This article continues our analysis of the “Open Source Seed Financing Documents” released by the Australian Private Equity and Venture Capital Association Limited (AVCAL). We put venture capital firms under the microscope to dispel the idea that during negotiations, venture capitalists are the “bad guys”.
1. Protecting Against Potential Risk From Speculative Investment
If a client comes to us with the impression that a venture capital fund is trying to exploit their company, naturally we will listen and investigate our client’s concerns. But as for the broader idea that venture capital firms typically seek to exploit startups, such notions are dispelled with a more informed appreciation of the commercial context in which these firms operate.
All venture capital firms want the startups in which they invest to succeed. However, more likely they will all have had at least a few investments which have failed miserably. Such is the nature of the high stakes of venture capital.
These failures can harden even the most well-intentioned venture capitalist and sensitise the firm to the potential downside of a deal. Naturally, a venture capital firm’s key priority is to protect against inherent risks in a speculative investment that in many cases is based on the promise of a founding team.
2. Ensuring Founders Act in Accordance with Agreed Expectations
Whereas founders stand to lose time and effort if their startup fails, venture capital funds are accountable to investors whose hard cash comprises part of their investment portfolio. It can be tempting for some people to label venture capital firms as exploitative because of a firm’s desire in some cases to invest funds only on certain conditions, such as retaining a high degree of control of the company. This, however, represents a legitimate mechanism to protect the wealth which they invest (up to a point of course).
Also, consider that many venture capital firms have experience not only in investment losses but also with founders who have shaken their expectations. For example, burning through cash investments much faster than expected and in unexpected ways, such as high-risk marketing campaigns which fail to bear fruit. Consequently, impacting their overall portfolio results and damaging their fund’s performance relative to their competitors and in the eyes of their clients. Ultimately the venture capitalist has capital at its disposal not to empower founders emboldened by early success, but with the goal to deliver real results, real revenue and real profits.
3. Australia’s Venture Capital Industry is Comparatively Young and Underdeveloped
The experience of venture capital firms with high risk, failed investments naturally gives rise to a desire to protect themselves when investing in a startup. In a negotiation where a venture capital firm is negotiating with a heavy hand, a founder can press on with negotiations without yielding as he or she sees fit while at the same time reminding themselves of the commercial context and history which the venture capital firm may have with previously failed startups. Template legal documents represent a suggested starting point for negotiations rather than a document designed to undermine and exploit your position.
The ultimate goal is for negotiations between investors and founders to lead to some middle ground that balances the interests of deal participants. Relationships between investors and founders will improve in many cases if founders can more fully appreciate the context in which venture capitalist firms participate and compete in their industry. If you have any questions about your legal documents, get in touch with our startup lawyers on 1300 544 755.