Secrets of sand hill road

When starting a new company, the decisions you make in structuring and forming your business will greatly impact your ability to seek venture capital (VC) funding down the road. It's critical that you make the right choices when establishing your enterprise, as the wrong ones could preclude VC financing in the future. How you initially set up your startup will largely determine if VC is an option later on. It's vital to the long-term health of your company that you structure it appropriately from the outset.

In most cases, you should form a new venture as a C corporation at the beginning. C corps offer several key advantages: They have no limits on the eventual number of shareholders. This provides flexibility as more investors come on board. C corps allow for different classes of shareholders, each with distinct rights. This enables preferential treatment of certain shareholders, like founders or early investors. Investors in a C corp don't have pass-through tax liability. This avoids complicating taxes for shareholders.

Once you've formed the legal entity, an early decision is how to divide equity ownership. This generally involves allocating shares to three main groups: Founders' shares - These often vest over 3-4 years to incentivize long-term commitment. You want founders to have enough equity to be highly motivated, but structured so they stay invested in the company rather than moving to the next idea. You should also determine how founders can value, sell, and transfer shares if they leave, including in an acquisition or IPO.

Securing venture capital (VC) investment is a complex and challenging journey for founders, with the term sheet negotiations being a pivotal moment. This legal document outlines the investment's terms and conditions, making it essential for founders to be well-prepared before engaging with VC firms. Founders must first assess their financial needs, desired valuation, and the reasons behind these figures. While the instinct might be to aim for the highest numbers possible, a more strategic approach involves a thorough analysis of the market opportunity. As VC investor Scott Kupor points out, the success of VC investing hinges on the potential market size. Founders need to convincingly argue that their market is expansive enough to sustain significant growth over the next 7-10 years, evolving into a highly profitable venture worth hundreds of millions.

The process begins with securing an introduction to pitch to VCs, as cold contacts seldom yield results. Building relationships with angel investors, seed investors, or law firms can lead to warm introductions, which VCs value as indicators of a startup's potential and the founder's determination. According to Kupor, securing a warm introduction, though not mandatory, can significantly influence a VC's initial impression of a startup's viability.

Venture Capital (VC) funding is crucial for startups looking to scale and succeed long-term. However, it's important to understand that VC funding comes with economic and governance constraints that must be followed, especially by the board of directors. The board plays a vital role in guiding the company's strategic decisions, while the CEO handles day-to-day operations and long-term vision.

Public company boards prioritize maximizing company value for common shareholders. Private company boards, on the other hand, can be different due to financing terms that dictate board composition. Private companies often have multiple share classes, leading to disagreements among board members, especially regarding acquisition proposals where preferred shareholders may benefit more.

VCs have a dual fiduciary role, balancing value for common shareholders and limited partners who invest in the VC firm. Conflicts of interest can arise when a VC's economic interests as a preferred shareholder diverge from those of common shareholders. The board's formal responsibilities include hiring and firing the CEO, guiding long-term strategy, approving major actions, evaluating CEO performance, and ensuring compliance and governance. VC-specified roles may also be outlined in agreements.

For the VC cycle to continue operating, money must ultimately flow back to VC firms (and their backers). If insufficient returns make it through the full cycle, the financing spigot could run dry.

VCs aim to exit a company when a liquidity event occurs: An Initial Public Offering (IPO) makes the company publicly traded, enabling VCs to sell or exit their equity positions. An acquisition offer from another company pays shareholders an agreed price for their stock. Both allow VCs who invested early to realize returns. Before 2010, IPOs were more common than acquisitions as exit events. But acquisitions now outnumber IPOs substantially.

Previously, IPOs helped companies raise capital, build brands, and create liquidity. Today, private sources often inject $100 million or more pre-IPO, reducing the need for public markets access. Companies now utilize social media for branding and lead generation. Many enable periodic secondary sales to approved buyers, creating some liquidity.

However, public listing benefits companies selling business-critical technologies by signaling stability and longevity. It also provides acquisition currency.