Editor’s note: Venture Watch is a regular feature on Tuesdays.
RESEARCH TRIANGLE … If your startup is so hot that venture firms compete to invest in your killer ap or that late stage, life-saving drug, you probably won’t have to worry about getting partners in the venture dance to Tango.
But as almost everyone else in the venture community knows, getting a deal closed often takes longer than entrepreneurs and startup execs expect. Covering the venture community for the last five years, we noticed that deals often stretch out weeks and months after we first hear a deal is about to close. This year has been no exception.
Daniel Egger of Eno River Capital, a fully invested fund in Durham, is also a private investor. Egger says delays can be as simple as investors getting cold feet when it comes time to sign on the dotted line. “Don’t count on your money until it’s in the bank,” he suggests.
John Glushik of Intersouth Partners, the Research Triangle’s oldest and largest venture fund, which has managed over $500 million for its partners, tells Local Tech Wire he sees three main areas that affect how long it takes to close a deal and put venture money in the bank.
First, says Glushik, “How broad and deep are the risk factors?” That, he explains, relates in part to what stage of growth the startup is in. Or, it depends upon the complexity of the market in the startup’s industry or the complexity of its technology. “The more complex the issues, the more due diligence we’ll do to validate, test, and learn the market opportunity,” he says.
Related to that, he notes, is what happens if VCs hear negative feedback during the due diligence process. “To the extent that we might hear negative feedback from people we know or people in the market place, things that might not feel good about the deal, we might have to back step to address those issues,” Glushik says. “We have to reconcile that feedback to get a positive outcome.”
Second, he says, “Competition for the deal is going to speed it up, no doubt about it. All investors worry about losing out on a great deal,” Glushik says. “It you think it’s possible someone else will get the deal done before you, you move faster.”
Third, Glushik says, “No matter how much you think you can compress the process and minimize the risk, you have to understand that VC firms both want to get to know you–and need to get to know you. The most important part of a deal is getting to know the people and you do not do that in a matter of days. The people are the most important part of the investment.”
Glushik says that a good VC fund wants to spend time with the entrepreneurs it might back even if it’s not specific to an issue or presentation. “It’s important to the investor and should be to the entrepreneur too,” he says.
We mentioned that some local companies appear to be taking advantage of an improving economy and keeping deals open longer than planned to raise more money than they originally planned.
Too much money?
“We are seeing some rounds become larger as companies go through the fund-raising process,” Glushik says. “The danger is raising more money than you need. You start tailoring the size of the round to the types of investors in it. Many large VC funds, those with $500 million or more, often look for a larger investment amount. You have to be careful not to convince yourself you need more money because investors want to put more money in,” he cautions.
“Your strategy should not be dictated by the capital markets.”
One sure way to speed the process, particularly in the final stages, where reviewing legal documents of hundreds of pages is necessary, is to use experienced attorneys, says Glushik. “The deals that go quickest for us are the ones where the corporate council is experienced at doing venture deals, especially those that have represented both venture firms and entrepreneurs.”
‘We just get busy’
Scott Albert of the Aurora Funds, Durham, which manages $155 million in four funds, says the primary reasons a deal can sink into molasses near the final stages is that “We just get busy.
“We find the deal, do due diligence for two or three months, offer a term sheet, that takes four or five weeks. Then we want to get the deal closed, but don’t have time to do the legal documentation. Lawyers always slow things down.”
Albert says an outsider might say, “You closed the deal Friday, why can’t you wire the money next Friday? It takes three to five weeks to get the legal documents done, even if things are going well after the term sheet.”
Frequently, he says, novice entrepreneurs don’t understand the terminology used in the legal documents, which can run to hundreds of pages.
“We would like to see the entrepreneur educated on the general structure of venture deals and legal terminology before reviewing the terms sheets and legal documents,” Albert says. “It takes a lot of time when someone doesn’t understand basic terms. If I send you a term sheet on Monday, I expect to hear feedback by Thursday.
It adds a week
“But, if three or four days later you call and say you don’t really understand the terms, when can we get together, you’ve just added a week while I find half a day in my schedule to meet with you.”
That means, Albert says, that an entrepreneur needs to not only know the definition of the terms, but also understand them. They need to understand the normal parameters of venture deals in many areas.
“They should know that an option pool of 15 to 20 percent for an early stage company is reasonable and not come in and say they want to do 3 percent or 50 percent,” he says. “That’s just one example. The problem gets compounded when you look at legal documents. A term sheet is ten, twelve pages, legal documents can run to 150 pages.”
Albert recommends that entrepreneurs “spend a little money on training sessions or seminars” such as those offered by the Council for Entrepreneurial Development and similar organizations and by law and accounting firms. “That level of knowledge upfront is very important,” he adds.
He seconds Glushik’s recommendation that entrepreneurs find “attorneys who have done deals before. It’s especially important if the entrepreneur is unpolished.”
“In the overall scheme of things,” Albert says, normal delays slow things down. Everyone has that pile of legal paper to crank through. “People are on vacation, or doing other things. That last four or five weeks tends to drag on.”
Attorney Chris Matton with Kilpatrick Stockton’s Raleigh office, says that entrepreneurs need lawyers who can “educate their clients quickly.” He offers a starting point, too.
“Even after the deal is wrapped up, frequently enough,” Matton says, “you need to obtain shareholder signatures and that can inject days or a week delay. Entrepreneurs should attempt to limit the number of shareholders. The more convoluted the capitalization table looks, the longer it will take to get to closing.”
Intersouth Partners: Intersouth.com
The Aurora Funds: www.aurorafunds.com
Kilpatrick Stockton: kilstock.com