Careful what you wish for – setting precedents as an early investor

I suppose this about short term greedy vs long term greedy.

It is short term greedy to put onerous terms on to an early stage company just because you can. This is not about finding (or adjusting to) the right price – this is about unreasonable participating liquidation preferences (multiples thereof), too high a dilution from the get go (30%+ seed rounds etc) instead of adjusting the round size, taking key rights away from the entrepreneur or angel investors, etc. There’s a large torture tool kit folks can use if they want to.

It is long term greedy not to do that because of the compounding returns on reputation for being a fair and good to work with investor (get in to the better deals long run) + the added bonus of not screwing up the company as an investor.

But there’s another, slightly more selfish, reason you may want to ease off the torture tools as an early investor: it’s because they may be used against you come next round.

So say you negotiated a 2x participating liquidation preference (not pari passu) for the Series A – the folks leading the Series B may want that too. And if you invested $2m and they’re investing $15m you’ll have a participating $30m ahead of your $4m in the liquidation preference stack. That’s all fine if the company is a blow out success; most are not – it will hurt you, maybe badly.

Say you negotiated that you as the lead investor in Seed / Series A get to say amen to literally any kind of important decision at the company with little or no important rights left with the entrepreneurs or angels (no ‘balance’). Well guess what – great precedent. The new lead investor is going to want that too – i.e. all the power, no balance. Also to your detriment if need be.

Now, good investors that join later may not ask for any of the nasty early terms but would rather ‘fix’ all of that by correcting the terms also for the A / seed and restoring a more healthy governance. But even if they do – the reputation damage for the early investor is still significant; the entrepreneur will of course be focused on the folks that came in to save the day.

I could go on, you get the picture. You have to be careful when setting precedents as an early investor.

 

  • Freya Watson

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