What You Need to Know About VC-Favored Structures vs. Founder-Favored Structures

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Silicon Valley startups looking to attract venture capital investors tend to hyper-focus on dressing the part, but they do so at the expense of some important aspects that could save them down the line. 

The VC world has become very busy to say the least. In 2020, startups saw the highest median VC investments since 2008. Yet startup founders are setting terms on the outset that have desperation written all over them. Startups that are willing to submit to disadvantageous requirements (either out of incomprehension or despair) appear out of options, which is why they should never set pre-ordained terms. And for reasons beyond comprehension, there have been plenty of top-tier startups that effectively chose pro-VC structures in their initial corporate form and equity.

Here’s what startup founders should know to avoid completely eliminating founder-favored structures as they seek to attract investors.

Re-thinking typical VC structures 

The mantra for first-class startups going the VC route includes: Delaware C-corp, the 10 million share model, one share class (plain old common stock) and four-year founder vesting (probably with a cliff) with double-trigger acceleration.

This is largely considered to be the “right” structure for VC-focused startups because it’s what VCs want.  VCs like Delaware corporations, and they will generally want to invest in C-corps.  They don’t want anyone except themselves to have shares with special rights. And VCs want founders whose shares are subject to vesting so they’ll stay with the company. They also don’t like single-trigger acceleration because an acquisition may depend on founders and other employees remaining after the exit transaction. The incentives to stick around dwindle if founders and employees aren’t stuck vesting after an exit.

When founders are at a point where they’re choosing structures, they tend to forget that they can establish the terms they want, and don’t always know that alternative structures do not necessarily cost any more than the VC-favored default. In fact, they may be less costly. Furthermore, founders may be sending the wrong signals by making all of their initial choices based on VC wants — essentially eschewing all the choices that would protect their long-term interests. Here’s what going all-in on VC structure tells investors:

Related: Think You Need Venture Capital Backing to Start Your Business …

There’s a need for VC financing – The founders don’t care about control  

Everyone knows that if a founder doesn’t need VC financing, there’s little reason to choose the VC-default structure. There are many other structure options that can be more beneficial to founders, leaving investors to question why a founder would default to such unfavorable structures. The VC-default structure provides founders no protections vis-a-vis future employee/service provider shareholders.

Why would founders not put protective provisions in their initial structure that would allow them to mainta

Source: Entrepreneur.com

Read more from the original source:
What You Need to Know About VC-Favored Structures vs. Founder-Favored Structures

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