I have for a long time wanted to write my experience of how we nearly got screwed by a Silicon Valley based angel but was worried about repercussions of doing so. Still I will censor the name of the investor involved to not create unnecessary reputation loss for him. My only goal is to educate and warn 1st time entrepreneurs especially those new the fundraising game of the big bad wolves out there and the games they play.
This Feb we were in Silicon Valley for a 5 week road show and acceleration program with our incubator IncubaUC.
It was the most intensive learning experience of my life. We pitched angels, VCs and serial entrepreneurs daily sometimes even twice daily. At the polished corporate offices of Palo Alto based law firm Greenberg and Traurig we pitched members of prestigious Silicon Valley Band of Angels and the Sandhill Angels. That is where we met Wolf (his name censored) our first interested professional investor.
It was a time when Fundacity was still young, without a ready MVP, clients or a solid business model. We were still searching for product market fit. Silicon Valley was not impressed and we realized how far we still had to go to get any serious investment interest in a place like the Valley. However to our surprise WLF took interest and the talks began. It was like a dream come true.
As first time entrepreneurs, we were totally inexperienced in investment negotiation. We had no idea what to watch out for and what fair terms were. Worst of all we were enchanted by the buzz of what we saw in the Valley. We wanted to be here…badly…and we thought Wolf was our golden ticket.
We tried hard to push for a term sheet before our flight back. I remember pressing Wolf hard for a soft commitment when we took a car ride in his Mercedes the day before my flight back to Santiago. We needed this deal as we had less than $5k in the bank. With Wolf deal we could get a few months of breathing space and qualify for CORFO’s next $100k of grant funding. CORFO wanted a to see serious investor interest from the Valley. In addition, we thought this deal could get us market entrance to the number one market for seed investors. The USA. A lot was at stake. We were needy and our counter party sensed it.
We fought hard to play the game and keep the deal hot over the ensuing 3 months from Chile. Long distance relationships are hard and its no different for business deals. Regular Skype’s and emails gong back and forth. We hustled to keep the intrigue going and show progress.
At long last, on 5 June 2013, we received a term sheet. Based on my research the deal seemed fair at the time. $1m pre-money that asked for a liquidation preference. Moreover, the investment would be small enough, $20k, not to dilute us too much at this early stage. If things went well, Wolf would help us close a series A. Awesome right? Well not quite. Separately, the deal came with the ‘offer’ of Wolf’s advice and connections. He asked for 10%…upfront!
Even with our little experience we sensed this was completely unreasonable. 10% upfront…jeez…for what exactly? We tried to convince ourselves that this was acceptable because we wanted the deal to materialize. We needed the money. Diego was flat broke living with his mom and I was in LatAm, far from home, couch surfing at a our first employees studio flat. I could hardly think straight under all the pressure. We were paying a developer $2.2k/month and were running out of money fast. I drew no salary and lived from savings which were dwindling fast.
Fortunately we had some great mentors. Sam Zebarjadi from 500 startups and Hiroshi Wald the MP of Austral Capital.
Hiroshi is probably the sharpest investor I had the privilege of meeting. His advice was bang to the point. Sam Zebarjadi knows the industry from both sides of the table and is a seasoned entrepreneur. He knows hows things work. Both our mentors unanimously told us to walk away and that the deal was ‘crazy’, but there was a lot at stake and things were getting emotional. It was indeed a lemon deal looking to exploit our inexperiences. Wolf made us wait long and hard for this deal and had us completely beta trapped. Our view of him was distorted as day by day we overestimated his importance and potential in making Fundacity great. We were complete suckers to made the deal work.
Wolf’s offer for the 10% upfront equity, I quote:
1. Help design the website functionality2. Detail the deal flow process from an angel point of view3. Promote the website to angel and accelerator groups ( marketing function ?)4. Contribute ideas to make the site superior to competition and popular. Examples are a better due diligence process5. Design a crowdsourced screening and due diligence process6. Coach the team on all financing and management issues and help secure future financings
The Questions / thoughts from our advisors
Hiroshi and Sam helped us regain rationality in 3 ways:
- Advised us to scrutinize each point in isolation and ask question that evaluate the true value it represents.
- Gave us benchmarks to industry norms. i.e. what is the usual equity advisors get.
- Differentiate between what an investor is expected to do by default and what is additional advisory service.
1. Help design the website functionality does he have relevant design expertise?
- Extremely vague
- This is usually something you would have as part of the internal team vs. advisory
- Do you need this? i.e. is there an issue with design and functionality at this point?
We concluded that this point had no value to us as we had no needs/issues on this front. Diego, my co-founder is a unicorn and design master whilst Wolf had no verifiable credentials on this front. He was 60+ and we had to teach him how to navigate around Skype and at times his browser.
2. Detail the deal flow process from an angel point of view
- Do you already have access to this information?
- This information is readily available online and via several programs, including the incubation one you’re probably involved in
- Seems like you can get this by picking up the phone and speaking with 5 to 10 angel investors
Indeed whilst the promise of access to investors sounded amazing to us. In reality, all we had to do was get out of the building to find this information. In fact, if we were unable to contact our target customers we really had no business to be creating a tool for this user base. Looking back, between May and July I interviewed roughly 50+ investor groups from 10+ countries to gain feedback. I didn’t spend a cent to do this. Imagine I paid 10% of our company…
3. Promote the website to angel and accelerator groups ( marketing function ?)
- Could be interesting but what does it entail? Sharing a URL with colleagues may not help…
- As an investor with a 2% stake, would hope that he would be encouraged to promote the site.
- Sharing a link on Twitter, Facebook and LinkedIn won’t garner interest.
- Is he willing to actively do business development i.e. make calls, do meetings, drive sales?
I find that this could be interesting but we needed milestones. Working at PricewaterhouseCoopers I learned that goals had to be SMART (specific, measurable, attainable, relevant, time-bound). A lot of advisory documents have milestones or other deliverables in them. This is needed to ensure that advisors don’t come, sit back and vest stock. You must make them work for it, and this guy needed to do the same. I asked Wolf to suggest KPIs along these lines, but he made it clear that he wanted the equity upfront and not vesting subject to time or KPIs.
4. Contribute ideas to make the site superior to competition and popular. Examples are a better due diligence process.
Whilst it was a desirable outcome, Wolf had no specific ideas to offer. It lacked substance thus had no value.
5. Design a crowdsourced screening and due diligence process
- Cool idea
- What are the details?
- Does he have the right qualifications and knowledge to do this?
- Do you need this?
Wolf had no concrete ideas here. He did not have an verifiable qualifications or experience developing anything digital based. Also. I was not keen on developing this feature at all. In fact, he required us in his term sheet to develop something around this. It is something he wanted. Therefore, he was asking us to develop something vague and was unable to bring anything to the table in developing or even defining it. Valuable?
6. Coach the team on all financing and management issues and help secure future financings.
- Traditional role of advisor @ 1% or so.
- An investors with a 2% stake should be motivated to do this without additional equity.
In general, when looking under the hood we found there was no substance or value to be gained in return for an upfront 10%. Sam shared with us a advisory contract from the Founders Institute that help us benchmark what was a fair price. I have shared it countless times since with fellow entrepreneurs. You can view here. If the above analysis still left me with doubts then this document made things absolutely clear. An investor is expected to give us mentorship and make introductions as its in their interest to maximize the value of their investment. However, if more is on the offer then equity can be offered but that should rarely if ever be more than 2%. In fact looking at the Founders Institute contract the most involved and active advisory contract grants 1% equity!
Lastly, such a deal, i.e. giving high equity upfront, may be a deal breaker for later deals. Investors in later rounds during their DD will see that you gave lot’s of equity up without a good reason. They may break off the deal as they think less of the team or ask for equity for ‘advice and connections’. Before you know it you have lots of great advice and connections but no company.
I consider myself very lucky to have had mentorship during this challenging time. Had we signed and only realized consequences later it would be too late. We would have overpaid for advice and connections that may have brought us little more than Wolf reviewing our designs and giving some standard client type feedback and calling in some favors for investors to have meetings with us. Sure, getting meetings with top dogs is valuable, but there is a huge gap between a meeting them and a sale/investment. To close we would still need to cover the basics ourselves. A great product was needed and with or without him that would still be left to us.
Thus, fortunately, despite our dire need for cash and lack of a BATNA (best alternative to a negotiated deal), the team and I unanimously agreed to turn down the deal if the terms could not be negotiated. But how do we do that? It took me lots of mental practice and preparation to lift myself out of the beta position I felt swallowed in and rise to the role of equal…role of potential partner where entrepreneur and investor should always be. After all, both sides should be bringing something to the table. No one is doing anyone a favor so we had to stop thinking like he was.
Then we realized he was a big bad wolf
Hiroshi gave great advice. He advised us to be upfront and honest and talk over our thoughts. We had our call to tall things over. The response from Wolf was that it was a
Take it or leave it deal.
Moreover, he threatened by:
I will hire indian contractors to do the project without you if you don’t agree. I already have a great team lined up! It will cost me much less…
If we weren’t sure of partnering with him before well now we definitely felt he was not the right guy now. After re-asking whether it was a take it or leave deal and him coldly confirming it was. We saidL
…well in that case we’ll have to just leave, Wolf.
I sounded cool and confident but inside I was very upset and looking at Diego it was clear he was as well. We said bye to Wolf and I actually thought Diego would burst into tears when i heard his crackling voice say ‘bye’. My advice is you must never be afraid to walk away.If the deal isn’t a win-win from the get go then will forever regret the union later. Worse still is we would have lost all our authority in front of Wolf by confirming to him that he calls all the shots.
Following that meeting Wolf actually wrote an email to our incubator to say he was shocked that we walked and that he wanted answers. He said felt advisor did not understand what he had to offer. I responded with the email below hoping to open the doors for reason and reflection but still reaffirm our position:
Dear Wolf,I am frustrated that we did not find our middle ground yet. As said, we are really excited to have you as an investor. We are ok with the pre-money valuation you offer, which is not high, but we accept and welcome it.Also, we are interested in your mentorship, advice, contacts and ideas.To formalize your involvement that is outside what an investor would do we propose using the Founder Institue expert advisory agreement. Which specifically asks the advisor for:
– Twice monthly meetings to provide feedback on Company’s strategy for at least two hours each.
– Contacts: Advisor agrees to make introductions to and assist in the acquisition of marquee customers, strategic partners and key industry contacts and attend meetings with such potential customers, partners and key contacts.
– Projects: Advisor agrees to assist the Company on at least one strategic project as requested by the Company during the term of this Agreement.
You will notice this is exactly what our current relationship is like and how we imagine it to be. For this, as per the Founder Institute, we can offer you 0.8% and very happily do so because we really want you on board Wolf.
The 10% without offering something else/more is not justifiable and is a killer for future fundraising rounds and for our existing investor Donatas. The 10% was originally discussed in return for a patented idea(s) you conveyed you were working on. We are still interested in offering it but only in return for a valuable idea which for us means a patented idea that is tested, validated and integratable with Fundacity.
Equally, the terms were in February, where Fundacity was at very early stages. Today we have an even stronger development team and almost version 1 ready and that should be reflected in current terms.
We sincerely hope we can find a workable agreement. I believe collaboration between us will be fruitful and can be structured to be a truly win-win for both sides.
We look forward to receiving your thoughts.
He ignored it. He was clearly not going to get 12% of Fundacity for a flimsy $20k. Good riddance I say. My advice is
Be honest. Be transparent. Get advice. Remember you are the prize and the money is the commodity.
Don’t be afraid to walk away
Happy hacking and innovating fellow hustlers.