Interview
Understanding Investor Terms & Incentives || Rookie Mistakes with Dalton Caldwell and Michael Seibel
- Founders should prioritize funding terms (rights, pro-rata, board control) with the same rigor as valuation and check size, as unfavorable terms can be detrimental even at high valuations.
- Investors often leverage founders' desire for high valuations and press releases to negotiate for superior terms, such as participating preferred stock or super pro-rata rights, which first-time founders may not fully understand.
- Founders risk losing control and being fired if they cede board control; using standardized paperwork and lawyers experienced in startup deals is essential to prevent this.
- Founders are advised to seek investors with a track record of backing billion-dollar public companies, as these investors optimize for massive exits rather than modest $10–$20 million sales.
- International investors often structure deals to optimize for base hits ($20M exits) because they lack experience with billion-dollar outcomes, creating a suboptimal environment for high-growth founders.
- A specific tactic involves issuing term sheets with partial funding commitments (e.g., offering $1M of a requested $3M), forcing founders to find the remainder elsewhere while creating an illusion of a secured deal.
- The phrase "come back to us when you find a lead investor" is frequently interpreted by founders as a genuine offer, but often functions as a polite rejection or a "free option" for investors to invest later if they are impressed by a third party.
- Investors who say "no" while waiting for a lead often gain the advantage of a cost-free right to invest later, allowing them to pass on the initial opportunity while maintaining a positive relationship.
- Founders face an information asymmetry similar to job candidates, where professional investors play the fundraising game daily and are adept at tying up negotiations, whereas founders are focused on building the company.
- Investors may appear incentivized to push for more funding or faster growth not solely to help the company, but to meet their own internal ownership targets or LP obligations.
- The shift from small funds and angels to professionalized seed funds has increased misalignments of incentives, as newer funds must adhere to specific ownership percentages to ensure their business models function.
- In the current market, an abundance of capital leads investors to compete by convincing founders they need more money, sometimes exploiting fear rather than identifying genuine capital needs.
- Founders should recognize that investors are selling money and act defensively by analyzing the specific incentives behind every pitch rather than accepting them blindly.
- There is a potential misalignment where being profitable without high growth is the worst outcome for an investor, whereas it may be a sustainable and acceptable path for a founder.