The Only Truly Terrible Venture Term is a Tranche - The Entrepreneurial Way with A.I.


Thursday, June 23, 2022

The Only Truly Terrible Venture Term is a Tranche


So with times much tougher in the venture and public markets, you’ll see a lot more talk about tougher “terms” in VC rounds, especially later rounds:

  • Structural terms, guaranteeing a certain return that many VCs will say are “more akin to debt”
  • Participating preferred, where investors get more than common in many acquisitions
  • More types of antidilution protection, including ratchets in later rounds, if there’s a down round or a down IPO

Early stage investors especially with complain about all these terms.  They force founders and earlier stage investors to take more risk than a nice, clean unicorn round at a clean price.

But here’s the thing — almost all these terms in the end, are just about price.  And many just modify the economics if the exit price in the end is lower than a certain baseline for the investors.

Is this bad? IMHO — no.  A price of $10 a share, but modified to $8 if the IPO is less than $10, is still a price and a term.  And if that’s the best deal — get it done.

No, let me simplify it all IMHE to one thing to avoid, really just one thing that is slowly coming back in earlier stage deals especially.  Tranches.  An investor putting in some money now, but the rest later if certain milestones are made.

This sounds fair, at least somewhat, on the surface.  And it appears to de-risk things for the investor.  But in fact, it often does just the opposite.  Founders end up relying on the second tranche, and not getting it.  And often are blocked from raising from others instead.

The one venture term even in tougher times I’d walk from is a tranched investment.  Better to take more now, at a lower price, than theoretically more.

And really, for the most part, only second-tier and more untraditional investors propose tranches.  But it does happen.

The rest of the “less founder-friendly terms”, well, try to negotiate them out for sure.  But they are just part of being in times when SaaS stocks are down 60%-70%.  With no evidence of rebounding.

The rest of the terms, are mostly just price.  And yes, sometimes that will go down.  Or not be quite what you’d hoped.

(Now and Later image from here)

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Jason Lemkin, Khareem Sudlow