Of late, I’ve been in few discussions where investors proposed terms that honestly were counter-productive. Early investors often don’t realize they set the stage for future. If they set bad terms, they’ll get retained in future rounds & come back to pinch them.
So here’s a list of terms that angels & startups should strongly avoid:
1. Participatory liquidation preference:
On liquidation event, investors get back the amount invested AND pro-rata of shareholding. Double dip. Skewed & misaligns founders/angels with later investors on exits. Fair is 1x non-participatory.
2. Full-ratchet anti-dilution:
Means in a down round, investor isn’t diluted – killing for a struggling startup. Should be broad-based weighted-average.
3. Milestone-based tranches or valuation:
Promised investment is split in tranches based on milestones, or pre-money valuation now is linked to future milestones. Distracting & seeds distrust.
4. No accelerated vesting:
Means incomplete vesting on founder being terminated w/o cause, or on liquidation event. Builds perverse incentives to fire founders. Should be accelerated.
By optimizing for the upside in short term, angels set themselves up to lose a lot in the long term.
Be founder friendly, it helps.