I had the pleasure of attending a daylong symposium at Dartmouth College last week, Dartmouth Ventures. One of the panels featured these prominent VCs speaking about “Financing 102- After a Seed Round.”
Ned Hill, Managing Director- Mercury Fund
Steve Bloch, General Partner- Canaan Partners
Liam Donohue, General Partner- .406 Ventures
This was a fairly cut and dried panel except a few things stuck out:
On the subject of how to find the right valuation, I was expecting to hear “the market sets the price” and “we look at similar transactions” and the other basic VC valuation tools. However, what I heard was a discussion about “What’s fair?” “How much money the company needs” and “backing into the right ownership.”
Of course, the right ownership is up for debate and the subject of much friction between investors and entrepreneurs. The implied definition of “right” in this case was high enough to provide meaningful incentive for the entrepreneur but also low enough to provide a large stake and significant returns for the venture fund.
The other really interesting part during the discussion of valuation and the preferences that investors get through their Preferred Stock. One VC talked about the idea that “management has an implicit preference” relative to the investors and other stockholders. This refers to the “Liquidation Preference” that virtually all VCs insist on- namely, that they get their money back out before the common shareholders.
The concept of an “implicit preference” (and this is somewhat advanced for 1st time entrepreneurs) is that in a liquidation or exit scenario, the management team needs to be taken care of. So as much as the VCs rights allow them to get their money first, potentially taking all of the exit price, this doesn’t really happen in practice. The buyer will take care of management, often making them whole, since management is needed to run the company and extract the value for the acquirer. This “implicit preference” of management could trump the actual legal preference that the VC gets through Preferred Stock.
The implication from the VC panel was seemed to be that founders don’t have nearly as much downside as it would seem on paper. And that the VCs felt justified in asking for somewhat lower valuations, and higher ownership positions, as a result.
What do you think?