I always enjoy the reality show Shark Tank, where startups make appeals to a panel of well-known individual investors, seeking their venture investment. However, most of the negotiations are only focused on two deal points: how much will be invested, and what percentage of the company the investor will get. In my legal work, more often than not, these basic financial terms are already worked out by the time I get involved, and the heavy negotiation, particularly when the investor is a venture capital or private equity fund, is about special rights that the investor can obtain: board representation, veto rights over major (or minor) decisions, preferences upon sale or liquidation, anti-dilution rights, and many more.
At times, the rights sought by the investor can be pretty onerous. The investor will argue that they are necessary to induce the investor to make a risky investment. There is some validity to this reasoning, though I think it’s a bit overstated.
What if, however, a fund investor decided instead to take a Shark Tank-type approach and negotiate only the amount invested and valuation with no special rights – just common stock, no board representation, no economic preferences. (By the way, I have no idea whether the sharks on the show negotiate these sorts of rights as part of their deals – it would be too boring to describe to a network TV audience – but I’m just using the show to illustrate a point.) The approach on the part of the investor is that if a due diligence investigation shows that this is a promising venture, just give the company the needed funds and let the founders do their thing, providing advice only as requested by the company. Of course, some ventures won’t work out, but in any event the idea (particularly with venture capital funds) is to spread funds around many investments and wait for a few to pay off big. The rationale for stepping back like this is to make yourself attractive to companies seeking capital, allowing you to be more selective in the companies you invest in, hopefully leading to greater ultimate success.
I’d be curious to hear if any readers have experience with funds that take this approach. In my experience, I’ve seen exactly one example.
