Closing Your Funding Round

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Ep. #616 - Closing Your Funding Round

In this episode of Startup Hustle, join hosts Matt DeCoursey and Matt Watson for Part 20 of “How to Start a Tech Company” while they explore everything you need to know about closing your funding round.

Covered In This Episode

Now that you made your pitch and checks are being secured – the next step is closing your round. But what should you prepare for closing your funding round? How do you, as the founder, approach investors to finalize that much-needed investment?

Matt and Matt talked about how to make a pitch to investors in the 19th episode. In Part 20 of the “How to Start a Tech Company” series, the Matts discuss everything tech startup founders should know about closing your funding round. With their experience in both roles—investors and founders—they share the important steps founders should take to close their funding rounds. They also remind founders not to delay but instead follow up with interested investors before they change their minds.

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  • Introduction to episode 20 (0:08)
  • Most funding rounds die in vain (1:47)
  • Reasons why you fail closing your funding round (2:38)
  • Take it as fast as possible (6:39)
  • Don’t wait for everything to come to you (10:25)
  • How long is a funding round (14:50)
  • Term Sheet (16:23)
  • What’s on the Term Sheet (25:03)
  • Liquidation Preference (32:27)
  • Dilution (37:31)
  • Convertible Note (44:20)
  • What does closing a round look like (45:22)
  • Key Takeaways (48:44)
  • Wrapping up (51:45)

Key Quotes

When it comes to equity investments, oftentimes, you’re gonna go through a diligence process, they’re gonna find things they don’t like, the valuation could change, the terms could change the general attitude and climate towards the company. Like they just basically, in the end, they find something they don’t like, they find someone they don’t like, or they could, in many cases, find something else they like better.

Matt DeCoursey

I think my number one suggestion is, when you’ve got somebody who’s ready to send you money, you take it as fast as possible.

Matt Watson

It’s easier to get rid of your current spouse than it is to get rid of your business partners or investors. So make sure you know what you’re getting into. Get good advice. It’s worth it.

Matt DeCoursey

At some point in time, you have to realize the businesses got to grow up, right? To get to the next level, we’re just gonna have to do it. We’re gonna have to bring in a bunch of management, a bunch of board, and it’s just gonna become a different company. And sometimes that’s just where you get to if we’re going to the next stage.

Matt Watson

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Rough Transcript

Following is an auto-generated text transcript of this episode. Apologies for any errors!

Matt DeCoursey 0:00
And we’re back. Back for another episode of Startup Hustle, Matt DeCoursey, here with Matt Watson. Hi, Matt.

Matt Watson 0:06
Hey, what’s going on, man?

Matt DeCoursey 0:08
Part 20 of 52, baby. Part 20.

Matt Watson 0:15
I got a question for you.

Matt DeCoursey 0:17
Lay it on me.

Matt Watson 0:19
Aren’t you the closer?

Matt DeCoursey 0:21
Yeah, on many days I am, and at the same time, that is there. Is there another part to that?

Matt Watson 0:29
I need somebody to help close a deal.

Matt DeCoursey 0:30
It will closing the funding round and closing a deal can be different than Now technically, they’re both deals. But closing a sales deal and a funding round are once again quite different. You know, Matt, it’s it’s amazing that you happen to need this out because that’s exactly what we’re going to talk about today. Closing and funding round. Now. Before we get into that, I don’t know if you know this mat. But today’s episode of Startup Hustle is brought to you by Gusto. And Gusto is a simple online payroll and benefits platform. It’s built for small businesses. Gusto automatically files your payroll taxes and directly deposits your team’s pay. Plus, you can offer all kinds of benefits 401 K health insurance workman’s comp and more because you’re Startup Hustle Listener, three free months, once you run your first payroll, there’s a link in the show notes, go check out what they do sign up, bring some efficiency to it. So you don’t have to worry about closing your payroll round every two months. Now, Matt? Yes, I do consider myself to be a closer but you sir, have way more experience with today’s topic than I do. So where should we start, man?

Matt Watson 1:47
Um, I think we start with saying it’s hard to even get to the point to close a deal. But if you’re going to close one, congratulations, you have joined an elite club that’s actually raised capital.

Matt DeCoursey 2:02
Yeah, and let’s go back to that, because, you know, we spent quite a quite a few episodes and maybe stacked up what to some listeners might have felt like a rather uninspiring list of reality. But the fact is, is most funding rounds fail, they die on the way they die on the vine. I mean, is that and that’s why you’re saying what you’re saying, right?

Matt Watson 2:25
Yeah, I mean, most people spend forever chasing the money. And then once you catch one, you got to know what to do to close them, and how to close them. That’s a whole nother thing. So

Matt DeCoursey 2:38
yeah, we’ve we’ve talked about some of that. And then you know, last week, we’re in here talking about how to pitch to investors. And when things go, Well, you know, you might get around, you might start to see that move forward. You’re gonna go through a diligence process. Now, Matt, we talked a little bit you went through a diligence process, both with your recent acquisition of Stackify by Netrio, do you guys want to watch that whole process? Do you want to watch Matt age? Over a 20 minute video, go look, go to the Startup Hustle YouTube channel, and you’ll see it because there’s a whole process that you have to go through due diligence, a whole lot of that now, that’s hard to kind of encapsulate in the in a podcast because there’s so many different steps before we get into closing out. I mean, what do you what are some of the most common reasons that we don’t even get the chance to close the round?

Matt Watson 3:26
He had a terrible startup idea. That’s the first one.

Matt DeCoursey 3:30
But But, but no, let’s let’s you wouldn’t have had the opportunity to close it. This is more centric around, okay, now you’ve got someone interested, which here’s the thing, even when people are interested in you, and you say, Hey, we’re going to take a closer look at this, in my experience, and this isn’t just like my own deals, but people I talked to they seem to fall through nine out of 10 times.

Matt Watson 3:54
Yeah. And you and I have experienced with this, we you and I both dealt with some investors that said they wanted to invest, I said they want to do the deal. They want to do the deal. And then when it comes time to wire the money and sign the paperwork, all of a sudden they just disappear, and

Matt DeCoursey 4:10
well, they are changed or change or something changes. And you know, that’s that’s not uncommon either.

Matt Watson 4:17
And I think that goes to the level of the sophistication of the investor you’re dealing with, right? Is it an angel investor? Is it a family office? Or is it a VC fund? You know, you’re dealing with a family office and then like, oh, yeah, the family has got a bunch of money, but it might be nine brothers, sisters and cousins that have like, a billion dollars between them because their great grandmother invented something or whatever, right? And now the family office has all this money, but then you gotta get all of them to like agree to do the deal and like vote or something or then God forbid somebody in the family dies, and then forget everything. Like the family office is like in total disarray because grandma died. I’ve seen that happen. Like, that should just goes on hold, just pause, everything will be back after a few weeks. It just stuff happened

Matt DeCoursey 5:07
and, and you know a lot of this stuff to the there’s no data around it because when these things happen, oftentimes the founders and the companies that could have or would have received funds aren’t, aren’t reporting this to a central database as far as like, why, why someone didn’t want to put money into the company. And even that’s a real thing, too. So, you know, if you’re gonna get an investor that now with Angel investors now, we also raised a pretty large amount of capital, with basically no diligence process. At false on that was a different kind. But those were all like people we know, and they didn’t run. Now, when it comes to equity investments, oftentimes, you’re gonna go through a diligence process, they’re gonna find things they don’t like, the valuation could change, the terms could change the general attitude and climate towards the company. Like they just basically in the end, they find something they don’t like, they find someone they don’t like, or they could, in many cases, find something else they like better. So you know, there is, like I said, and we’re not trying to we are realists on this show people, we are just here to bring you the real story of entrepreneurship. And it’s got a lot of like, a kind of ugly, dark secrets behind it. And you know, sometimes I think sometimes reasons rounds fail is that, you know, sometimes the investor just wasn’t that sincere in the first place, they might just want to get in there and kick tires and get data.

Matt Watson 6:39
I think my number one suggestion is, when you’ve got somebody who’s ready to send you money, you fucking take it as fast as possible.

Matt DeCoursey 6:48
Try that’s like, yeah,

Matt Watson 6:51
that’s like number one thing, because you just never know, you just never know. I mean, it could be that a week goes by. And then they’re like, Well, I want to wait a couple more days and see how you finish the month. What are your numbers look like for June? And then you’re like, oh, fuck, we just turned a couple big accounts. We didn’t close a lot of deals in June. Oh, my God, we’re gonna

Matt DeCoursey 7:16
I’ve been so busy messing with you, you and this funding round that I took my eyes off the prize. But yeah, so there you go. Tip one.

Matt Watson 7:25
That’s the thing.

Matt DeCoursey 7:27
You check the fucking check, get a wire and do it. Yeah, done

Matt Watson 7:33
numbers. The numbers look good. And may, you know the first week of June, they were all excited. And then they you get like a couple days for June ends. And now like, well, let’s see how you finished June. And you’re like, oh, fuck, I’m telling you. This is what happens. It’s absolutely what happens.

Matt DeCoursey 7:48
So Matt and I mentioned we’ve had we had an issue with this. And some of it was right before the pandemic we had, we thought we had lined up about a million dollars with funding and investment in Full Scale. And then I had to leave, I was leaving for the Philippines, which slowed things down, and then COVID hit. And next thing, you know, that whole thing was off the rails. And, you know, we ended up revisiting it later. But, you know, we had the majority of our time, we had the majority of our time, effort and energy and trying to keep our business alive, you know,

Matt Watson 8:18
perfect example, like two weeks before COVID is going to happen. could assign the deal. We know we were kind of slow, slowed down and then fuck pandemic. Now what now nobody wants to do anything, right? I mean, it could happen. That’s what I’m saying. Like

Matt DeCoursey 8:31
my stock this my stock accounts are failing. We don’t know where it’s going. There’s a lot of unforeseen, blah, blah, blah, blah, blah. And here’s the thing, too, is like, when we went back around to it, it was like, well, kid, give us some financial projections. And I literally replied to that I was like I can but I mean, your guess is as good as mine. Because I’ve never been through a pandemic you haven’t done and I don’t know what’s coming. So now look, we have some tips that first off, I think that’s maybe the best tip is like, get the money in the bank, just like Hurry up, like do whatever you need to do. If you’re close to it, and you smell it like make it your priority to get paperwork signed, don’t push it off. Let’s just get it done. Because my God, there’s a million things that can go with it. All right, so look, let’s just not let’s talk about some like like little 101 kind of things. You might even be like 100 level courses, not even a 101 like so if you want to close this around and you’ve gone through this. And in the very first tip is like make a checklist for what needs to occur for your funding round to get done. And that occurs that’s things that you might need or want. And also just ask the person that’s investing you know, if you’re working if you’re getting you know, venture capital or institutional type money, grants that come like that’s another thing like a grants a form of investment, that’s a funding round, there’s going to be specific things that they need or want checkboxes that need to occur. So make a checklist, make a checklist right Oh,

Matt Watson 10:00
yeah, do you gotta be prepared, they all want to see the same documents, the same information, you gotta have a data room, you gotta have a deal room that you put all this stuff in and be ready to go. So when somebody’s ready to sign the check, you got your convertible note or whatever it is, and you’re trying to continue to get pieces of it, get all the information, ship it right over. wire me the money. Let’s go.

Matt DeCoursey 10:25
Okay, so now and you know, we I know, we’re talking about closing, but on the way up to it, like, you know, we’ve mentioned some of the things that can and could make deals fall apart. I think one of them is, like we mentioned, it’s easy for us to be like, hurry up and cashed a check. Look, you’re you’re a salesperson, at this point. And are you that means you need to have follow up. You need to not be afraid to ask them to make a commitment. Yep. Like in one of the in one of those rounds where Matt and I were talking about things hadn’t gone well, for us at Full Scale. We were, you know, and literally, I got to the point where he drags on and I just sent an email said, hey, look, we’re investing a significant amount of time, energy and focus in this process right now, where are you at? Because we weren’t, we weren’t getting the answers we needed or where we wanted. And that is actually what like, it’s sped things up. So I think a lot of people when they get an investor or an opportunity in front of them, they want to they get real quiet, and they hold on waiting for them to come back. I’m waiting for them to reply, like how have you handled that, Matt?

Matt Watson 11:35
Well, it’s always hard, and especially if it’s your friends or family and stuff like that, too, right versus total strangers, and you got people all over the board. And, you know, as we talk about closing around, you know, it’s different if it’s a small angel investment versus like a series a from a VC or like I did a venture debt round. And then we sold the company. And so all these things are kind of done totally different. And as you can imagine, there are from the least complexity to the most complexity, along that scale, a lot of angel investors, they just meet with you, and you’re like, Oh, I like that Mac guy. He seems like a smart guy. His business idea sounds pretty good. I’m just gonna give him a check. And like, literally, that’s it. That’s all they do. It’s like crazy. And then of course, I’m still a company, you go through like six months of proctology exams, that’s a totally different thing.

Matt DeCoursey 12:28
Right, and that checklist. And but that’s a check. There’s a checklist there. And that’s why, like I said, you can you can, if you can start it. And then it’s as simple as asking, you know, so that will play will play on the company. You’re the investor. Right? And let’s say you’re some institutional money. Hey, Matt, you know, thank you so much for your interest in our company. I know that you guys have closed deals with other companies. What’s that process look like? And what can I do to make it smoother, more efficient or less of a hassle for you? Do you have an actual checklist of things that I can prepare, get ready?

Matt Watson 13:07
Yeah, absolutely. But first, we have a weekly board meeting next week. Let me let me meet with them. And then we’ll get back with you in a week or two, and then we’ll send you the checklist.

Matt DeCoursey 13:18
That’s not a hot

Matt Watson 13:19
lead. That’s usually about how it sounds.

Matt DeCoursey 13:23
Yeah, but that but here’s the thing, the temperature gauge on that opportunity is mild, Mike. And here’s another thing, too, is, you know, you mentioned like quarterly board meeting. If you get on the wrong side of some of these schedules, you might find yourself that that just occurred last week. And now you’ve got now you’ve got to wait three months for it to happen again. Yeah, right. Right. Right. Yeah.

Matt Watson 13:50
Yeah, hold it. How do you get the whole investment committee together to make a frickin decision when one of them is on vacation every week?

Matt DeCoursey 13:56
Yeah. And so but that’s, that’s part of why, you know, like, like, you can’t be afraid to push a little bit, especially when it’s just when it’s just for like, reasonable stuff. Now, look, you don’t have to be an asshole about it. But hey, man, I’m trying to keep this process moving along. And with that, I just want to see what the next step is.

Matt Watson 14:15
It’s all about patient management. Yeah, right. And if some sense, you’re trying to set your own expectations, you just ask them like, Hey, can we get this finished by July 1? Like, even if they say July 3, you really don’t care? It doesn’t really matter. What you want them to do is to commit, let make them say, okay, yeah, July 3 is great. So then when July 3 comes around, if they don’t have it done, you got a reason to like, bust them for it right and give them a lot of grief. Where if you did if you never set a goal or a timeline, then it just kind of floats on and it’s hard to nail him down.

Matt DeCoursey 14:50
Yeah, and the whole point is don’t don’t sit around waiting for everything to come to you because it probably won’t. And that’s that’s the thing now you know, So in this whole process and then here’s other things that we get, here’s a new game map things we’ve said to VCs rather than things VCs have said to us like, alright, what what is what is the process look like and closing around with you guys. There you go. Like that’s it. Like another thing? How long does it typically take you to close around? Once? You know that’s, you know, it’s an investment you want to make? And by the way you do? Yeah, yeah. And by the way, the answer The answer to that question is usually really disappointing to the founder that’s asking it because man, how long do you think the normal round takes for non angel money?

Matt Watson 15:41
I would say for a normal like series, a kind of round, I’d say it’s probably 30 to 60 days, once you’ve once you’ve even got kind of a commitment. Once you’ve got the commitment, it’s still going to be some different due diligence and process and all that kind of stuff that’s still gonna go on and other 3060 days, probably. And if you’re selling a company, it’s more like three to six months.

Matt DeCoursey 16:01
Yeah. So most VCs will tell you that like, and this is from your local fund to something bigger that it’s about a five to six month process from beginning to end, and maybe more maybe on the latter side of that. It just depends on what the sense of urgency is now, well, especially if you

Matt Watson 16:23
include from the original, like talking to them and all that right. Like, I mean, if we’re talking about closing it, I mean, you’ve kind of already you’ve already got, you get to the point where you got a term sheet, and now we’re ready to like execute it, it still takes 30 to 60 days.

Matt DeCoursey 16:36
Yep, yep. So okay, so some of the other things too, is like, and this is where we’ve made mistakes in the past, like, do you even have a term sheet? Like someone’s interested in investing? Like, Matt, what’s the next step? Like? Okay, send me a term sheet. Can you explain what, like, the LOI? Like what that even is? And like, what those look like, and how those have kind of how those have materialized or blown up in front of you over the years?

Matt Watson 17:04
Yep. And so I guess at first of all, saying, we’re talking about more larger rounds, if you’re dealing with Angel investors, you really don’t usually have term sheets, probably it’s more of like a handshake and shake deal of like, oh, we have a convertible note, and these are the terms and whatever you kind of you’re in, you’re out, but you get to work out, right? Yeah, once you get a little further down with the VC right, and you’re they’re gonna give you a term sheet or an IOI, or LOI or, or whatever you want to call it. And, you know, on the sacrifice side, when we were selling the company, held, we negotiated that term sheet for like, 30 days, just to negotiating the term sheet because we’re going back and forth around reps and warranties, and this and that, and how much is the earn-out? How much is hold back? How much is in escrow? How long is it like, but we were selling the company, right? And but you can spend a lot of time just like fine tuning that. And God forbid, you’re in a competitive situation where you’re dealing with five different VCs that all want to do it and you’re kind of, you know, hit, you know, competing them against each other, and you’re going back and forth. And that’s what we did the VinSolutions days, it was like a three month ordeal of just that of just trying to get everybody to offer a little better deal. It takes a lot of time.

Matt DeCoursey 18:22
So here’s the definition of a term sheet. And this is important a term sheet is a non binding agreement meaning it’s not the deal is not done at the term sheet. It’s a non binding agreement outlining the basic terms and conditions under which an investment will be made term sheets are often our most often the source associated with startups entrepreneurs find that this document is crucial to attracting investors such as VCs with capital defined enterprises now here’s the thing is there’s a lot of work that happens after the term sheet so if you’re not even agreeing on the terms the pricing that what the the the vehicle meaning like is this is this a safe note is a convertible note is straight equity transaction, like Matt throughout a whole bunch of things like warrants and blah, blah, blah, blah. Because the thing is, is if you can’t agree on the basic structure Alright, so now let’s take this down the most elementary level, I will give you one Mark McGwire baseball card for one Jose Conseco that is a child’s version of a baseball card term sheet. Right now, you haven’t made the actual swap yet. You’re saying are you interested? Because then those are like the two worst examples but but you know, like so that’s we’re saying, Yeah, we’re talking about making a deal now in order to to get that done. Okay, so how are we going to make this deal? Am I going to ride my bike to your house or you’re going to ride your bike to my house? You know, like some of that stuff and this is important stuff because if you can’t get the basic terms in the term sheet and that stuff down, then all the other crap that needs to occur after it, don’t bother. Don’t bother

Matt Watson 19:59
that that thing is, virtually everything can change past the term sheet, right? But what you want to do is make sure you’re on the same page and negotiate some things up front. I’d say it’s no different than going on a date with a girl, right? First thing you wanna know is like, Hey, do you want to have kids? Do you not want to have kids? Do you want to get married? The mean, you know,

Matt DeCoursey 20:16
that’s a really good example.

Matt Watson 20:18
Can you go to church? Do you expect me to become a Catholic and go to church every Sunday? Like, right? Not into that, or we ended up like figuring out some of their deal breakers right away, you’re like,

Matt DeCoursey 20:29
excellent, excellent, excellent example map because they’re, like you said, there are just certain things that you’re not going to be down four. Yeah. You know, and and if you can’t get those basic things out, you’re wasting your time. Doing the other stuff past and I look, I’ve made this mistake, we’ve made this mistake, everyone’s made this mistake. No, no, that’s a whole nother we’re gonna do a different, we’re gonna do a different, okay, we’re gonna do a 520 part series on that later. And that’ll be pretty in depth that talks about startups being like an onion, meaning the further you get into it, the more you cry, that ex wife episode might might be the king of all onions. But but so here’s the thing, your term sheet when we say non binding, that’s not a contract, that’s not a deal. Those are those are the loose parameters, kind of like that, compared it to like with dating or meeting girl, like, it doesn’t mean that it’s like, Okay, here’s the basics of what I’m into, like, because here’s the thing is if one, if one person really wants to have kids and the other person does, it could be a deal breaker, what’s the fucking point? Why are we even moving forward? And then the dating process is your due diligence, you’re trying to figure out? Is this person crazy? can I manage to be around them? Do they manage their finances properly? Have they managed their finances properly? Do they have the right supporting cast around them? Am I going to be happy to be around my mother in law in five years, like all that is the same kind of stuff you go through with diligence. But if you can’t agree, if you don’t have a basic term sheet, and that stuff out of the way, you could very much you are setting yourself up for major disappointment.

Matt Watson 22:12
Well, and that the number one thing that comes with a term sheet is a period of exclusivity. And it’s much akin to the dating of like, hey, we just got engaged, we’re engaged for the next 45 days, and we’re gonna figure out if we’re really gonna get married, and exactly the same sort of thing. And that’s what, that’s the dangerous part, right, as you become exclusive with whoever the VC is, or whatever. And so if somebody else comes along with a better deal, you can’t even talk to

Matt DeCoursey 22:41
them. Right now, but that isn’t always the case. It can be the case, it depends on like, is this? Is this person writing the check for all of it? Because in that case, yeah, there may be some exclusivity, if it’s just a portion of it, be careful with that looks like it depends on who it is. And also, remember, if you if you if you enter into some form of exclusivity, you’re going to really limit your ability to create a backup plan for what happens if things don’t go now I want to talk a little bit more about some of the things that are typically on a term sheet, and what to look for. But before we get into that, just a quick reminder that taking care of employees has never been more important. And for years, gussto has been helping more than 100,000 small business owners run payroll offer benefits onboard new employees, and Morris why they call it the people platform doesn’t just look nice, it works. Your payroll taxes are filed, deductions are calculated your team gets paid. Can you even offer health insurance 401 ks and you get three free months with when you run your first payroll, just use the link in the show notes forward slash payroll once again, forward slash payroll. And you know what, thank you gussto for re upping your sponsorship with us, which is something that happens a lot in investment. Now, if you get your term sheet and all of this right, you will likely have a much smoother path when you go back to your initial investors for a later round. But when it comes to like term sheets in general, I mean, one of the very first things Matt is like, Okay, so what’s the price? Right? Like how what’s the price always

Matt Watson 24:19
the big one. And one of the companies I was just recently invested in was recently going through a potential acquisition and they kept going around around about the price and the deal and the structure and eventually they had to walk away because talk about if you can’t align at the very beginning on price, like none of the rest of it matters. And

Matt DeCoursey 24:37
Matt are always looking, I know you’re looking for a car and I have a car I’d like to sell you isn’t the very first thing you’d ask is well, what it what kind of car is it? And

Matt Watson 24:47
how much can I afford you?

Matt DeCoursey 24:50
Right and how much is it because you know, I know you’re shopping for a Tesla that I’ve got one that you can buy it’s $200,000 and then you say what, it’s gotta be there. roadster now it’s a model three,

Matt Watson 25:02
do they call it a pair? That’s

Matt DeCoursey 25:03
like, that’s fun? No. And you know, that’d be like a you need a four-pack at that price. But But yeah, so so the price is is almost always the very first thing you’re discussing. And then other things could be things like what? What format? Is this investment going to follow? Like? What’s that? What’s the structure of it? So you have things like a safe note, a simple agreement for future equity. Okay, Google, it’s a whole nother topic, you have things like convertible notes, straight equity purchases, some of them are just options to buy later. Some could be, hey, we’re gonna give you this investment now. But we want the option to buy more later at the same price. And then also, like, who’s going to control the company? What are things like voting rights? You know, like, Matt, what are the that board seats? Just like a whole lot of stuff. I mean, what are other things you’ve seen on term sheets,

Matt Watson 26:03
in early stage deals, the other one to look out for is making the founders vest their stock, sometimes that’ll come up, which can be so they’re like, Okay, I’m gonna invest $2 million in your company, Matt. But we’re gonna take all of your stock away from you. And you’re gonna vest it over the next five years. So if we decide to fire you, we can do that. And then you lose all your stock. But if you’re a good employee for the next five years, you can keep it.

Matt DeCoursey 26:29
And some of that, so my next question could be is all right, we’ll water who’s who controls whether or not I still work at the company. Now, that’s where the board can come in. Yep. Right. So, you know, like Matt, and I own together and come check it out what we do, we can help you build a development team, but we are 5050, we don’t have a board, we make decisions to like, and either we agree or we don’t. And now that said, if we brought in another investor, that investor wants a vote, they want a seat at the table, and they want to be able to say something about it. Now, be careful with this, because I, you know, some people give away a bunch of board seats for like a tiny amount of money and then find themselves really regretting it later.

Matt Watson 27:14
Or you see these horror stories where they come in and fire the current CEO, or the whoever the, you know, the founder is and stuff like that, because, yeah, whatever. And it all happens. So

Matt DeCoursey 27:26
I mean, that’s like that, like the Hollywood shit, you know, it’s like, someone builds this company. And next thing, you know, they’re out. And you hear about this a lot. Like, this is not an uncommon thing. And you say, Well, why did they fire you? Well, I mean, it could be as simple as you made a really shitty deal. And you weren’t as important to everything as you thought you are. And if you’re in if you’re in a position, so let’s just paint this picture real quick. Let’s say Matt and I, we bring a third investor in, and now the board. So I’m the CEO of Full Scale. But now the board is me, Matt and one other person, if the board controls the who runs Full Scale, and Matt decides that I’m not doing a good job and pairs up with the investor, they out vote me to One, I’m looking for a job. That doesn’t mean I don’t own my shares. But it does mean that I don’t run the company, it means that I don’t get a paycheck, it means that I need to go do something else. Well, in

Matt Watson 28:19
a good example of this, where this happens, usually is probably major changes in the direction of the business of, let’s say, we bring in a new investor, and they’re like, We don’t like your current go to market strategy, we’re gonna fire your entire sales team, we’re gonna go to this partner model or whatever, like major changes, or in the case of Full Scale can be like, hey, you know, some developers, we don’t really like that we’d rather do call center work. So we’re going to hire 500 people in the Philippines, in a call center instead. And we’re going to get rid of the software development thing, because we’d rather do the call center thing. We got a buddy who needs to hire 500 call center agents, we’re going to chase that. I mean, you just never know.

Matt DeCoursey 28:56
And that’s why we mentioned like that, you know, the term sheet. Like a lot of this is like dating, like, you know, actually, Matt, we had someone that was interested in making a pretty substantial investment, and Full Scale, and this particular investor wanted a job like, Hey, I get paid, I’m gonna get into work once a week. And and the thing was, is like, at first we’re like, Okay, this might be useful. And then all of a sudden, we’re like, Shit, I don’t think this person understands what we do or how we do it. And is that just gonna, is that going to be something we really, really, really regret

Matt Watson 29:29
and be a pain in the ass.

Matt DeCoursey 29:31
Good or bad. And you know, and that’s, and that’s a problem, you know, because here’s the thing is, once you make these deals, they’re hard to get out of, they’re really hard to get out of it. So, you know, like any there’s other things that like you mentioned, term sheets, including like exclusivity permissions, and that would mean like the company cannot enter into negotiations with other investors, while the interested parties complete its due diligence before their commitment and then complete They’re investing their investment. I think you got to be really careful with that stuff. Because okay, what I just read there, the question is okay, when does that end? Is there a timeline does this need to be done by a certain time like, because the thing is, is if you’re if you have a runway that is shortening, and you go exclusive with someone and it falls apart, you might be risking the future of your entire company.

Matt Watson 30:27
Well, and this is why you’ve always got to raise the capital kind of way before you need it. Because the absolute worst thing you can do is be against that deadline, where you’re going to hit that brick wall. And once you kind of go down the path of being a venture backed company, you’re playing the game of chicken, because you’re like, we got to raise, you know, $5 million, we’re gonna go spin it real fast. And then 18 months, we’re gonna need to raise more. Well, if you have any kind of bad month, or bad quarter or anything along the way, there, you may be totally screwed, not hit your numbers, not hit the next milestone and not get that next round of funding. And it’s a dangerous game of chicken. It really is. And you really, you got to be careful on, you know, you’re like, Oh, we’re going to do great. And then we hit a pandemic, right, like any of these things can happen. Can you imagine all the automotive industry right now is totally screwed, because they don’t have enough microchips. Like they literally can’t make cars. I mean, you just never know. But the key thing is, is having a backup plan. And always knowing what your runway is, and trying to extend that runway, and raising money before you get dangerously close to it. Because the last thing you want to do is be like, Oh, we don’t have money to make payroll in three weeks from now, and we’re desperate. Or we’re gonna have to lay off half the team, like, you want to raise the money way in advance,

Matt DeCoursey 31:47
and you find yourself doing desperate stuff, that doesn’t really bode well for the future of the business. Alright, so like a few final words, on term sheets, it’s pretty easy. Like you got to identify the purpose of what you’re trying to accomplish. Just a simple summary of terms and conditions, you want to list your basic terms. These could also include things like dividends, liquidation preference, or different provisions. Now, liquidation preference. Now explain that real quick, because this is the one thing that you can find yourself getting screwed on, if you don’t even know what it is, Matt, what’s a liquidation preference?

Matt Watson 32:27
Okay, so there’s two parts to this that are super important to understand. There’s the liquidation preference. And then there’s also if the equity is participating or nonparticipating preferred stock, those two factors dramatically changed the entire structure of the deal. So if, let’s say a stock Fi is worth $10 million, and somebody we agreed to take $3 million, if it’s a normal, preferred equity, that means they’re guaranteed to get their $3 million dollars back first, like worst case scenario, right? But if their liquidation preference is say two times, that means they’re guaranteed to get back double their money. So they’re guaranteed to get $6 million back. So worst case scenario, they’re guaranteed to double their investment. So to some degree, they may not even care so much about valuation, they’re like, Okay, fine, we’ll give you a $17 million valuation, we don’t even give a shit anymore, because you just guaranteed we’re gonna double our money, because we got a two times liquidation preference, right? That’s how you get, that’s how you get people to be more flexible on valuation, they’ll give you a higher valuation, if you take if you give them a better multiple on that. The other thing you have to watch out for is the participating preferred or non participating preferred stock. So that is similar from the sense of, they gave you the $3 million dollars. And if it’s participating or not, it depends on if they get their $3 million back, and then they still own like 30% of that company, or do they just own 30% of the company, and they’re guaranteed to get at least 3 million. So the other way they double dip, they get their $3 million back, plus they own 30% of the company, they’re double-dipping on you. And you really got to watch out for that one. That’s a huge, huge one too.

Matt DeCoursey 34:20
So if you haven’t figured it figured it out yet, having some attorneys that know what they’re doing is a pretty good idea. Because all this stuff and tell and you know, Matt, it’s like, man, I’ve known you for quite a while and we’ve had a gazillion conversations and the depth of your knowledge and understanding that never ceases to amaze me because, you know, here’s the thing is and you know, that’s because Matt’s done this a couple of times it made from exits to raising to all of it. And you know, I’ve been around it. I’ve been been involved with a lot of it, but look, unless you’ve done it a bunch. It’s really easy to miss something here and You know, Matt’s talking and that was talking about. So that’s referred to as participation rights, you talk about who’s going to be on your board of directors that’s, and then, you know, really like those voting agreements and other matters. And those might as not, those might not as much be a term sheet matter. But if you’re the CEO and the founder, or I’ll give you an example. So it’s control. Well, we own the company together. And in order to not make me have to pick up the phone every time I want to buy paper at Staples, there are thresholds and things that are set up. These are just general, you’re probably going to have to change your operating agreement and your articles of incorporation, which are the things that establish certain stuff. And if you look if you don’t, if you’re one of those people, okay, so I heard someone quote the other day, it was just talking about entrepreneurs, I was watching the Titans that made America and it was Daymond. John, he’s like, well, most most entrepreneurs became entrepreneurs, because they didn’t want to have other people telling them what to do. Yep. So but if you’re if that’s you, then you know, some of the stuff might not be for you, like it might feel very, very excruciating, and very difficult to palette. So

Matt Watson 36:12
a lot of it comes down to your company and how you run it versus how the board and the investors may want to run it. For example, you might run pretty loosey goosey on budgets, and planning and all that. But they might bring in the new board and all of a sudden, they want to approve all budgets, everything. I mean, that’s the world I live in. So now, which is a bigger company, everything is ran by a budget, every single thing where before you might have been real loosey-goosey didn’t have budgets, the concept of a budget never entered your mind. But you bring in different investors, and they want to bring in different leadership and they want you to hire a CFO. And now you’ve got budgets for everything you spend all your time planning and coming up with budgets. Like it’s a whole different world.

Matt DeCoursey 36:52
You know, I think there’s one more I think there’s one more thing we should address, because we know we’re sitting here and I know that for some of you folks, like you’re going oh my god, there’s a lot here. But guess what, there is a lot here, and we’re talking about closing your funding round. So we’re trying to help you avoid the things that are going to make you cry later. Man, let’s talk about dilution. For a second, cuz I don’t think that most people really understand it on some levels. And like dilution is a normal thing. But you can, you can hear things like anti dilution, or, you know, like, Maybe Matt, when you think about what is dilution?

Matt Watson 37:31
Well, usually when you raise like a series, a kind of round, the new investors are going to own 20 to 40% of the company, right? So you’re going to, you know, so if there was 100 shares, now there’s gonna be like, 130 shares, or whatever it will end up being, and so you own less of a bigger pie, like the pie gets bigger, right? You’re gonna get diluted, and every time you bring in new investors, you’re gonna continue to get diluted. And this is why venture debt is also a popular option as well. And we did that at stock five, we raised some money through venture debt. So we didn’t give up any equity. There was no dilution. But we had to pay back the debt. So that’s another pro and con, I had a buddy of mine call me last week. And he’s like, Well, I’m thinking about raising $5 million. I’m like, Well, what are you gonna do with it? He’s like, Well, I don’t even know. But I figure if we’re gonna raise money, we’re gonna have to raise like a big amount. If you’re like, I talked to him for a while. And eventually, he’s like, Well, we probably really only need like, 500 grand. I’m like, buddy, sounds like you should go raise venture debt instead.

Matt DeCoursey 38:32
Yeah, well, we did that and Full Scale to venture debts, basically, just like creating your own loan. And in some regards, and there’s a bunch of different ways you can do it. But, you know, part of that is, and that’s also why things like safe notes exist, because you don’t you might not know what your company’s worth. And like, I mean, I know it’s difficult to say but you know, that it’s not always a there’s not a clear cut answer. There’s not like a price guide that says this company’s worth this. I mean, this is these are arbitrary things. These are, that’s a NAFTA how many people have you had ask or bring up? They’re like, Well, what I mean, do you think that’s a good valuation? I don’t fucking know. Do you? That’s a question you should be asking yourself, do you think it’s a good valuation because the only valuation that’s good is the one you feel at least mildly comfortable with or that you’re willing to accept? It

Matt Watson 39:23
reminds me I was at the antique store the other day and they had some old GI Joes it was like $70 for this old GI Joe car and I literally just threw one in the trash and I’m like, it wasn’t worth shit to me. I wanted to go but to somebody else, it might be worth a lot.

Matt DeCoursey 39:38
Right? Right. What else are you throwing out? Man? I might stop by um, you know,

Matt Watson 39:43
I might be thrown two by fours I hear they’re worth a lot of money if you want to Yeah, no

Matt DeCoursey 39:48
doubt no doubt. I know. I’m thinking about selling my house for parts. You know, kind of like the good old carpet right or like the some of Part Two is worth more than the whole. I don’t know. Yeah, I’ll get back to you on that. Maybe we could get together and see if we could pull some stuff. Okay. So, you know, like, we could go on and on and on and on. And there’s some, you know, things that these are the basics. And this is, you know, some of the stuff like dilution is something you need to understand it’s calculable, it’s something that you can, you can, there’s math behind it. Now, one of the things you want to look out for is making sure that that your investor, or at least knowing like you, there are situations, well, you look at like the movie, The Social Network, right. And there’s that scene where Eduardo comes to visit. And he goes in to talk to the lawyers and he finds out that everybody that has stock is the only stock that diluted and he went down to like point zero 3% ownership, and everyone else said the same. That’s because he signed a fucking agreement, at some point that literally said that his stuff, he was able to be diluted, but the other stocks that the preference of the other stock, or the class of it didn’t allow for that, which meant that they created a shitload of more shares using his ownership percentage, but not there. So these are terms and things you want to look for. Really, in the end, once again, get a good get a good lawyer, because and try to find someone that that deals with a lot of us actually we’ve second associates here, Sheila sack here in Kansas City has sponsored the show before and does a lot of this stuff, including like helping other businesses buy and sell themselves to each other. But okay, so we finally got the term sheet down. Now, in diligence mat, you know, there’s really something that I learned from you watching the Startup Hustle TV acquisition episode, was that you need to have a really high amount of patience during this on some levels. Is that correct?

Matt Watson 41:51
Yeah, because it just drags on and on and on. And it’s always one thing or another, especially in an acquisition. I mean, that’s a much bigger deal than just raising a round.

Matt DeCoursey 42:03
Yeah, and now you can head into this stuff by having your shit together, have your numbers have your books, and like, I’m in luck, I’ll be the first person to admit like, Full Scale grew so quickly. We’re still like, repairing and improving and like doing a lot of that stuff, because life and business March on, but one of the things that’s guaranteed gonna guarantee to cloud your your closing or slow the process is poor financials, not having that stuff together. Your own response time is important. But when I say Be patient, that doesn’t mean like wait forever. But don’t send your financials off at 4pm on a Friday and expected answer at 9am on Monday, or the same from Thursday to Friday, like, you got to give people time to go through it. But do continue to follow up. Those are things that will get in the way. All right. So now, when it comes to the to the ground, now we’ve we’ve talked about the term sheet, and we’ve signed it, but we mentioned the term sheets non binding, meaning like if anyone wants to walk away or change terms that can still occur, right?

Matt Watson 43:10
Absolutely. Everybody can walk away.

Matt DeCoursey 43:13
So non by that wasn’t a real contract. It’s almost like it’s just a simple agreement on this is what we’re looking for. But what do you think? What do you think the percentage chances are, especially with institutional money coming in that the term sheet will change between signing the term sheet and cashing your check?

Matt Watson 43:32
I would expect something small to change most of the time, but probably nothing big. I mean, sometimes they may get nitpicky about oh, and diligence, we found this or found that or you guys said your financial plan was this and we don’t agree and blah, blah, blah. I mean, they may try and are, you know, negotiate a sweeter deal a little bit sweeter deal, but it’s kind of to be expected almost.

Matt DeCoursey 43:59
Have you had anything specific? I mean, as they’re like, what’s what’s something to really watch out for me, I think obvious a major change in valuation or structuring of shares or, or the way limini like, we don’t want to do well, we want to do a convertible note. And Matt, what is a convertible note?

Matt Watson 44:20
Well, it’s it’s a loan that has the option to either be repaid like a loan or to convert into equity at a future at a future time.

Matt DeCoursey 44:32
So that’s once again, like you talked about that. Yeah. So now, here’s the thing is what if the investor decides they don’t want to convert that into stock now you have that? Yeah, that’s debt that needs to be repaid. Yep. I had that happen, right. So you know, there you go. And that but so know what you’re getting into there. And look, once again, there are so many ways to structure Okay, let’s talk about something more exciting. So now Say we’ve all agreed, we did we did a term sheet, you did diligence, we’re going to get married. We’ve made this decision. Now how does that normally work? Because I you’ve you’ve described this as as being somewhat anti-climatic, in some regards, if it’s going well, but how do you the actual act of closing how what does that normally look like?

Matt Watson 45:22
Did we skip the four weeks of the lawyers arguing about like three words in a sentence somewhere? Yeah. So you have to go through all of that for $500 an hour. About, you know, the word should

Matt DeCoursey 45:34
be capitalized. This,

Matt Watson 45:37
though, is literally they literally argue about, like, So and so shall versus so and so will like, the littlest words, yeah, that’s all they do. But um, you know, once you get to the final day of closing, it’s easy. It’s like, it’s like a non event, you’re like, Okay, I got the DocuSign. Click, click, click, click, click Done. It’s like all this word, I did come to this climax, which was like very anti-climatic.

Matt DeCoursey 46:06
So you’re saying that the God there’s not a guy that comes in with a suitcase? That’s like, handcuffed to is his dress?

Matt Watson 46:15
No. And he doesn’t come with one of those big checks. I know how much you love those giant big checks? I

Matt DeCoursey 46:20
do. I love it. I love a big check. No other big check. Now look, here’s the thing, though, you can you can negotiate that in your term sheet if you really want. I am not willing to be paid through any other methods and to check that it is at least three feet tall by six feet wide. That’s what term sheets do. If you’re that’s really that important to you. That’s how it works now. No, I mean, typically, like you said, it’s either an in person thing, and you just go sign something and usually not all together, you sign it, they sign it, and then what happens now, like, what the next day, then within the next few days, then there’s more money in your bank account.

Matt Watson 47:02
Yeah, usually that day or the next day, you get the funds. Like in the in the metro world, we actually had some, like, the investor had to give the money to the VC and then the VC had to send the money to us. And there was a hiccup along the way. So it slowed it down a couple days or whatever. But you know, at that point, it comes very anti climatic, you’re just like, Okay, I did all this shit work for weeks, and then I DocuSign to my digitally sign my name today. And that was it. And then you’re just nothing.

Matt DeCoursey 47:34
Right? And I’ll never forget you the times that you’ve talked about when you sold your first company event solutions, which was a huge exit. Just like you just literally describe that as anti climatic. Like we signed some papers and the next morning at a bunch of money in my bank account. And I was like, Oh, okay. So that’s how that works.

Matt Watson 47:59
So it’s a different number on the screen. Other than that, everything’s the same.

Matt DeCoursey 48:03
Yeah, yeah. And you stay and you went to work, because you still work there, because you had an urn out. And those are different things. All right. So we’re gonna do the founders freestyle in a second. But once again, today’s episode Startup Hustle is brought to you by ghetto. If you run a startup, or you have to you gotta try gusto payroll, just to put you can deposit paychecks file payroll taxes automatically. Plus get employee health insurance, onboarding, expert, HR and more. You’ve even got three free months when you go to Forward slash Startup Hustle once again, forward slash Startup Hustle, there’s a link in the show notes. Matt, let’s we’ll go quick here, because we’ve covered a whole lot of ground. I mean, what’s the bet? What are your takeaways or your best advice from today’s show?

Matt Watson 48:44
I, I have not tried to go full Erlich Bachman on any VCs, I don’t really recommend that either to close a deal. But if you want some good entertainment,

Matt DeCoursey 48:56
you mean whip it out and put it on the table. Putting it all

Matt Watson 48:59
on the table. I don’t really recommend that. But if you want some highly great entertainment around closing deals, definitely watch Silicon Valley on the HBO show. It’s pretty hilarious. And, and it really they talked about a lot of these same topics we’re going through, they go through them and it’s kind of funny, but it’s entertaining.

Matt DeCoursey 49:19
I mean, overall, I’m gonna just remind everyone that there are so many resources on the internet. You know, like if you run into term clauses, you can look up what they are, but really in the end, don’t pretend you’re an attorney when you’re not. You know, like if this is I mean, if it’s if you have big, big money, changing hands, and remember, it’s easier to get rid of your current spouse than it is to get rid of your business partners or investors. So make sure you know what you’re getting into. Get get good advice. It’s worth it. And you know like and While we did say, get the money in the bank, as soon as you can at the same time, like, if you can afford to, you know, don’t worry about getting that done in two days, either, you know, overall, when it comes down to this, like, you know, get good advice, really try to understand and know what you’re getting into both from like, who is invested in you to how that control matters. You know, like me personally, like, I don’t really personally want a board telling me what to do every day, all day, every day. Now, am I willing to make that sacrifice? Yes, but it comes at it at a certain amount of investment that I have yet to define. You know, and I think that that is fair, you know, so at what point you know, if you need the money, you want it, you might not have a choice with that, but you just got to kind of decide what’s good for you the VA a fair valuation, and a good valuation is one that you feel good about. And remember, most of the time, both people don’t leave in negotiation happy. Let’s see, you may gonna have to give a few things up. And you might have to make a few concessions, you just got to think about how bad you want all of it, whether you’re willing to live with that, and do you feel comfortable with it, I mean, now that I leave anything out?

Matt Watson 51:20
At some point in time, you have to realize the businesses got to grow up, right? It’d be even with Full Scale, we get to the point where like, we grew this thing it’s doing 50 million a year in revenue are like to get to the next level, we’re just gonna have to do it, we’re gonna have to bring in a bunch of management, a bunch of board and a bunch of, and it’s just gonna become a different company. And sometimes that’s just where you get to, you’re like, if we’re going to the next stage. Well, we have to go through

Matt DeCoursey 51:45
Well, and you know, and just a follow on to that, like, you’ve heard me set it an actual table and tell people that like, hey, if any point arrives, and I realized that I’m not the right person to run this company, because it, it grew past my ability or understanding your interest. I’ll be the first person to tell you that because you got a vested interest in it too. So you know, anyway, just keep keep be patient, be patiently impatient. Keep the process moving, stay organized and do anything you can to just be out in front of the things that can or could get in the way. So, Matt, I’m off. I’m going on vacation, Dude. I’ll see you when I get back.

Matt Watson 52:26
Dang, can I go with you?

Matt DeCoursey 52:28

Matt Watson 52:29
Shit. Alright, fine. I’m getting back to work.