Fair and Not Fair in Deal Terms
I have been thinking of the NVCA meeting of the forms group that I attended in LA last week. One of the themes of this group has been to make the NVCA forms even handed. The forms are not intended to be either investor friendly or entrepreneur friendly. They are intended to represent a fair compromise of the issues that are inherent in any VC investment. They are also intended to be consistent with current market practices. So, if the market has evolved in a direction that seems unbalanced, well, the form reflects market practices. In the areas where practice is variable, the forms either provide alternative provisions or make reference to differences in footnotes.
One good example of how the NVCA forms try to balance fairness and current practice is in the area of founder representations. Founder representations are rare (extremely rare) in west coast deals but appear with some frequency in east coast deals. In general, the trend is away from founder reps. So, the forms (in their next iteration) will provide a footnote explaining this (and going through the limitations commonly seen in connection with founder reps, when they appear).
Having said this, to the extent that there are obvious areas of unfairness that have found their way into regular market practices, then the forms just reflect the prejudices of the market. One example of this is the ubiquitous presence of weighted average antidilution provisions. I believe that (with the exception of deals that have full ratchet provisions – far worse for entrepreneurs) all VC investments have weighted average antidilution provisions. Despite what I am about to say, don’t try to get these provisions out of VC docs; you will fail and will waste time, resources, and will leave an impression that you are difficult to deal with.
How can anyone justify antidilution? As far as I can tell the reasoning is that it is up to management to increase shareholder value. If management fails to do this, the argument goes; they should take a hit for that failure. As far as it goes, that argument has some merit.
If we agree with this argument, how do we deal with the effect of antidulition provisions on common stockholders other than management (angel investors for example). By the way, management is often holding options, and they are often "topped up" with more options. In effect, the people who suffer the ill effects of antidilution are not the people who are responsible for the performance of the company.
If you get past the issue I just described, how do you deal with declines in shareholder value that are not due to poor management? For example, what if there is a world-wide recession that affects all businesses, without regard to the quality of management? What justification is there to put greater risk of macro-economic events on management (or the common holders) than on investors?
Let me be clear, if you try to get antidilution provisions out of VC investment docs, you will (a) fail and (b) cause people to think that you are weird. So don’t try.