.svg)
Hard clauses in a term sheet
On today’s episodeAvnish Bajaj, Founder & Managing Director at Matrix Partners india, & Sudipto Sannigrahi, VP at Matrix Partners india, dissect the Hard clauses in a term Sheet.
Sudipto:
Hi, everyone. Welcome to a very special Matrix Moments series that we’re doing today. i’m Sudipto and i’m part of the investment team at Matrix Partners. And as you can see there’s a lot more color today in our Matrix Moments than it usually is. And the reason behind that is we’re in Goa for our annual offsite and over the past few days we’ve been discussing and debating on multiple different topics from investing, term sheets, on about becoming a VC, not becoming a VC. And we thought we’ll get all of these together and share it with our viewers and call it the Goa Brew series.
So welcome to the Goa Brew series. So, hi, everyone. in this episode we will discuss about hard clauses in a term sheet. We have Avnish with us and as early-stage investors generally we’re always on the same side of the table as the founders are other than the time when we’re negotiating a term sheet with the founders. And Avnish and i were discussing actually about one particular company a couple of days back and we realized that a lot of these terms are actually for the benefit of the company outside probably the commercial interests of the investors, the commercial right, all the terms sometimes also benefit for the company which sometimes it gets lost while discussing with the founder.
And i’ve seen Avnish discussing with me and saying that if i were a founder i would do it this way. And we thought it would be good we bring some of those points in front of our viewers so that we can also explain why some of these clauses are there in the term sheet. So that’s a little bit of the context. Thanks, Avnish, for taking the time out.
Avnish:
Thank you. For those who don’t know Sudipto by his pet name at Matrix, we call him Dada. He suggested this and you know we have this series called the Goa Brew series so very excited to be here, Dada. You said i say that i think like a founder because i was a founder and honestly there are two, three things that i have learnt in this business after starting as a VC and now i’m going back to my founder roots and i find it much easier to bridge that gap for myself and for the founders.
And, you know, one of the things that founders should realize is that it’s a asymmetry of information business. When we give out a term sheet, when we’re investing the reality is we know 20 percent of what we should know, founder knows 100 percent. Often in a term sheet a founder expects symmetry, no, wrong assumption. And i’ve been a founder, i’ve expected symmetry and then i’ve realized but i have all the information. i don’t need protection, the investor doesn’t have the information, they need protection.
So it’s an asymmetry of information business, it’s your company, you know the most, the investor needs protection, you don’t. And as we go through it you will see over a period of time some of that changes. So that’s one. Second is one of the things to remember both for founders and investors, i used to stumble over it, i see founders stumbling over it even now and investors.
You don’t make money on terms. You make money on getting into business in the right company. i know as a VC we have increasingly moved towards that viewpoint, terms matter because they’re rules of engagement. Okay, and having rules of engagement is very important in any engagement. But money is not going to be made or lost basis that, and i think if a VC keeps that perspective and the founder realizes that the VC has that perspective some of this is easier.
And final point is at Matrix also with this i remember when i started i used to think of every edge case. There are two contra points here, one is legal agreements are about possibilities not probabilities. What happens is when you’re discussing those edge cases and possibilities it makes people question intent specifically the founder questions the VC’s intent. We’ll talk about event of default. it’s not that we’re expecting you to default but it’s a possibility. if it is all going to be on trust why have a legal document.
So that’s one thing to keep in mind and third and the final point to that is the reverse is we believe that things should be moving to market terms and increasingly, you know, we’ve been in discussions. You see me saying it to our law firms what is market, i don’t want to get anything that is better than market, i don’t want to give anything that is worse than market. Let’s all play by the market rules.
in the US the National Venture Capitall Association has actually taken out a lot of the clauses and made it very simple. We as VCs tried to actually do it 2-3 years ago, we couldn’t reach agreement. Kabhi na kabhi ho jaiga, but until it gets there you have to realize that everybody has their few sensitive points but nobody is trying to make money by screwing the founder or vice versa.
Sudipto:
Yeah, and i think as early-stage investors we only make money when the founder is successful, we don’t make money when the founder is not. And given we’re founders first and obviously talking about the founders so let’s start with the founders reverse vesting, right, our shares, investor shares don’t reverse vest so why should founders’ shares reverse vest, that’s one. And should it be reset to zero when the first round of investment is happening or say the founder has run the company for two years so it should start with 20-30 percent. So how should the founder think about it?
Avnish:
So in a lot of these -- Dada, i’m going to give you non technical answers. We’re putting money, when does that money go in, at a moment in time or over a period of time?
Sudipto:
Moment in time.
Avnish:
Founder is putting in sweat, when does that go in, at a moment in time or over a period of time?
Sudipto:
Period in time.
Avnish:
Answer is right there, why should we be vested and why should founder be vested. Because the sweat is not there yet. You haven’t earned your equity. i had reverse vesting when i started Baazee. Now typically what the founder and some of this i think will come back to bite us if a founder sees this. What i think if i was a founder i would say is how many years i’ve been doing the business. if i’ve been doing the business a few years you’re investing in a certain stage of my business then vest me 20-30 percent upfront. i think that’s a fair ask.
i think you would see that in any of our deals somebody asked that we will say take it. Now the contra argument is when a new investor is coming in, let’s say we’ve invested, these are -- you can pre vest 20-30 percent. The poor new guy has not seen all of that work. So they sometimes will want the clock to get reset. So there is no black and white answer here.
it’s a gray area, i think fundamentally one side should vest is very clear, one side should not is very clear. How some of that plays out is a nuance of the business, what is the stage, how much time has gone in. That’s one side of the argument. The other is always remember what founders don’t realize the repeat founders do. i have had a repeat founder tell me i didn’t put reverse vesting in the term sheet. i’ve had a call saying apne reverse vesting kyun nahe dali, i said because most of the time it gets negotiated, i respect you a lot. if i have to worry about you running away then i shouldn’t be investing with you. He said, nahe nahe, bohot important hota hai, agar meri reverse vesting nahe hai, tou mere sab co-founders ki reverse vesting hoigi. Co-founders ki reverse vesting hoigi, koi choud ke jaiga, wo equity hamare pass wapas aai gi. so that’s the part that founders don’t realize that this is actually a -- i know, Dada, you’ve made this statement before and you should add to this, think company first. it’s not investor first or founder first, what’s best for the company.
Sudipto:
Yeah, yeah, fair. And a lot of the terms that we’ll discuss today, right, if we keep the objective of what is right for the company versus what is right for a single founder i think most situations will be amicable. And the company generally is the constituent of multiple different founders as well. Now moving from reverse vesting to control and who should control the board and typically when we invest say in seed or series A it’s a founder dominated board. But as more and more investors start investing typically the board switches from founder dominated to investor dominated.
How should a founder think about it?
Avnish:
Like you know, this is where you will say that when you’re negotiating i tell you to do something else but what i’m actually about to say is something else. i don’t think it matters, i think in india companies are not run by boards. Boards are rubber stamps, i was just talking to a founder where i know we’re supposed to advice that when a new investor comes in another investor seed goes up, founder should not increase their board seats. i advised them exactly the opposite.
i said you want to keep board control keep board control. indian companies are not, until iPO, until much later stages they’re not run by boards. They’re run by SHAs and i know we will come to investor thresholds and stuff like that. As a founder what’s in the SHA in terms of voting thresholds is far more important than who is controlling the board. Because the SHA overrides the board until the board overrides the SHA which only happens at iPO. When you convert your stock and it becomes a board governed company it’s all irrelevant, so to me it doesn’t matter.
i know now some founders will see this and they’ll assume that it’s a founder controlled board for the future. i’ll tell you as a founder how i would think about it. Ultimately today the founders who are starting they want to take their companies public they’re not looking to sell. As you go through the journey, as you start thinking about iPO i would actually personally want to transition from a founder controlled board to an independent board, not to an investor controlled board. And the way to make it independent is equal seats between investors and founders and independents appointed by concurrence of both or each appoints one which kind of makes them loyal to one side or the other.
So i think people should increasingly start thinking iPO backwards, for the transition from founder to investor controlled i don’t worry about. if it is very important to founders i let it go, personally i don’t think it matters because i think the company is run by the SHA.
Sudipto:
Yeah,
Avnish:
And that’s where the nuance lies.
Sudipto:
And then we’ll spend a lot of time for the investor majority in AVi but before we do that a couple of more things that we generally discuss with founders. One of them is ESOP pool, right, when there are multiple co-founders, they’re starting up, everyone has 20-25 percent equity but as early-stage sort of investors we still generally advise them to have a significant ESOP pool. A, why have the ESOP pool and B, what’s a good benchmark at sort of inception.
Avnish:
Yeah. i mean who was telling me -- one of our companies where funding round is not announced yet, well, Ofbusiness we can talk about openly. So he prides himself, i don’t know what the number is but it’s something in the tens, maybe 50 or 60 dollar millionaires on paper. The company i was just thinking about the first thing he said after he got a term sheet at a good price he said, aapko pata hai 50 crorepati bangai hain, that’s why you have ESOP, otherwise wo kase banenge crore pati.
And ultimately companies are built by teams and organizations, there is also you know, we talk about internally about digital nation-building but also about the wealth creation. Narayan Murthy actually started this in india, i could argue even before that Dhirubhai Ambani started the equity culture, infosys was the first organization that went deep in ESOPs, made a bunch of dollar millionaires. So i think it’s a no brainer.
Actually the issue is a little bit that in india it’s not appreciated enough, didn’t used to be appreciated enough. Founders were trying to say 7 percent, 8 percent. US is standard 20 percent, early stage 20 percent. So in my view it depends how many co founder you have because what we’re trying to solve for is the key pillars of the organization owning enough. if you have three or four co founders maybe you can have a 8-10 percent. if you have one founder and one co-founder you have a 20 percent because you’re trying to think about size of the pie not the slice of the pie.
The other piece which actually we cover in other podcasts but just to finish it here is at some point depending on the seniority stage of the company you move from thinking about percentages to multiple of CTC for the person. in my personal view somebody whose joining at ex CTC assuming they stay with the company 5-6 years and company does well should make 5-10 times their CTC. 5-10 times CTC is very different than making 5-10 times your salary by staying somewhere 5 years, A because that is likely to exceed but B it’s capital gains.
And you have still made the salary in that time. So it just accelerates so i think that’s the purpose of it.
Sudipto:
And probably the line that was most interesting was size of the pie not slice of the pie and as founders also and when we talk to early stage founders, right, early stage founders are also looking for employees who come with the founder mentality, who think of themselves as founders and for that to happen they need obviously the ESOPs and the equity.
Avnish:
You know, you said something so you know we talk a lot about experienced founders in our portfolio whether it’s Anurag of OneCard, Ashish has all the characteristics of our business, Revant, Jiten, like there are so many, Amit Lakhotia. You know, what’s common in them? i don’t necessarily agree with this, but they don’t pay them their last salary. They don’t pay the key people their last salary, they want people with 30-40 percent haircuts to salary because that tells them they’re really -- and by the way then they will give them co founder titles.
Sudipto:
Yes.
Avnish:
And then they will give them tonnes of equity. i think that’s brilliant culture-building although i think this 30-40 percent lower is unnecessary because people get used to a certain lifestyle typically and you don’t want to -- but i like the concept.
Sudipto:
Fair. They’re essentially converting agents to principals and i think that’s the point.
Avnish:
Yeah.
Sudipto:
Moving on what about founder top-ups in ESOPs?
Avnish:
it’s a terrible idea.
Sudipto:
it’s rare in the US but reasonably common in india.
Avnish:
it’s a terrible idea, it’s bad behavior taught by all investors including people like us but more by later stage investors. it’s used as a tool to divide and conquer. They will say, later stage investor will say take this valuation which may be lower than what the company can get. i will make you up in your dilution by issuing you ESOP. What about my valuation, other people’s valuation. And i was debating this with a founder and you know, it’s hard for me because he said, sir apko milti tu aap nahe lete. so i said i don’t know, i probably would have.
So i said but the difference is i may not ask for it. So his counter was it’s my job to ask, the other side can say no. The problem is in current circumstance the other side is not saying no. And i think at some point it’s the founder’s job to not ask. And they’ve to stop asking for these things, they misalign incentives, people remember generally.
Now there are situations where the reality is if a founder’s wealth got diluted a lot is it my fault, is it the investor’s fault. No. There are situations where you can have a founder who’s done a great job but market circumstances, competition, something or the other they fought but they just got diluted a lot. i have some empathy and sympathy for that. But usmein kya karna hai performance linked.
Sudipto:
Yeah.
Avnish:
And it has to be value creation linked, not any business milestone, nothing and generally should be exit linked. And you know, in the recent iPOs there’s a lot of talk about the founders getting issued new ESOPs. Lot of them are at 2x, 3x, 5x the prices. Yesterday i sent you guys an article on Elon Musk becoming the richest man in the world. Guess what he’s become the richest man in the world actually through MSOPs because he took zero com, he had this big package he signed on 3-4 years ago which sounded crazy at that time.
That if Tesla became $700-800 billion or a trillion and Tesla may have been 30-40 billion at that time. So with that kind of wealth creation is happening should something go back, yes. But the problem is there is no nuance to this, ye default hojata hai, ke maine 100 million se 200 million valuation kardi tabbhi, clawback, 100 million se 2 million kardi tabbhi clawback, that i don’t agree.
Sudipto:
That i think also sometimes the situations where probably the multiple co founders and in the beginning one co founder may not have had enough amount of equity and essentially probably that co founder is driving the company. Then the board comes across and thinks to sort of --
Avnish:
And by the way i’ll tell you one thing, if you look at public companies in the US, more in the US because in india public companies have tended to be more promoter run so independent boards never existed. in the US the CEOs even if they’re founders typically do get topped up every year in stock grants. i mean if you look at Sunder Pichai and Satya --
Sudipto:
i was about to say the same, Satya Nadela.
Avnish:
i mean they’ve become millionaires on the back of stock issuance, that’s also MSOPs. And one of the founders told me -- when he said it i didn’t like it but then i thought about it and i agree with it. He said what is happening is if the owner, the founder is also the manager then it’s assumed that they already have. But if a professional is coming to manage the board happily gives. So i think there is something for the boards also, this is where by the way board matters, not in all the other stuff.
This is where a good board, a comp committee having -- it is by the way in our companies i think you’ve seen this. i make sure that by Jan or Feb we’re discussing the compensation package of the founders before they bring it up. So i think part of it is also the responsibility of the board and the investors, don’t let them bring it up. But right now its 70:30 the other way.
Sudipto:
So from founder MSOPs the founder is going to accrue and own more. Let’s talk about founder liquidity basket where essentially they want to sell and encash. What’s your thought on that and how to think about it across stages?
Avnish:
Yeah, you know, it’s scary but i can paint one i noted this down. i could paint one situation where a founder raises a tonne of money they’re huge investors but does secondaries along the way because you’re saying that should be allowed also. Starts angel investing, makes more money in these other companies, i mean it’s ridiculous. Where is the alignment of interest? You’re asking for top ups and you’re liquidating at the same time, it should be one or the other.
Sudipto:
Yes.
Avnish:
But again it’s today accepted. Personally if you ask me i am in favor of secondaries, i believe because i was chasing my first million dollars i believe people chase their first one or two million dollars. i think you should get that out of their system. So some of it is what percentage of ownership, some of it is what how meaningful to lifestyle. And to me if it’s 2, 3, 4, 5 million dollars, somewhere in that range and if it is in the 5-10 percent of their ownership. So obviously that means some value has been created, i think it should happen.
i think people get a second wind, they get actually more fired up, they become hungrier. One of the founders who i think is along with his co-founder going to be worth a billion we were chatting the other day and he’s like i’m more driven, i’m hungrier, i want to do this i want to do that. That also happens and you see that with the Elon Musks and the Bezos and all of that. So again cuts both ways, so what are the rules?
Modest, one time, should not keep becoming an ongoing thing, ideally should not be the one who’s also asking for MSOPs, should be a significant lifestyle change and then your judgment call that this founder is just going to explode. i think it’s a balance.
Sudipto:
Fair. Very interesting. The next one rule is one of the trickiest ones, this is around cause and the impact of cause on founders. So we have reverse vesting, the founder is on the board, but when cause gets triggered essentially the founder loses his vested shares more often than not they --
Avnish:
Explain what cause means, maybe just for everybody like what are the different triggers in an employment agreement. So first of all founders sign an employment agreement with the company.
Sudipto:
So essentially either a founder can be asked to leave without cause or with cause. Cause typically is -- generally it’s a very high bar of cause but cause essentially fraud or misrepresentation. That’s broadly what cause is and if cause is triggered because of which a founder needs to leave the company they have to essentially let go of everything that accrued till then.
Avnish:
Yeah. But you know what happens is and including in our documents maybe 3,4 years ago, 5 years ago, investors used to be too cute and they used to make cause so vague that it could be interpreted to be performance. it could be something random like you made a mistake, you were driving a car you have got into an accident, there’s an FiR against your name and your company is gone from you.
So i actually stepped into this one both with our lawyers and with the founders and i thought about again what would i want, what is fair if i was a founder. And to me if i’ve committed fraud i’m done. But allegation of committing fraud versus committing fraud is two different things. So the way i think we are now able to structure and like i said before a lot of these experienced founders are very sensitive on these things. i think that we’ve reached convergence is separate the trigger from the consequence. Trigger, make it as tight as possible. And i advise the founders also. First of all this framework i tell them openly and say make the trigger so whether it is -- see it depends again on the stage of the company. But it should be something that is provable or proven, not just FiR is filed, court case chal ra hai, kuch level of finality honi chaheye. So that is the trigger. if that final trigger is actually hit our trigger, consequence is you’re done.
Sudipto:
Now moving from founders to a little bit on investor rights, right, and as Avnish you mentioned before in india it’s not board dominated it is SHA dominated. And the most important part of that is investor majority and then AVi right’s linked with investor majority. So first what is investor majority and what’s the right processes.
Avnish:
Why don’t you explain how this works first like what are we discussing right now.
Sudipto:
So if you look at a typically SHA in india you will have this concept of investor majority which is all major investors and there are thresholds, 3 percent, 4 percent, 5 percent, owning more than that, so they constitute the investor majority. They constitute the major investors and when a percentage of them constitute the investor majority that could be 50 percent, 60 percent and some of that which we’ll discuss.
Now the items which are reserved matters or AVi items and if a founder essentially needs to do any of them across the AVi items they need approval from the investor majority. And that’s how essentially all big decisions in early stage companies are taken, so that’s the construct for it. Now the question is, A, why investor majority why not all investors? And, B, what’s the right threshold for the investor majority.
Avnish:
Yeah. So two, three things, first, founders will say why aren’t we included in the investor majority. So there we go back to point number one, it’s asymmetric, it’s your company, we’re the minority, we need protection.
Second, should only be major investors, second criteria. So first it won’t be common stock holders, it will be major investors so not everybody can do some gamification, bring some group together which by the way you see it’s in the front pages of newspapers today about public companies. Some investor group doing this, you don’t want any of that, so major investors. That’s the second threshold.
Sudipto:
And people vested in your, because people have been there not for only financial reasons but have probably put in enough amount of effort for the betterment of the company and understand the business.
Avnish:
Yeah. And so the concept is that large group that is very invested in it both monetarily and in terms of time they should be able to drive. Now what is the alternative, the alternative is in series A when we invest we have the veto. in series B by the time we come to series B both have the veto, when we reach series C sometimes we say two out of three. By the way at that stage itself my advice to founder is no two out of three because two out of three, because two out of three ke baad four out of, it doesn’t work.
At that stage itself i recommend now reach investor threshold, what does that mean? it is either simple majority or super majority. Simple majority is greater than 50 percent of the investor voting together as a class. Now all of this can get fairly complex, as companies become larger and larger and have series H, i, j, K things, incentives might change. So some of the most stringent ones will have investor majority by series. Okay, that’s almost like an individual veto but it happens and it’s a terrible thing for the founders. But overall all investors voting together as one class simple majority or super majority.
Super majority of 60 percent, two thirds and 66 or three quarter 75 or 80. i think this is one of the most important clauses for the founders. They should not be worrying about board composition, they should be worrying about investor composition. When i design it as an investor in a company i actually think about and i’m giving the secret away, i actually think about who’s likely to vote with me and i give a number where i know i can hit that threshold. it’s the founders’ job to figure out who is likely to vote for me and how do i make sure that that doesn’t happen.
Right, so we actually have -- actually lawyers will do this, they will say 60 percent these blocks can get it done. Founders often don’t realize that that’s what is happening at the investor’s rights and I think the founders should. This is much more important than anything else.
Sudipto:
A, I think Avnish is making my job of monitoring term sheets extremely difficult but moving from investor majority to AVI rights and that’s probably the core of essentially how all last decisions are taken. Sometimes founders don’t want to run around for all small things like ESOP grants, hiring, finding a KMP and essentially ends up becoming a bottleneck for them. So what should be part of AVI and what should not be part of AVI?
Avnish:
Yeah. Just going back to your comment on making life difficult actually the objective is the opposite, Dada. I had like we’d started off saying money is not made on terms.
Sudipto:
Yes.
Avnish:
If in the future we can reach a situation where we send this podcast to people and in seven days the deal is closed, you’re done. Life becomes so much easier because the reality is we’re giving both sides over here. Now so coming to this, look, initially not worth discussing. There will be 20 AVIs, you don’t have the negotiating leverage as a founder, it is what it is. It sounds much worse than it is in reality. You were telling me most of it is on e-mail, why do people even worry about it.
So initial stages there’s not much debate and by the way this is separate from the thresholds we discussed. The thresholds decide who gets to trigger, this is what gets triggered. Now as companies scale and this is where I was just advising another founder how to handle this there are three types of AVIs. There is economic rights, there is governance and there is operating governance. In economic rights are generally around what affects my shareholding, no one can touch it. Founders should not try to move it into a threshold, I’ll never allow another shareholder to vote on what should happen to my liquidation preference.
So when it comes to these it’s typically almost individual veto or it will be that super majority threshold. When you talk about governance should a company do M&A, should it go public. I could argue that it affects my shareholding but it also affects a lot of other people. It’s not targeted at me personally or Matrix, right, or one investor. I think that moves to some other threshold which is lower than almost an individual need and then you get to operate it. By the time you have reached this level of capital raise if you ask me I think the company has only reached that because they’re doing well.
I don’t like to have -- you know, I like to keep operating governance very, very loose. There should be an annual budget, very simple, on the annual budget there should be a x deviation percentage from annual budget. I don’t even like to say it can’t take loan more than this. If it’s in the annual budget you can do whatever you want because it’s our job as investors to then check that annual budget and make sure we’re comfortable. Other than that for simple annual budget deviations from annual budget KMP it’s a controversial one, I don’t care.
I think I care about ESOP issuance beyond a certain level, above 1 percent or something. If I don’t trust the founder in hiring somebody why am I even doing that.
Sudipto:
And I like the fact that you brought the point of trust. I think it is finally information asymmetry. At the beginning both the parties are trying to trust, I think companies which are mature we never even discuss about this because there’s a level of trust that’s already built where you know the founder will do right by the company.
Avnish:
Yeah. No, so I was just in a board meeting before this where the last slide was ESOP issuance and it was 2 lakhs, 3 lakhs and I asked the founder like why are you showing us this. He’s like because it’s in the SHA, I’m like, damn, it shouldn’t be in the SHA.
Sudipto:
Good. Block on sale to companies.
Avnish:
Yeah, this is my favorite one, Dada, and I put it in here. I think this gets negotiated the most. And do you want to explain the clause or should I just keep going.
Sudipto:
Keep going.
Avnish:
So this is I’m a founder, I don’t want you to sell my company to the competitors, fair. I don’t want you to sell your stake to the competitors I’m not sure it’s fair. So it needs more nuance. Now typically founders will say you can’t sell, I just don’t think that’s fair. You know, ultimately if the company if I have to remember one thing and we were joking about this before. I think the simple contract between founder and investor should be founder should say to the investor do not mess with my company and investor should tell the founder do not mess with my exit. This is messing with my exit. I should have all possible exit options.
Now, what is fair? I think giving founders some time before you’re allowed to do this is fair. Two years, three years founders will say till exit period. Boss, then we’re all the way 5-6 years, maybe you’re not creating any value along the way.
Sudipto:
And then block on sale to competitors anyways still exists, after exiting it falls away so it doesn’t matter.
Avnish:
Yeah. So then there is a question, do you have a block or -- I’ll give you a right of first. They’ll then say give me a right of first refusal. It’s not fair because if you give a right of first refusal you can’t exit because nobody is going to -- people know the price can be matched so it’s a right of first offer. So what is fair? This clause should be in favor of the investor not in favor of the founder. Okay, because investor needs that exit.
I think there should be depending on context of the company a 18 month to 3 year period where you’re blocked. After that you’re allowed with a ROFO and in that first 18-24 months also or whatever that number was you’re blocked to a very small named list. You can’t just block me from anybody. You tell me who do you think is competition today, two or three people, okay, fine, I can’t sell. After that I’ll give you a ROFO after that exit free.
Sudipto:
Fair. And I think similar to that is exit and the investor’s right to drag, I think the answer is very similar.
Avnish:
Don’t touch. So the issue is founders say you can’t drag other investors, you can’t drag me. How will I sell the company and incoming buyer wants to buy 100 percent of the company. So I just don’t think -- negotiate the exit period, don’t negotiate what happens after the exit period.
Sudipto:
Which is fair and very reasonable. The founder should have multiple shots at the goal but after that obviously the investors should get their right to exit.
Avnish:
Yeah.
Sudipto:
Let’s quickly maybe cover investor tag.
Avnish:
I don’t even know why it’s here but sometimes other investors, founders will say if you’re selling I can tag other investors. This is just -- these are actually clauses that are nonstarters. These are the nonstarter but its don’t touch, these are things that affect an investor’s exit. Nobody can tag when the investor is exiting because it increases the amount the buyer has to pay, there’ll be no ROFO or ROFR anything on the shares that they were investing because again there’s asymmetry ask. Because we have ROFO, ROFR on the founder’s shares, they should have ROFO -- no.
We have invested in your company so these are like non starters where sometimes I think people just waste too much time. Event of default it’s a possibility it needs to be there to make the document complete, I’ve never seen it triggered. So I just think it’s one of those that founders should say it looks ugly, make sure that trigger is very, very narrow but I can tell you that in my 15 years it’s never been triggered when the going was shitty. So now that the going is good I’m hoping it will never happen.
Sudipto:
Fair. Maybe let’s go to legal fees. I think financial DD and legal DD fees also ends up within negotiations.
Avnish:
This is a shoutout to Archana and Rajaram legal because they wanted it to be included. And you know the point they made actually resonated with me. I would also as a founder really I hate paying lawyers, I mean much as we love Rajaram legal. The point she made was if you’re going to pay me very little please recognize that we’re billing rates I’m going to staff the cheapest resource that I have. That cheapest resource is not empowered to make decisions therefore things will drag on longer, therefore the time is dragging on and ultimately I’ll have to jump in with a bigger mess and that kind of resonates.
And so maybe we’re all being penny wise pound foolish. There’s a range, you know, sometimes I see foreign investors the big funds, 100, 000, 150,000 and founders pay because they’re putting in that much money. But in the 10, 15, 20, 30 lakhs range which is our playfield I think these are --
Sudipto:
Fair. And it’s speed versus cost.
Avnish:
And quality.
Sudipto:
Yeah. Final question I think this is hopefully 2021 is the beginning of IPOs for India and most of the founders starting up today are all running their companies must be thinking of IPOs. So how should one think about terms upfront keeping a IPO in mind.
Avnish:
I wouldn’t worry too much about it. See, the SHA dissolves, we have to convert. This is something the founders shockingly don’t know. The first step of becoming a public company is you dissolve the SHA, we convert our stock into common. All the stuff that we just talked about goes away, right, so focus on getting the company to be public to go public rather than all of this. I’ll tell you the only clause which has become something that founders and investors wrap themselves around which I think is a waste of time.
SEBI allows a company to go public based on either a professionally managed company or designated promoter, who is designated as the promoter. Investors try to get cute and that requires 20 percent of share. Investors try to get cute and say we will not get locked in as that promoter. And the founder says what if I’m below, and this negotiation goes on forever.Arey boss public jou, ouske baad decide karenge. Everybody has a lot of companies going public, we have two companies that are going public this clause didn’t get discussed, it just fell into place. Thoda sa jota hai, because 20 percent is required for lock ins so now as an investors are you locked in.
But interestingly in one of those companies the largest shareholder wants to sell the most and the shareholders like us want to sell the least. If we had tried to negotiate it earlier we would have refused lock in and they would have agreed to lock in. It’s turning out exactly the opposite so I just think focus on taking the company public.
Sudipto:
True. With this we’ll end sort of this episode but thank you Avnish for taking the time out. And for our viewers would love to hear back from founders if you agree with us do let us know. If you disagree with some things we said would love to hear from you.
Avnish:
Do let Dada know.
Sudipto:
But with that thank you so much.
Avnish:
Thank you. Cheers.
Salonie:
Thanks for tuning in. For more Matrix Moments episodes, you can head to www.matrixpartners.in/blog. You can also follow us on Twitter, LinkedIn, and YouTube for more updates.
