A must read for entrepreneurs seeking venture funding

Rick Segal at Post Money Value has a recent post dealing with the topic of liquidation preferences and double or triple dipping in venture rounds – i.e. participating preferred . Rick makes excellent points in this post and entrepreneurs seeking venture funding should heed his advice.

His suggestions at the end are right on the money. I’ve always felt that the VCs should have a right to get their money back in full first before the entrepreneurs can cash out. However, this should be a choice and not an ability to have their cake and eat it too.

Rick’s suggestion of a non-participating preference is what I have gone with in the past and it works. The VC can choose to get their money back and then the remaining common shareholders can divvy up the remaining proceeds on a pro rata basis, or the VC can convert to common and take their pro rata share of the outcome.

In Rick’s example, say the company that raised $5mm at $5mm premoney sold the company for $9mm for some reason. In this case the VC would choose to get their $5mm back. The remaining common shareholders would split the $4mm that is left on a pro rata basis.

Worst case, use the forced conversion feature at a set price that Rick suggests at the end.

The big point being made here is there is way more to a venture round than just the valuation. The VCs know this game and there are many ways to a deal that works. As an entrepreneur, you cannot be obsessed with valuation alone. You may get the price you want, but the strings that come along with that are more painful in the long run.

— brian