VC Mandatory Moonshot - The Unwritten Terms in the Investment Agreement
Over the past few years there have been several fascinating blog posts about the unwritten terms in VC term sheets.
Josh Kopelman in an excellent post titled ‘When the music stops . . .’ said:
“Entrepreneurs should understand the ‘unwritten term in the term sheet’: few VCs will willingly part with a ‘winning company’ (i.e., a company that is executing/performing well) for less than a 10x return.”
In another post titled ‘Unintentional Moonshot,’ Kopelman said:
“They need to pay attention to the unwritten term on the term sheet. Specifically, they should make sure they are comfortable with the exit multiple that would generate the returns needed to satisfy their VC. While every situation is unique, here's a simple rule of thumb:
• Series A - 10x
• Series B - 4-7x
• Series C - 2-4x
So, once you sign a Series B the term sheet valuing your company at a $50 million premoney, you’ve basically signed up for at least a $200 million exit target. With the data showing that there are fewer exits—and those that do exit happen at lower prices—I think it's worth considering whether you want to eliminate the head-end of the M&A curve.”
Kopelman goes on to add:
“As a investor in StumbleUpon and del.icio.us, I can pretty confidently say that had either company elected to raise a Series B round—it would have been very difficult (if not impossible) for the founders to choose to sell their companies when they did.”
This unwritten term in the VC term sheet can have devastating effects on entrepreneurs and angel investors. It means that VCs will often block an exit that would have been fabulous for the entrepreneurs and the angels.