In a bull market, terms and conditions - those pesky yet important details related to liquidation preferences, protective provisions, dividend provisions, and anti-dilution provisions, to name a few - matter less than in a tough market.
Many new entrepreneurs make the mistake of focusing too hard on the valuation attached to his or her company. Instead, they should be focusing on the far-more important terms and conditions, said Pete Mountanos, founder and chief executive of Charitableway.com and a former Softbank Technology Ventures executive.
For example, liquidation preferences, which typically will be purchase price plus declared and unpaid dividends, refer to what happens in case of a sale or change in control, as well as bankruptcy liquidation. Investors may ask for two to four times the purchase price.
"Any concession over money back becomes a precedent for the future," Mountanos said, "and entrepreneurs should challenge that."
The demand registration clause is another touchy area. If set up in terms favorable to the investor, the investor gets his money before the entrepreneur. Good legal counsel is imperative, the panel agreed. Dividend provisions are another area where crystal-clear counsel may prove invaluable, as there are many possible outcomes for various scenarios.
The protective provisions clause is also worth paying attention to. The question to ask here is, "Can you predict the outcome of a vote?" said Harold "Bud" Enright, vice president of corporate development at Compaq Computer (NYSE: CPQ).
In many cases the answer is no. Control of shares and alignment of interests becomes all-important when it comes to such matters as a merger or sale of assets, amendments to a company's articles of incorporation, or dividend payments.
In addition, the importance of research in preparing to negotiate terms can't be underscored enough, said Dennis Cagan, chairman of Pacific Palisades, Calif.-based Acorn Technologies and heavily involved with the Santa Barbara Technology Incubator LLC.
First step? Due diligence. Get the names of CEOs the venture firm has worked with, and ask them how the relationship is, if they've been treated fairly.
Picking a venture partner may also depend on what the venture capitalist is looking for. From a corporate investor perspective, exclusivity or preferred supplier deals are typically term number one, said Enright of Compaq.
"We're willing to put money in and we want you to use our products," he said. Yes, Compaq wants the return on its investment, he added, but the firm is also "putting money out to enhance our basic business."
And for a start up to truly succeed from the venture point of view, it needs a large market and strong management.
"If you don't have a competitor, you don't have a market," said Larry Barels, who founded Wavefront Technologies in 1984, was the first investor in Software.com, and is currently a principal at Pacific Capital Resources and an advisor to several venture capital firms.
"We come in for the financial return," said Tom Gielselmann, a partner at Bertelsmann Ventures. And while venture capitalists want the company to be successful, they don't necessarily want to run it. So having skilled management is important.
"If we have to exercise control, it's taking time away from other things," he added. "There's no inherent control desire from VC companies."
Mavis Scanlon is a staff writer for the Los Angeles region. Comments and story ideas are welcome.