What do entrepreneurs give up to VCs?
Insight September 01, 2009
Lots of young entrepreneurs in Silicon Valley these days hope to begin their business, let people know their companies, and furthermore, draw the attention of venture capitalists, who will devote money to their new enterprise.
Something that an entrepreneur must keep in mind is something that he must give up to VCs when getting money from them – most commonly stock of the new company. Generally, a venture capitalist asks for “preferred stock” from the entrepreneurs; the owner of preferred stock enjoys shareholder rights superior to the shareholders of common shares.
Most types of preferred stock are designed to convert into common stock (for example, one share of preferred stock converts into five shares of common stock), either at the discretion of the investors (voluntary conversion) or when some preset threshold is reached (automatic conversion, for example, in a public offering scenario). Thus, the conversion condition, time of conversion (voluntary or involuntary), and the conversion rate, is always one of the most fiercely argued clauses in the investment negotiations between VCs and entrepreneurs.
Of course, another major issue to consider before seeking venture capital is the loss of control of your company. When VCs invest, they want to make sure their investments are secure, so they often require a seat on the board of directors and certain voting rights. This means an entrepreneur effectively has a new boss. This can be a good thing since VCs often add experience and credibility to the company. However, this often causes power struggles between the entrepreneur and the venture capitalists.