): You aren’t off base. Furthermore, this is a common problem and one of the reasons I strongly encourage every founding team to have four year vesting on their stock.

While some founders thinks this simply gives future investors a way to claw back equity in the future, it’s much more often the case that this protects the founders from each other, in cases like this or situations where one of the founders simply leaves.

In your case, you feel like the 32% founder doesn’t do any work. If your other two founders believe this also, the three of you should directly confront Mr. 32% right now. Don’t wait, don’t defer, don’t let more time pass. Deal with the issue – up front and directly. It’s an easy thing to solve – if you all agree (including him) that he should only have 15% of the company, then he can simply forgive (or give back – the mechanism will depend on how the company is structured) 17% of his equity. Then, each of you will end up with an increase of your pro-rata percentage of his equity.

If you have equity alignments early in your company, deal with them. Don’t let them fester.

Q: As a rookie VC trial by fire is a great way to learn. Aside from crunching through some early deals, where are the best executive programs and crash courses for newbies to the VC world?

A: While self serving, we recommend you start with our book – Venture Deals: Be Smarter Than Your Lawyer And Venture Capitalist. In addition, there are a bunch of courses now using the book that are referenced on the web that include additional materials that are helpful.

Jason also did an excellent Crash Course on Venture Capital – the 90 minute video is below.

Venture Capital Crash Course with Jason Mendelson from Andrew on Vimeo.

Berkeley has an excellent Venture Capital Executive Program as do Harvard and Stanford. In fact, a quick Google search on Venture Capital Executive Program turns up a bunch of great resources.

There is also extensive information on the National Venture Capital Association website, the four day Venture Capital Institute is entering its 38th year, and the Kauffman Fellows Program is entering their 18th year.

If you know of other web based resources, please add them in the comments.