TheFunded.com, a site entrepreneurs love but VCs absolutely hate, has pushed the envelope considerably by adding a feature that allows entrepreneurs to upload term sheets for others to view. A term sheet is essentially a letter of intent, a non-binding, revocable, starting point that is not final and culminates with a business transaction.
Short Term Repercussions
On the surface, yes, this does seem to violate some confidentiality clauses found in such agreements, but TheFunded.com has taken some measures to address those concerns, such as removing the names of the companies and investors and only publishing the actual terms, and not the sheets themselves.
But VCs have long funded companies that bundle private and confidential data to anonymously profit from it, this is basically the same practice, so I do not see what the big deal is.
I see a bigger practical shortcoming, which is most entrepreneurs won’t update recently obtained term sheets they intend on accepting (the ones that are fair and reasonable) out of fear of upsetting the party that made them the offer (the investor). If entrepreneurs end up submitting accepted-but-old term sheets or term sheets they passed on, then there is a risk that the sample of term sheets will not be accurate. But by the same token, the same was said about TheFunded.com initially… yet entrepreneurs gladly submitted reviews about meetings that took place recently, describing good and bad experiences.
Mind you, would I upload a term sheet’s details? Not if there was a confidentiality clause. I like to be very ethical, more importantly: if an investor of mine would ask me if I uploaded a term sheet, I would not be able to lie, so I would personally avoid getting in that situation (hey, just being honest). I would ask the investor if they minded, arguing, well, arguing what I am about to argue. Read on.
VCs Reaction: Thunder, Lightning and Hail
VCs - who have long been critical of TheFunded.com - will probably not like this one bit. Entrepreneurs on the other hand are probably smiling some more and asking themselves how they ever survived before Ted, aka Adeo Ressi, launched the site in 2007.
In fact, VCs have asked Ted to:
- allow VCs to comment; he has refused, allowing them instead to certify their profiles.
- refuse to allow anonymous comments on the site; which Ted claims is necessary to make entrepreneurs confident and comfortable on the site.
He is right on both points.
On the first: VCs have their own inner circles to comment on entrepreneurs, they should not be allowed to create shouting matches on a public forum such as TheFunded.com. The best way to avoid bad reviews from being written is not to have lawyers or hired PR people write comments defending VCs, it’s by VCs to become more ethical and fair.
On the second: keep dreaming. I’ve never posted anything on the site but trust me, as an entrepreneur, I’d not be 100% honest if I had to sign my name.
What TheFunded.com Has Done: Address the Subjective Nature of Funding Process
Does this create room for personal beefs to be aired on TheFunded.com? Yes. But what you see on TheFunded.com should not be taken as “the truth”. It’s one side of the story, the entrepreneurs’ side. Then, there’s the VC side. Somewhere in between is the truth.
What TheFunded.com Will Do Over Time: Create Efficiency
But since leverage and power are stacked clearly on the VC’s side, a service like TheFunded.com is indispensable. It also helps VCs weed out bad apples by cutting off their funding and encourages institutional investors to fund good VCs: Business Week reported that Ted claims the site is profitable, with revenues well into 7-digits, going on to add that his main clients are institutional investors who end up investing in VC funds. This is a very important mechanism: bad VCs won’t get money from big investors. Good VCs with bad reviews (it happens) will be able to let their track record, ethics and their side of the story prevail. Horrible VCs will be forced out of the industry.
What TheFunded.com Will Do Now By Adding Term Sheets: Address the Objective Nature of Funding
But allow me to take this argument one step further: VCs should not complain about term sheets being disclosed on the site, they should welcome it.
That’s not a typo. Let me explain.
TheFunded.com does not prevent me from working with a VC, it simply gives me a sense of what to expect.
TheFunded.com adds information to the marketplace in the sense that it levels the amount of information that entrepreneurs have relative to VCs.
In other words, because VCs have more information, they can earn “abnormal profits”. This is efficient market hypothesis, in fact. Any VC that says they welcome TheFunded.com is lying unless they are fine with making less money. The truth is, as VC Paul Kedrosky says, it’s a surprise such a service didn’t launch sooner. As such, VCs who say “it’s great” say so reluctantly.
But hitherto, TheFunded.com has been a limited tool for entrepreneurs (it’s only been a year, mind you). TheFunded.com gives entrepreneurs a sense of what to expect after an initial contact is made. But everything that happens from that contact onwards is pretty subjective.
If you let VCs comment on TheFunded, you’d see that surely there was a reason the VC:
- was slow to get back,
- showed interest only to suddenly lose it,
- asked for confidential information then shared it with competitors,
- was on their Blackberry during meetings, etc.
We don’t care about these details. It is a VC’s prerogative to be lack tact (not all do) and do those things. TheFunded.com exposes bad manners insofar as it allows entrepreneurs to voice their criticism.
But where TheFunded.com fell short, frankly, was in the objective side of things. While the initial back-and-forth is important, it is secondary to the term sheet. The term sheet is what VCs have to answer to. The term sheet is the black and white document that cannot be distorted: if a VC asks for a 3x liquidation preference in a booming market on your average, healthy company (or if you ask me, anything over 1), that’s unfair. End of story. TheFunded.com needs to expose such brazen robber barons. In fact, good VCs should also want to weed out such criminal activity because in the end they will only be hurt by the practice.
In other words, if they are vulture capitalists, then the term sheet will reflect it.
If the VCs are fair, just, ethical etc., then the term sheet will reflect that, too. There’s no need to have them commenting on the site.
As such, adding the ability to view term sheets will actually do exactly what VCs want: their voices will be heard, but not through words alone (comments on TheFunded.com) but actual actions, measurable actions. Isn’t that what VCs ask for from entrepreneurs?
The Main Reason Why Entrepreneurs Will Benefit From Seeing Term Sheets: Managing Expectations
Last year I spoke to a VC regarding a potential Series A investment. The VC asked me what I thought our company was worth. I proposed a pre-money valuation using about 10 recent comparables in the marketplace, in both funding rounds and M&A deals. He came back and said “nope, that’s too rich”, arguing that he had seen “funding deals in Series B rounds that came in at that value.”
I asked him “which deals?” to which he answered: “sorry, it’s confidential”. I asked him for comparables that he was not involved with to back whatever figure he had in his mind. Sorry, no answer there, either.
So we played a song and dance that went nowhere, fast.
First off, his argument about the Series B valuation was poor because as founder/investor, I’d served as the initial investor when we launched two years ago, investing an amount that is awfully representative of an initial VC round these days (but that’s not the point I’m making here so I shall digress).
More importantly, talks broke down because this VC was making me jump through more and more hoops to show validation of what we were doing and forced me to spend 6 months living in a spreadsheet - which I refuse to do. I instead focused on signing more deals and generating sales. But he was making me do all of that to justify my valuation (which is somewhat meaningless in some ways, relative to other items in a term sheet anyway).
Had I been able to see existing term sheets in the market, I would have been able to quickly see if he was being honest about my valuation being too high or he was trying to low-ball me. Since then, seeing a lot of deals take place, I can tell you I was not being unreasonable. He was in fact trying to low-ball… not because he’s a douchebag (I actually liked the guy quite a bit, and no, he does not read this blog) but because that is what all VCs do!
In other words, up to now, TheFunded.com helps set expectations of what to expect from initial contact to the term sheet (assuming you will get one). But once you got a term sheet, TheFunded.com helped entrepreneurs in a very vague and ambiguous way (”the term sheet was a bad one” is very vague compared to “we got $2M in funding on a $8M pre-money with a 1x liquidation preference”).
It is often said that entrepreneurs are unreasonable with their requests and expectations. That is a fair criticism to be leveled against us, and in turn, by allowing the information in term sheets to be added into the ecosystem, then VCs should be happy because entrepreneurs will have an objective barometer to sense where the market is at.
Reducing Cycle Time of Financing Deals
Valuation is not about what an entrepreneur thinks his or her company is worth, it’s about the market. In fact, it’s not even about a term sheet we get, because term sheets are not final. This is why I don’t understand VCs beef on the confidentiality matter. VCs are not even bound by term sheets, oftentimes they change the terms. By allowing term sheets to become part of the information ecosystem, even if they remain anonymous, then it helps shorten the funding process too: a VC has to be in line with the market, as does an entrepreneur. More companies will get funding, more opportunities will be capitalized on, and there will be less frustration in the process.
Ultimately, VCs won’t welcome this
Despite all of these advantages, VCs won’t be happy and the reason is simple: VCs are in the business of maximizing their earnings, which means their objective is not really in line with an entrepreneur’s goal, it is in fact almost inverted!
For VCs to achieve their goal, it usually start at the term sheet by getting unfair advantages. TheFunded.com addresses this, it’s a welcome and indispensable tool in the equation. If VCs don’t like it, it says a lot more about them than it does about you.
End Game for TheFunded.com
Interestingly, Ressi mentions that if he wanted to raise money, it would be a challenge, but I disagree. He could raise money for this or any other venture easily. I can see TheFunded.com remaining private and independent, especially on its current run-rate. But I also see TheFunded.com selling to a company like Thomson Financial, News Corp. or Bloomberg. Maybe non in the exact incarnation it is in today, but I can see it evolving to a place where such financial information companies could help it become a clearinghouse of data (and maybe money if they can overcome some major conflict of interests) in the private financing space.
Related:
- My 15 minutes with TheFunded.com’s Ted
- Why do Entrepreneurs Accept Draconian VC Terms?
- Biggest Mistakes VCs Make
More on VentureBeat, TechCrunch, Business Week.
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