Sorry, Dorothy, No Easy Way Back to Kansas this Time

If we collectively click our heels together, can we avoid a recession and a protracted bear market? I suppose we have not tried this yet, but certainly all other forms of wishing we were someplace else have failed. I have been a serious bear for more than a year now, so I am not just the latest Chicken Little burned by the market this week. In fact, I have been short the market for months, so I have some extra change in my pocket this weekend.

It really does not matter who is ahead in the presidential polls, what Bernanke says, or how much of our tax dollars Dub’yuh sends us by mail, we are faced with a recession and a bear market. All I want to know is how far down the death spiral do we go and will we continue to dig in our collective heels in vain, thereby extending the pain for many quarters. For those eternal optimists (also known as pundits on TV, retail stock brokers and politicians), can you please tell me how we ignore the following facts?

• Hedge fund meltdowns and bond defaults
• Bank failures and corporate bankruptcies
• Record foreclosure rates and looming credit card defaults
• Unemployment rising and food prices soaring
• Oil prices at new record levels
• Consumer confidence at historic lows and a weak dollar
• Polar icecaps melting (sorry, that’s just piling on)

I know these optimists will say that despite all of this, it is always darkest before the dawn; however, that wonderful idea only applies at the end of the death spiral when we experience complete capitulation (including from these optimists). I am afraid that the worst is ahead of us, not behind us.

You had better look at Japan or many Latin American nations if you want a history lesson on what we may be facing today. Can you spell S-T-A-G-F-L-A-T-I-O-N? Anyone? Anyone?

An even scarier prospect is how these problems can ripple through our global economy…

Of Cap Tables and VC Term Sheets

Unless you are operating a sole proprietorship, you should maintain and understand your capitalization table, which you can maintain as an Excel spreadsheet calculating how much you and others own of your company. For those of us that want to appear too busy and sophisticated to spell it out, we call it our Cap Table. Your company may be structured as some form of Partnership, S-corp, or LLC, in which case your cap table may consist of general partners, common stock owners, or LLC members holding stakes of similar class. Conversely if you have a C-corp, you may have stakeholders with common stock, different classes of preferred stock, stock options and warrants. If your cap table is still fairly simple—but you plan to raise venture capital—get ready for your cap table to become more complex and frequently misleading.

Venture capitalists typically structure their investments as preferred stock, and each VC firm has their own boilerplate Term Sheet they like to use. Many terms that define this preferred stock can chip away at the value of your common stock and your employees’ stock options. These terms can be difficult to plug into your cap table calculations. Liquidation preferences, ratchets, convertible cumulative dividends, redemption rights, rights of first refusal, and escrowing of founders equity are not term sheet legalese you can gloss over; you must understand the impact these terms may have in various scenarios.

The complexity only increases if you have more than one round of investment and/or more than one VC involved. If you are not careful, you can find your common stock devalued to the point of worthlessness in all but the rosiest of liquidity scenarios. To be clear, many of these terms are necessary for all but the most foolhardy VCs. You must remember that VCs are not in the business of awarding grants and they have a fiduciary duty to protect the investors in their funds as best they can. Nevertheless, every term sheet is a starting point from which to negotiate terms that may impact the value, ownership, and control you expect to maintain, and you need to focus on more than just the valuation and size of the proposed check.

You should consult your financial advisor, investment banker, corporate attorney, medicine man and mystic before negotiating or signing a term sheet; however, anyone whom you ask for advice MUST have experience with venture capital term sheets… and most I-bankers and attorneys do not. You must find advisors who have been down this road before.

Here are some things to consider regardless of how confident you are in your ability to understand and negotiate terms:

• Raise more money than you think you need for the next 12 months; rule of thumb is about 50 percent more;
• Control the board as long as possible; consider what voting rights a VC may have without board control as well as what board decisions should require a super-majority;
• Insist on employment contracts with cash and equity guarantees upon termination or a liquidity event;
• Encourage competition among interested lead investors; the easiest way to negotiate terms is to have more than one term sheet in hand.