Raising venture capital (VC) is often seen as a crucial milestone in a startup’s growth. But for founders, it’s typically the first time they relinquish financial control of their company—and poses a litany of risks for the future governance of the startup, according to founder and former SRTX CEO Katherine Homuth.
“An investment document is 100 percent red flags. Nothing in the term sheet is in your favour.”
Katherine Homuth
At both the BetaKit Town Hall: Most Ambitious and Startupfest in Montréal, the repeat founder argued for a standardized employment agreement where founders can dictate preferred terms for everything from board structure to periodic salary evaluations. While some VCs said it might be a tough sell to investors, they agreed that founders would benefit from better resources before raising their first round.
“An investment document is 100 percent red flags,” Homuth said at Startupfest. “Nothing in the term sheet is in your favour.”
Homuth, who recently founded new startup Oomira, thinks a standardized “founder constitution” would better prepare novice entrepreneurs to negotiate with investors. Employment conditions such as severance terms, pay review cycles, share distributions, and parental leave policies should all be included in this document, she said. BetaKit reached out to Homuth to request a copy of a draft agreement, but did not hear back by press time.
“Most VCs wouldn’t think any of this was unreasonable,” Homuth said. She explained that the trouble could occur later, if tensions arise within a company’s board of directors, and the founder has no negotiating leverage.
Homuth claimed that VCs and lawyers reassure founders that many circumstances laid out in “exceptional” clauses “usually” never happen, such as convertible notes not getting converted. But if they do, the founder is in a tough position.
The SRTX founder was drawing from her experience raising roughly $250 million USD for SRTX, which manufactures Sheertex rip-resistant tights. Homuth stepped down from SRTX in February as a condition of an important fundraising round closing for the company.
Shambhavi Mishra, associate partner at Antler Canada, said VCs might not be very happy with founders bringing their own terms, but that such resources should exist. Antler Canada calls itself a “day-zero” investor, and works with pre-launch founders to connect them with founding teams.
“Founders need to be aware that capital is just one part of what you get from a VC,” Mishra told BetaKit. “There should be a playbook that exists even before a founder starts on a fundraising journey, [that acts] as a bible.”
Founders should take care not to compromise on terms that seem irrelevant at the early stage, Mishra said, but could become problems when it comes time to raise a Series B or C.
Shambhavi Mishra
“Founders need to be aware that capital is just one part of what you get from a VC.”
Antler Canada
AQC Capital investment partner David Dufresne told BetaKit that terms tend to be favourable to founders up to the Series A round. However, things become more difficult when founders miss milestones and have to raise more capital and renegotiate with investors at new valuations.
“Your best protection is hitting your numbers and delivering on what you sold,” Dufresne said. “It’s when things go sideways that problems might start to happen.”
Some financing contracts are designed specifically for early-stage companies, such as the simple agreement for future equity (SAFE). SAFEs were developed by San Francisco-based accelerator Y Combinator (YC) to account for both the startup’s and investors’ interests, according to the YC website. Crucially, founders are not obliged to repay the investment if a SAFE never converts into equity.
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But SAFEs are not always offered, VCs told BetaKit, particularly when engaging with larger institutions and banks in Canada.
Triptyq Capital partner and repeat entrepreneur Bertrand Nepveu told BetaKit that more intense competition for startup deals in the United States forces VCs there to be more founder-friendly.
“But here, since it’s a less competitive market, they can ask for less favourable terms,” Nepveu said.
Lending conditions that include secured debt, for example, he added, make it difficult for founders to start a new venture if their first startup goes bankrupt.
Nepveu said he has heard of founders who have put assets on the line, including their homes, to secure financing for early-stage rounds. Beyond the severe financial consequences if the startup runs out of money, these personal guarantees can impact a founder’s credit history, Nepveu said. This makes it harder to build another company and secure more money in the future, pushing founders out of the entrepreneurial ecosystem.
Educational tools for founders, such as Homuth’s constitution idea, could represent one way to protect founders from these outcomes, Nepveu said. Another is for large lending institutions to change their mindsets when it comes to early-stage startups.
“You need a community to show you the best practice,” he said.
Feature image courtesy Matt Tibbo Photography for BetaKit.