How to Manage a Venture Capital Firm’s Multiple Liquidation Demands
Friday, March 20th, 2009A new study on venture capital exits has revealed that entrepreneurs are feeling the bite of acquiring big capital. As a response to changing economic conditions, VC firms are demanding higher payouts at their exit and requiring stricter demands on their exit terms, even before a check is written to a new startup venture.
The survey, conducted by California law firm Fenwick & West, revealed that VC firms are looking at liquidation preferences as their number one exit strategy. For the entrepreneur, this means when you make your business such a success that it is acquired by another bigger business, the first to take the cash will be the VC firm.
What Else Venture Capital Firms are Demanding from Entrepreneurs
According to the study, the stakes even are higher than liquidation preferences. VC firms are requiring two and sometimes even three times the investment they put into a company. If a VC invested $5 million in your company and you later sold it to a larger conglomerate, the VC would insist upon a payout of up to $15 million before you even saw a dime.
Companies that go public through an IPO are also seeing higher stakes. Usually, a VC firm will ask for preferred stock at the IPO, giving them a non-ownership stake in the company, but first pick on dividends. However, lately some VC firms are requesting common stock, which gives them voting rights in the company. A VC firm with a large common stock share can continue to have much influence on a public company.
How to Negotiate with Venture Capitalists
How can entrepreneurs get their fair share and prevent VC firms from taking the lion’s share of profits? It is important to stake your claim in your company and negotiate appropriately for the initial investment terms. While venture capital firms may seem to have the upper hand in doling out the funds you need, keep in mind that their industry is very competitive. If your business idea is truly genius, innovative, and profitable, there are many other VC firms that are waiting to take over the deal – and the VC firm with whom you are negotiating knows this fact too. Remember, you are the founder of the company, and you should enjoy your fair share of profits once you bring the idea to successful fruition.
Another way to prevent a massive cash-out to the venture capital firm is to find other ways to capitalize your business. VCs offer a lot of money to help companies expand, grow, and ultimately gain the market share that makes them successful. But they require a big payout for that investment. If you can find other options that are more reasonable, look to them as alternate ways to finance your business.
Of course, you could simply live with the terms that the VC is seeking. If you plan to be with your company for the long haul, then let the venture capitalists take their money at their exit. As long as your business continues to be successful after a VC cashes out, you will ultimately see the financial reward for your work.









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