Betsy Flanagan: In terms of when entrepreneurs are actually negotiating a deal with VCs, what are the top five things that they should be focusing on?

David Hornik: I don’t think there are five.

Flanagan: OK.

Hornik: I mean, number one, with whom are you negotiating? It is so much the most important thing that the rest of the stuff is almost irrelevant. It’s not irrelevant, it’s important, but you’re not going to take money, I’m not going tell you, “I’m so spectacularly great and helpful that you should take money from me at a dollar versus $100 million.” That’s crazy. But to the extent that there are investors who are interested in putting money into your company and they are relatively close in valuation and terms and these sort of things. Frankly, choosing anyone but the person that you believe would be the most helpful to your company is crazy no matter what those terms are. So that’s the first thing I’d say.

The second thing is, in reality, the majority of these terms are pretty clear and obvious and have virtually no impact in the long-term value of the company for you or the company for your investor. Companies are either very successful, in which case everybody does quite well, or they are unsuccessful, in which case everybody does not. There are small differences in the middle and that’s what we argue about in these terms.

But I think, truthfully, that the importance of that stuff is pretty minimal compared to working with the right kinds of people and being fair. What is fair? So, you know then, the only thing that really matters then are sort of two issues that impact the valuation of the company. There’s the valuation, how much money are you willing to pay per share? And then there’s the stock-option pool, which is how many additional shares you’re going to add to hire people in the future. Those things in combination will impact how much ownership the existing people have in the company and how much ownership the investor will have in the company. And that’s relevant. And how much money will you pay to get that ownership. That’s pretty much it. I know there are all sorts of things. There are things like liquidation preference, which tells you who gets money out first and how much. There are things like purchase rights and registrations rights. And I do think there are plenty of terms that are unreasonable. There are plenty of terms that an investor might ask to impose on you that I wouldn’t, myself, and I don’t think are rational.

And then there are set of controls that do have an impact. There are sets of things called protective provisions. Protective provisions say I, as an investor, get to vote on these things in particular and I get control over. And it’s the deal. You know, if I’m going to give you $8 million, if you want to sell the company, I get to choose whether that makes sense or not. If you want to issue 8 billion more shares, I get to choose whether that’s a reasonable thing. If you want to add four more people to the board of directors, I get to choose whether that’s a rational thing. Those are important terms and I think you should have a conversation with your venture investor about which of those makes sense and how those controls are exercised and all that. But again, it goes back to do you trust the person with whom you’re working. Are you working with someone who you think is interested in building the long-term value of your company? Because as an early stage investor, I’m exactly in the same position as the founders once I’ve put that first money in. Everybody wants a company to be so much more valuable than my liquidation preference. Like, I put $4 million in, for my liquidation preference to be the only value I get, the company has to be worth $4 million, right? That’s not an outcome I’m excited about, you know, nor is it an outcome that the founders are excited about. So I’m much more focused on the long-term value of the company.