172. Valuation Is Only One Part of the Term Sheet

VC Minute
Founders should look beyond dilution in term sheets, focusing on board configuration's significance and understanding the option pool's impact. AJ offers words of encouragement, emphasizing resilience and daily learning for success in the competitive market.

VC Minute – quick advice to help startup founders fundraise better

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AJ Bruno:

Every founder I talk to, when they get the term sheet, they’re so excited. They’re like, “AJ, got this great term sheet!” And they send it to me, and they’re so focused on like dilution is only 15%. It’s only 21 percent. Oh, my goodness, I’m so worried about the dilution. It’s 30 percent.

But what they’re not really recognizing in these term sheets is there’s more than just that one number.

It’s almost like going to an auto dealership. When you go to the auto dealership and you sit down with a salesperson, they have four numbers, the MSRP, the down payments, the interest rate, the trade-in value. And if you’re focusing on one of them, the MSRP, they’re going to work you on those other numbers.

Dilution is the same thing. Board configuration, I would argue, is much more important than the dilution of your own shares. Say that again, board configuration is much more important than the valuation of the company in a term sheet.

The thing that first-time founders don’t know is board control actually does matter. There are lots of voting agreement rights that will take place during this time. Whether it’s from comp to your team, equity that you want to give, to operational control. And those decisions can get much, much harder and much more distracting if you have a board that’s very operationally involved.

There’s a great saying in venture “nose in fingers out.” and for the most part, I found that to be very true, meaning that, they funded the company because they want you to run the company. If they wanted themselves to run the company, they’d probably be an operator and not an investor.

That’s something to keep in mind. But when there’s a lot of money at the table and the stakes are high. We all know emotions run high in that same room, and those decisions can get emotional. And as founders, we know emotions are tough. We have to balance this objectivity with those emotions.

That’s something to keep in mind. But when there’s a lot of money at the table and the stakes are high. We all know emotions run high in that same room, and those decisions can get emotional. And as founders, we know emotions are tough. We have to balance this objectivity with those emotions.

I would not worry about dilution. Of course, you have to be a little cognizant of it like, if you’re 50 percent dilution, well, that doesn’t make sense.

The other thing that founders don’t think about is the option pool. And the option pool will work against you, depending on whether it’s carved out before the round or after the round. Most cases before the round. And why is it before the round? That way the new incoming investors aren’t diluted down with an option pool, it’s already carved out.

What do I mean by this? Let’s say your options are down to 5 percent, meaning you have 5 percent that you’re allowing for new hires, key employees that are coming into the business, and an investor says, okay, I’m going to give you a 5 million and the dilution on that is let’s keep it easy, 10%. But what they might not tell you, or what you might have to read the fine print is that they want the option pool to go to 15%. So that’s an extra 10 percent dilution there that you’re going to get pulled out of everyone, including the current investors.

Just be cognizant that there’s more at play than the valuation and dilution.

What are some words of encouragement? Well, in today’s market, we’ve heard a lot about the numbers and they are down year over year quite a bit in 2023. But here’s the words of encouragement that I’m hearing. I have 2 friends and 2 founders that have successfully raised and raised with good economics on their deal, but also good valuations, and they all felt like it was a winning deal.

And so don’t get discouraged. If you get no’s, that’s okay. If you get no’s in this market, Well, guess what? You would have gotten no’s in the previous market too. Why do I know that? Because I’ve gotten all of those no’s. So it’s okay. You have to keep moving forward, be relentless, be clear, really every single day matters.

And so just every day, wake up, make sure you’re thinking about what can I learn? How can I grow? How can I get better? How did that conversation go well? Where did it not go well? Every single day, stay curious. That’s it, my friends.

About QuotaPath
QuotaPath brings ownership and accountability to your compensation process by automating sales commissions. Rally teams around shared revenue goals by building comprehensive sales compensation plans and providing visible earnings. Feel confident you’re paying commissions correctly on every deal.


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