Terms, Term Sheets, and Terminal Value

Mark Suster has a great post on calculating valuation and the things that VCs can throw at you to make the deal better for them (I guess I should say us) than it actually looks. Go read it. It's complicated stuff but you should try to wrap your head around it. I've written a bunch about this as has Brad Feld and other VC bloggers have too. The VC world is changing. We are talking about this stuff, explaining it, and discussing it. That's progress.

But here is the thing. Terms and term sheets are a necessary evil of the venture business but most venture returns don't come from terms. They come from terminal values. Meaning the size of the exit. One deal often returns the entire fund. The next three to four deals return it again. The rest of the portfolio might return it again and if you can do 3x gross, you'll raise another fund, and another, and another.

In my talk with John Battelle yesterday at Geo Loco, where I said some controversial and partly tongue in cheek things that were widely reported, I did talk about this. And I wish it was as widely reported as the sound bites. What I said was that there are only a few things that really matter in a venture investment. The first is the amount being raised, the second is the dilution to the entrepreneur and the ownership the investors are buying (largely the same thing), and the third is the relationship between the investor and the entrepreneur. Everything else is pretty much noise.

I do care about and want a plain vanilla one times liquidation preference because I think it is fair. If the company is sold for less than the valuation that we invest at, I think it is fair that the investors get their money back in that scenario. Any multiple of liquidation or participation should be avoided at all costs by both sides. VCs often use those tricks to bridge valuation gaps but I have come to believe you should resolve valuation gaps with compromise or just don't do the deal if the gap is unbridgeable.

I think the VC business is changing in many ways and one good way is that more and more VCs are thinking less about terms and more about terminal values. And that is best for everyone.