The Two Things That Matter
Strip away the noise of a venture deal and you are left with exactly two levers: economics and control
Feld and Mendelson repeatedly emphasize that despite the dozens of provisions in a typical venture capital term sheet, there are only two things that truly matter: economics and control.
Economics refers to the return investors will ultimately receive in a liquidity event and the terms that directly impact this return. The key economic terms are valuation and price per share, the employee option pool, liquidation preference and participation, anti-dilution provisions, vesting, and pay-to-play.
Control refers to the mechanisms that allow investors to either affirmatively exercise control over the business or veto certain decisions the company can make. The key control terms are board of directors composition, protective provisions, drag-along agreements, and conversion rights.
This framework serves as a powerful negotiation filter. When an investor or their lawyer is spending significant time pushing hard on a provision that does not materially affect economics or control, they are either inexperienced, using it as a distraction tactic, or signaling what they will be like as a partner. An experienced VC who harps on unimportant terms reveals something about how they will behave as a board member and partner.
The authors advise founders to start every negotiation by identifying the few things that really matter, focusing on valuation, stock option pool, liquidation preferences, board composition, and voting controls, and then being willing to concede on everything else. The goodwill this creates is worth more than winning minor points.
- Economics refers to the return investors get in a liquidity event and the terms with direct impact on this return, including valuation, liquidation preference, anti-dilution, vesting, and option pool.
- Control refers to mechanisms allowing investors to exercise control or veto decisions, including board seats, protective provisions, drag-along agreements, and conversion rights.
- If you are negotiating a deal and investors dig their heels in on a provision that does not impact economics or control, they are often blowing smoke rather than arguing substantive issues.
- The cliché 'you never make money on terms' is especially true outside of the few key terms that directly affect economics and control.
- How a VC negotiates reveals what that VC will be like as an owner, board member, and compensation committee member. An inexperienced VC harping on unimportant terms is a warning signal.
- The financing is only the beginning of the relationship. Building the company together while having a productive relationship is what truly matters.
- Classify Every TermGo through the term sheet and classify each provision as primarily affecting economics, primarily affecting control, or neither. Terms affecting economics include price, option pool, liquidation preference, participation, anti-dilution, vesting, pay-to-play, and dividends. Terms affecting control include board composition, protective provisions, drag-along, conversion, and voting rights. Terms that affect neither or have minimal impact include registration rights, information rights, right of first refusal, co-sale rights, founder activities, and indemnification.Pro tipCreate a simple three-column spreadsheet: Economic Terms, Control Terms, and Other Terms. This visual classification makes it immediately clear where to focus negotiation energy.WarningSome terms have both economic and control implications. Anti-dilution affects economics directly but can also influence company behavior around future fundraising. Pay-to-play affects economics by reducing liquidation preferences but also reshuffles the preferred shareholder base.
- Prioritize Your Top ThreeBefore the negotiation begins, identify your three most important terms and be prepared to articulate them clearly. Ask the VCs up front what their three most important terms are. This conversation sets the stage for the entire negotiation and can be referenced later if either side starts spending disproportionate energy on minor points.Pro tipWhen VCs pound hard on a point that was not one of their stated top three, it is much easier to call them out and note that they are already getting most or all of their main priorities.WarningDo not go into a negotiation without having decided in advance which terms you are willing to concede. If you try to determine this in real time, emotions will drive mistakes.
- Concede Gracefully on Non-Core TermsOnce you have secured fair outcomes on the key economic and control terms, be willing to give ground on everything else. The goodwill generated from this approach is significant. It signals to the VC that you are a rational, focused partner who understands what matters. It also accelerates closing, getting you back to running your business faster.Pro tipWhen your lawyer marks up unimportant sections of a term sheet, the VC immediately knows the entrepreneur is not running the process. Over 50 percent of term sheet markups include changes to registration rights, which most VCs consider a signal of an inexperienced lawyer controlling the negotiation.WarningDo not let your lawyer turn the negotiation into a battle over every provision. A bad or inexperienced lawyer will focus on wrong issues, fight hard on things that do not matter, and run up the bill on both sides.
Feld and Mendelson openly state that they consider people who negotiate registration rights in term sheets to be focusing on the wrong things. Despite publishing this view, over 50 percent of term sheet markups they receive include requested changes to registration rights provisions. When this happens, they immediately know the entrepreneur's lawyer is driving the process rather than the entrepreneur, and they keep a list of these law firms.
This insight came from Feld and Mendelson's experience across hundreds of venture capital financings over 25 years. They observed that the most difficult and drawn-out negotiations were the ones where participants fought over every term. The most successful financings were ones where both sides quickly identified the key issues, negotiated them fairly, and moved on to building the company together.