This early-stage VC says startups can still negotiate funding term sheets, but founders are facing a new predicament: valuation or 'toxic' terms


Russ Wilcox

  • According to Pillar VC partner Russ Wilcox, early-stage investors are still making deals during the coronavirus-led economic slowdown even as later-stage investors start to pull back.
  • But interested investors are struggling to build relationships with entrepreneurs remotely prior to providing funding, and include lowered valuations or unsavory terms to help offset the risk of investing in someone they’ve never met.
  • Although valuation is the headline-grabbing figure for most funding rounds, Wilcox thinks founders should focus more on the terms of the deal with a particular focus on who owns what percent of the company.
  • Giving investors outsized pro-rata rights, or the right to reinvest a particular portion of a following funding round, essentially guarantees the investor will negotiate less founder-friendly terms the second time around since they have that leverage, Wilcox said.
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Term sheets are still up for negotiation as long as founders are willing to forgo the headline-grabbing valuations of the last few years.

According to Russ Wilcox, partner at Boston-based Pillar VC, the power imbalance brought on by the economic slowdown has unearthed some “unsavory” venture practices. Founders are desperate for funding to keep their companies afloat, and some investors are more than willing to take advantage of the leverage after years of giving founders the moon and then some. Together, it’s a recipe for disaster if founders aren’t savvy enough to nip it in the bud, says Wilcox.

“Character shows in a crisis, and I have observed some investors who start to make outrageous asks in the term sheet given the situation,” Wilcox told Business Insider. “That’s a moment when people are opportunistic and will show their colors.”

Being an opportunistic investor has traditionally been a selling point for VC firms, signalling that a firm was willing to back a promising startup even if it didn’t fit neatly into its investment thesis. But in the current economic climate, Wilcox says, an “opportunistic” VC could have a more cynical connotation, indicating a mindset among some investors to press their advantage on term sheets.

To be sure, says Wilcox, it’s a tricky time to invest in new startups, from both sides of the table. 

Many VC investors are just starting to raise their heads again after the turmoil of the coronavirus. As they hunt for new deals, VCs grappling with a new challenge: how does an industry built on networking and personal skills translate to a remote world?

“The question is, can you invest in a founder you’ve never met in person?” Wilcox said. “Investors are trying to figure out how to do business, which is more difficult at the early stage because at the later stage, you are just looking at the financials. At the earlier stage, it’s just a handshake.”

“Your job is to get the cash you need to execute your plan”

The uncertainty and inherent risk associated with investing in what amounts to a total stranger is partially what’s driving the opportunistic investors and cratering valuations, Wilcox said. The two conditions that are still negotiable, the valuations and the terms of the deal itself, have to balance out in order for founders to get a fair shake in the long run. 

“I do not believe founders should worry about valuation, and that’s from a guy that’s been through many venture rounds as a founder and investor,” Wilcox said. “You will raise money a couple of times throughout the life of the company so it will sort itself out. Your job is to get the cash you need to execute your plan because not having cash will make or break your company.”

For the last several years, VCs in Silicon Valley and beyond have catered to founders with special terms to deals that rewarded them with outsized control of the company regardless of how many investors were on the cap table. It was a winning arrangement that let founders run the show and investors cash in. Now, investors are rethinking whether those terms are useful in a world that is infinitely riskier than it was just a few months ago.

In order to sign on to a high valuation in June 2020, investors will add terms to the deal that lets them dictate how the company is run to better protect their investment, Wilcox said. That can include diluting the founders’ ownership of the company or including significant pro rata rights, also known as an agreement to allow the investor to reinvest a specific percentage of a later round. Both of these tactics help cement a person or firm as the singular decision-maker for the company’s future.

“In the current environment the bar is higher because it’s harder to raise cash right now,” Wilcox said. “Before, you might end up with two term sheets and you could pick the best, but now you might just have one, so you have a difficult decision to make. I’d advise founders to be willing to bend on the price and be unwilling to bend the terms.”

At a lower valuation, investors may be more willing to let the founder exert larger control over the company because the stakes are lower, Wilcox said. That’s the easiest way to get around these terms, which Wilcox repeatedly called “toxic.”

“At the end of the day if you build a great business, it will be financeable, so if you want to get funded, build a good business,” Wilcox said.

SEE ALSO: Ditch the office lease and scrap the billboard: Here’s the financial checklist Brex and Rippling just published for other startups reopening after a shutdown

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