a16z Podcast: How To Raise Money from a Venture Investor

There are a lot of questions that come up when you’re fundraising. How much money should I raise? How much does my valuation matter? How should I evaluate the economic and governance parts of the term sheet? Scott Kupor—a16z investing partner and author of Secrets of Sand Hill Road: Venture Capital and How to Get it—talks to Frank Chen about what entrepreneurs need to know about raising money from VCs. 

Episode notes:
What’s special about Delaware C-corps? (1:04)
Protecting your intellectual property (2:44)
How much money should you raise? (4:32)
Valuations: Is higher always better? (7:32)
Choosing the form of your investment: equity rounds v. convertible notes (10:50)
Term sheet terms (13:22)
Liquidation preferences (14:56)
Structured deals and risk (17:52)
Choosing independent board members (22:26)
Navigating pro-rata rights (24:47)
What should you expect from early investors (27:08)
Stock restrictions and vesting schedules (28:15)

Transcript

Frank: Today we’re going to dig into the mechanics of how you work with a VC during the fundraising process and how you interpret the terms of the term sheet. As venture investors, we do this day in and day out. We will see thousands of entrepreneurs and we’ll write dozens of term sheets, whereas you may do this once in your life. We want to help you understand some of the terms, the art, and the science that go into fundraising.

TABLE OF CONTENTS

What’s special about Delaware C-corps? 

First question: Why do I need to be a Delaware C-corp? What’s special about Delaware and what makes other entities hard to fund from a VC’s point of view?

Scott: There are a variety of ways your business can organize. There are C-corps and there are partnerships. The main reason why you do a C-corp, and why it’s in Delaware, is there’s a lot of legal precedent there. Delaware made themselves the home of businesses many, many years ago. It makes people like us and lawyers feel comfortable because we know that there’s hundreds of years of legal precedent that says, “Hey, if this happens, this is what happens.” Things are fairly well settled. You could certainly go other places, but Delaware is pretty good. 

I think the main advantage of a C-corp is it allows you to have lots of shareholders. If you want to grow over time you’ll want to do that. It also allows you to have different classes of shareholders. One of the things we’ll talk about is the fact that you as an entrepreneur might hold what are called common shares, whereas the VC investors might hold what are called preferred shares. Delaware has a very well-established legal framework for us to have different shares that have different rights associated with them. Ultimately, investors are used to taking C-corps public. It’s a much easier, and quite frankly, more seamless way to think about starting where you want to end up.

Frank: The rails are well-defined, and I don’t have to blaze my own trails with a machete.

Scott: That’s right. There is no sense in blazing a new trail on this one. Every now and then we do get some entrepreneurs who come in here and want to do it and they’ve got lots of interesting reasons. So far I haven’t heard a really compelling one.

Frank: Yeah. The 14 reasons I need to be an LLC.

Scott: Exactly right.

Protecting your intellectual property

Frank: Let’s pretend I’m still working at a company. Let’s call it BIGCO. I haven’t incorporated yet. What advice do you have for me to make sure that whatever I do is protected and that my old company isn’t going to come after me for intellectual property?

Scott: This is one of those things where a little foresight can go a long, long way. When you pitch the VCs and say, “Hey, I’m working at BIGCO. In my spare time on nights and weekends, I developed this wonderful new product. Now I’d love you to fund it for me.” The first question that’s going to go off in our heads is, “Wait a second, do you actually own that technology? Or could there be some way in which your existing employer can say, ‘Hey, I may own that stuff.'”

You may remember the case with Uber and the company called Waymo. Waymo was part of Google and a number of people left Waymo and ended up at Uber. There was this whole question about whether the principle of that company had taken some kind of proprietary knowledge from Google and given it to Uber. The challenge with these cases is you’re proving the negative. In that case, Anthony Levandowski had to prove that he didn’t take anything as opposed to them proving that he did take something. Now, the law doesn’t actually work that way, but in practice–in perception–that’s the way it works.

Our best advice is if you’ve got a great idea, number one, don’t ever use your work laptop for any of these things. Have some physical separation. When you really get to the point where you feel like this is a real thing, either take a leave of absence from your company, quit your company–do whatever you need to do–because the last thing you want to do is come up with this wonderful idea, but you’ve just been sloppy. Then all of a sudden you can’t find a way to commercialize it anymore.

How much money should you raise?

Frank: Let’s get into the question, how much money should I raise? There are a couple of Twitter questions around it, beginning with, “Do I even mention a check size? Should I come with an ask, or do I let the VC tell me?” So, how much should I raise?

Scott: Let’s talk about the broad question. The simple answer to how much money to raise is how much money do you need to accomplish the objectives that you will need to accomplish to be able to raise the next round. I know in some ways that sounds funny, but the best advice I think we give entrepreneurs is, if you’re raising your Series A round today, you should be, at that point in time, thinking about the pitch you’re going to give the Series B investors. Then work backwards and say, “For the Series B investors to be compelled by what I’m doing, what milestones and what objectives will they need to be able to see? Then how much money will I need to do that and how much time will I need to do that?” That’s the way to back into your amount of money.

The answer to the Twitter question is absolutely. You should tell the VCs what you want and you should be able to articulate, “For X amount of dollars, this is what I can do. And, if you gave me X plus 50%, I could do this much more.” Part of the exercise you and your VC partners should do is say, “What is the right amount of money that doesn’t dilute us too much today but gives us enough degrees of freedom that when we go for that next round of financing, somebody will come in and hopefully put more money in at a higher price than we did this first round.”

Frank: If I’m raising a Series A of financing, I need to start this whole mental process with what do Series B investors want to see?

Scott: That’s exactly right. I think that’s the best mental framework. Remember, from the perspective of the VC who’s going to do the Series A, they’re asking, “Do I believe this person can accomplish enough so we can continue this ride?” As the CEO, you care about that too because the best thing you can do is to have this very nicely monotonically increasing valuation in share price over time. 

I tell this story in the book, which I know you’ll remember when we were at LoudCloud. Ben Horowitz and I spent a bunch of time raising a very large round. We raised $120M at an $820M post-money valuation. We walk into the all-hands thinking that we’re heroes and everybody’s going to clap for us and tell us how smart we are–and we get very muted silence. It turns out that everybody was upset, but not because we didn’t raise at a very high valuation. In fact, our last round was about $60M. We raised 12, 13, or 14 times our last round, but the company down the street from our storage networks had raised at a billion-dollar valuation.

I tell people that story because so much of a company’s success and employee engagement is a function of these external benchmarks that people think about. That’s why thinking ahead to the next round is important because, as much as you want to focus on accomplishing the objectives for your business, you also want to set yourself up so that you can continue to show progress to your employees by demonstrating that a new investor values the company at a higher level than your prior investor did.

Valuations: Is higher always better?

Frank: Interesting. That’s the perfect segue to this other Twitter question, which is, “How often do you find that founders pushing too hard on high valuations end up hurting themselves?” Maybe talk structurally about what happens if you get too high a valuation in this round? On its face, a high valuation means I suffer less dilution and I own more of this company. Victory. Why is that not always a victory?

Scott: I will fully admit that this is a very hard thing as a VC to talk about. The immediate reaction from an entrepreneur, and understandably so, is of course you want the valuation to be lower because it’s in your own financial interest to pay as little as possible and own as much as my company. I won’t fight that argument, which is true, but let me at least try to make the pro case for why I do think entrepreneurs should care about this. 

It goes back to the story I just mentioned. You’re the CEO and you tell the company that you just raised $5M from Andreessen Horowitz. Then you tell them all the things that we’re going to accomplish. Here are our objectives. Here’s what we’re going to do in terms of hiring and customer acquisition. Hopefully, you’re executing all of those.

Now, 18 months down the road, you say, “Great. We’ve accomplished all those objectives. I’ve been telling my employees they’re right on track.” Then all of a sudden I go out to raise money and I run into this buzzsaw where a new investor says, “Congratulations on all that, but I think you actually overvalued your company at that last round. Even though all of your metrics have doubled from where you said they were, I’m only willing to pay 50% more for the company.” There are reasons why that may happen that are outside your control. Maybe the market has changed and we now value companies differently. As the CEO, there’s nothing you can do about that.

However, what you can do is at least de-risk the situation, and say, “If I accomplish the things that I set out to accomplish, do I believe the market will reflect that in how it values the business?” It’s really hard as a CEO to imagine doing an all-hands when you’ve been telling everybody everything’s great all along, but now you have to tell them, “Oh, by the way, it’s not that great based on some external metric.” Even though it’s only one metric, these are important data points that, unfortunately for better or worse, do have psychological impact on how employees feel about their progress and how you think about recruitment and employee retention.

It’s a hard balancing act, but in general, the idea of having a stock price that goes up and down all the time is probably more disheartening to the company than something where the progress of the business also is reflected in the progress on valuation.

Frank: It’s hard because there’s an emotional moment when I’m negotiating this round of financing and I want to preserve as much ownership as I can. It’s harder to think about the long-term consequences.

Scott: Absolutely. It’s a very hard thing. As I said, this is a hard tension between entrepreneurs and venture capitalists, because, on one level, the incentives are different. At this point in time I’m investing as a venture capitalist, if I could invest less money for more ownership, that’s better for me. Where we are aligned is that it’s not good for either one of us if we end up in these situations down the road where we can’t raise more money or we can only raise more money at a substantially lower valuation than we thought. That has emotional and economic implications for both of us.

Choosing the form of your investment: equity rounds v. convertible notes

Frank: Let’s talk a little bit about the form of investment. You can raise a priced equity round or you can raise a convertible note where there’s no price. You have a recommendation in the book, so walk me through it.

Scott: I talk a lot in the book about convertible notes. You’ll hear this term if you’ve been in the VC world, called a SAFE, which is just a fancy way of saying it’s a piece of debt that ultimately converts into equity at some predetermined price in the future. They’re very good because they’re very simple. There’s very low legal costs for doing them. The paperwork is very easy. I’m all for efficiency and cost. The failure case that I’ve seen, unfortunately, with a number of entrepreneurs is it’s so easy to raise money on a SAFE, you often find people do what are called rolling closes, which is usually on a priced round. Usually we’re like, “Get your money in by June 30th, or else you’re out of this deal.” But the SAFEs have this very nice convention, which is I can close one on June 30th, and then I do one on July 31st. I can keep doing it, and that’s very good and convenient. 

The problem is never along that way does the entrepreneur see the actual capitalization table of what it is going to look like when all those SAFEs convert into equity. Several times we’ve had entrepreneurs come in here and they have sticker shock when we give them an offer on the A round and we actually build the capitalization table out of that. They realize that they inadvertently sold more of the company than they had realized based upon this concept of rolling close up notes. I’m not against SAFEs. I would just say if you do it, think about this failure mode. 

There’s a thing called Siri Seed, which is a very, very lightweight way of doing an equity deal, and I think you can use that to accomplish the same efficiency goals. I just would encourage entrepreneurs to make sure if they go this route they really do pay attention and understand how much of the company they’ve sold, so one day they don’t suddenly find themselves frightened when they realize how much money they may have given away in the company.

Frank: It’s very tempting, because the reason that you do a rolling close with these SAFEs is you’ve found the perfect advisor or the perfect early customer who wants to invest, or a friend or family member. It feels convenient.

Scott: There’s no reason why we should have these specific hard closes at different times. It’s convenient and again, it’s got a lot of value. I don’t want to suggest that it’s never the right thing, but it’s something to be aware of and make sure that you consider as an entrepreneur.

Term sheet terms

Frank: Let’s imagine I go through this process. I’ve assembled my pitch deck, I’ve got an offer, and now I’m evaluating offers. I’m in this enviable position of evaluating term sheets. Talk a little bit about the economic parts versus the governance parts in the term sheet. Let’s talk about liquidation preferences on the economic part of my term sheet. What is this?

Scott: There are several chapters in the book on this, but I’ll give you the 30-second version. The simple way to think about liquidation preference is it’s just the order in which money comes out of the company. Liquidation is a fancy way of saying hopefully not an actual liquidation where we’re shutting down the company, but hopefully, a sale of the company. It could certainly be the former as well. What that means is who gets their money and in what order. Generally, what happens in venture financing is the money that I invest as a venture capitalist has what’s called the liquidation preference on it, which means my money comes out first relative to the monies that would be owed to the common shareholders, which is typically where the founders and the employees sit.

Here’s a simple example: If I invest $10M and we sell the company for $10M, typically I will have $10M worth of liquidation preference. This means all $10M of that money comes back to me. Unfortunately, for you and your employees, you have nothing. That’s the simple way to think about it. It’s fairly common in venture deals, but typically it is capped by just the amount of money that the venture investors have put into the company.

Liquidation preferences

Frank: What’s the most entrepreneur-friendly liquidation preference formula that I should live with? There are so many different kinds of liquidation preferences, participating preferred, non, 3x. What’s most entrepreneur-friendly?

Scott: The most entrepreneur-friendly and the one that I think generally predominates in Silicon Valley is what you would call a 1x non-participating liquidation preference. If you break that apart, 1x just means one times the money we put in. I don’t get two times my money, I don’t get three times my money. I get my $10M in that example we talked about. Non-participating means I don’t get to double dip. Double dipping means not only do I get to take my liquidation preference off, then I also get to share the proceeds that reflect my percentage ownership of the company. 

Here’s an example: I put in $10M and I own 25% of the company. If I had participating preference, I would get my $10M first and, because we sold it for $20M, there’s $10M left over. Then I would also get 25% of that additional $10M. Fundamentally, you know, and I say this in the book, I think that’s very unfair to the entrepreneurs and to the common shareholders because liquidation preference is really intended to protect your downside. Once you’ve gotten your money out, it’s not obvious to me why you should also participate in the upside and take money away from the founders for the employees.

Frank: Yeah. So, when I hear my friends complaining about deals with structure, I guess this is an example of deals with structure and unfair liquidation preferences.

Scott: Another structure you sometimes see is called anti-dilution protection, which is a basic way to true up the venture capitalist to a certain extent if we raise money in the future at a lower price than we raised today. There’s a very common one called weighted average anti-dilution, which is fairly common. There’s also a very egregious form of that, which you sometimes hear called a ratchet. A ratchet is a complete price reset. If I bought shares at $2 a share and tomorrow you sell shares at $1 a share, my $2 price converts to the $1 price, meaning I literally get double the number of equity ownership in the company than I thought.

You’ll sometimes see a structure like this when people are trying to balance off valuation with some of these other rights. A lot of what I try to point out in the book is that it’s very hard to look at these in isolation because they all have some kind of economic value. If you’re going to push on valuation, you might expect a venture capitalist to push on some of these structure items.  The big advice that we always give entrepreneurs, and I echo this in the book, is the simpler you can keep it the better. If you have one deal that’s got a lot of structure at this price, ask what a clean deal looks like at a lower price that doesn’t have all the structure.

Structured deals and risk

Frank: I can actually get myself in trouble by taking the highest post-money because of all of this structure. How does the money come out in these scenarios?

Scott: I think there are two risks that you always have to think about when you do the structure. One is that you’re potentially postponing the inevitable, which is you don’t really know what the impact of these things will be until you have that next financing event. The world may be perfect and everything may go up and to the right, which we all hope, but that’s not always the case.

A great example of this was–and this is public information–Square went public at $8 a share. Their last round of financing was at $16 a share, and those $16 investors had this full ratchet that we were talking about. Those $16 shareholders were issued two times the number of shares to bring their price down to $8, and all the existing shareholders obviously bore the brunt of that incremental dilution from those shares. That’s the number one thing.

The second risk is, and this is why we always say keep it simple, everything you do today has a risk of creating precedent for the future. You may think, “Hey, you and I are buddies and I’m giving you these special rights because we’re friends.” But when that next investor comes in and looks at the paperwork from the previous round and sees that you gave that stuff to the other investor, the likely outcome is they’re going to want the same thing. Now you start to get the cumulative effect of some of these things, which can be pretty harmful over time.

Frank: Right. So, every subsequent investor is going to want the same deal as the prior investors, or better, so you have to think into the future.

Scott: That’s exactly right. You just don’t know how much negotiating leverage you’ll have at that time. You don’t want to set yourself up to start by having to defend or walk away from a deal that you did prior.

Frank: We’ve come back to the idea that when I’m raising my Series A, I need to really think about Series B, Series C, and Series D, and the sequence of investors that I’m going to need. I should think through the entire financing plan before I start fundraising for  Series A.

Scott: I think that’s right. You want to project as much foresight as you can, recognizing that markets may change or the financing environment may change, but those are things out of your control. What’s in your control is to have a thoughtful plan for, if I accomplish these things, is that likely to lead to a favorable financing situation. If I don’t load up my terms with all kinds of crazy bells and whistles, hopefully I set myself up for success.

Frank: It sounds like the big advice on the economic side of the terms sheet is to keep things simple and think about the subsequent investors. Don’t do something abnormal early, because that’s just going to bite you later. Let’s talk a little bit about the governance side of the term sheet. The first question is, I heard that Google and Facebook have these dual-class voting shares, so founders have ultimate control. That sounds good to me. Don’t I always want that? I want 10x the voting shares as anybody else.

Scott: We do get some entrepreneurs, even in the private markets, who ask us for that. The idea behind dual-class shares is that shares have differential voting rights. In the cases of Facebook and Google, you’re right that Mark Zuckerberg, Larry Page, and other founders have  high vote stock, which means they have more influence on corporate matters, than everyone else who has a low vote stock.

The reason those exist in the public markets is out of concern for potential misalignment between long-term versus short-term incentives in the market. In a company like Facebook, Mark probably has all kinds of product ideas that he wants to execute over the next 3, 5, 10 years. Those will all take time. They will cost money. There could be quarter-to-quarter gyrations in his expenses and revenue as a result of these product plans. The main reason why somebody like that puts in dual-class shares is because he wants to be able to make sure that, if there are investors who are more short-term oriented, they can’t outvote him and say, “I don’t like your product strategy because of these short-term gyrations.”

The reason why those don’t tend to exist in the private markets is we’re all completely aligned; none of us have liquidity. Many times we are prevented from selling our shares legally. There’s no liquid market and we have a time horizon that’s consistent with the entrepreneur’s time horizon. We don’t care about what they do quarter-over-quarter, other than the fact that it just represents them not being able to manage the business in a way that makes sense. That’s why you don’t tend to see them in private markets. What we’ve done with many of our companies is, as they get closer to going public, we have agreed with them that having these dual-class shares when and if you go public is a good thing to do. But we haven’t done that in the private markets.

Choosing independent board members

Frank: My first board members will likely be either my co-founders and then my early investors. At some point, we’re going to go on a quest for an independent board member. How should I think about that? When do we do that, why do I need one, who should I look for?

Scott: Most boards at the beginning don’t have independent board members. You probably have yourself and your co-founder, and then typically, when a venture capitalist comes into your company as an investor, you generally give them a board seat.

The reason I think independents are important is you want to have balance on the board. One of the phenomenons we’ve seen over the last 10 years is a change in the board structure. It used to be that the venture capitalist would outnumber the common shareholders. That was of concern to many founder CEOs because it gave the venture capitalist the unilateral right, in many cases, to be able to remove the CEO if they didn’t like them. Over the last 10 years that’s really shifted, and more of our boards have more common shareholders, more founder and employee-led board members, than they have preferred shareholders. That’s understandable and fair given some of the changes we’ve had in governance.

The idea behind an independent is can we find someone who is not just representing the founders and not just representing the preferred shareholders, but someone who’s going to take a more neutral and expansive view of the business. It’s hard to do it in your early days, but maybe as the board grows and expands to four or five people, having an independent or two would be valuable. I think most people who’ve done it have gotten great value out of it. Oftentimes, they might look for an industry expert in the domain they’re in and say, “Hey, we need more sales and marketing help, let’s bring in someone who has expertise from an organizational perspective.” Those are the characteristics we tend to see with independents.

Frank: As I approach an IPO, if all goes well, it seems like it’ll be expected that I have an independent board member. It’s one of the checklist items for going public.

Scott: That’s exactly right. You’ll see this with companies when they go public. The different exchanges, NASDAQ and NYSE, have what they call listing rules, which require some number of independents. They require some number of financial experts to be able to sit on things like the audit committee. It becomes much more prescriptive as you go, so you’ll often see a company at T-minus one or two years leading up to an IPO start to augment their boards to satisfy these listing standards.

Navigating pro rata rights

Frank: Let’s talk a little bit about pro rata rights. There’s going to be this element in the term sheet that says, “Here are what my existing investors can expect and what they are allowed to invest in subsequent rounds.” How should I have that conversation with an investor? What kind of pro rata rights do I want them to have?

Scott: One of the things that we as venture capitalists will ask for is exactly this right. It’s the right for us to invest additional dollars in the next round of financing in order to preserve the economic ownership that we already have in the company. If I own 25% of the company today, this gives me the right to hopefully put more money in later so that my 25% stays around that percentage. In general, it’s a very good thing. 

Pro rata rights become more challenging in the very, very good case that you are executing phenomenally well. You’re going to raise money and a new investor comes in and says, “Hey, I want to put a bunch of money in, but to make my business model work, I need to own a certain percentage of the company.” If you go back to where we started from our last session, a big part of the venture capitalist incentive is to get a Facebook or a Google. There are two big cardinal sins in this business. One is if you miss one of those companies and you don’t invest in them. The other is that you invest but you don’t own enough of it, so when it gets to be Facebook it still doesn’t meaningfully change your economics.

The pro rata thing is an example of the ladder where that new investor may come in and say, “I’m going to give you all this money, but I still only own 3% or 4% of the company. I want you to go back to your existing investors and tell them you don’t do your pro rata, but let this new investor do it.” Now, admittedly, it’s a good problem to have because it means we’ve got people who are pounding down the door. But that does create tension, and you often see this in Series A to Seed. Seed investors feel like they get compromised and that the A round investors are trying to prevent them from doing pro rata. It’s a very common thing to have, but it puts you as a CEO in a situation where you may have to manage conflicting incentives among your investors. You just need to go in with eyes wide open and hopefully, you’ve got a good enough dialogue with your existing investors where you can say, “Hey, let’s figure out some compromise here where everybody can feel like they can walk away from the table and be happy.”

What should you expect from early investors 

Frank: What should I expect from my existing early investors? If somebody invests in my A, should I expect them to be along for the ride and do their pro rata in the B, C, D, or all the way?

Scott: Different firms have different philosophies on this. The way we do it here is if we are the A round investor, our general thinking is that unless something dramatic happens with the company, we should expect to participate pro rata in the next round of financing. I think that’s generally the convention in the industry. Beyond that though, the answer for most firms, and we treat it the same way, it’s an independent decision at that point in time because the dollars can get very, very big. You have to think about how much do I own at what kind of cost basis. 

I think it’s an important conversation to have with your VC when you take money from them because you certainly don’t want to miss the expectation between the two of you. You also want to make sure when you go raise money that you’re not creating some signaling effect where the new investor is expecting your existing investor to participate. If they don’t, the new investor can read this as a negative signal. That can happen if you haven’t kind of had this conversation and set the right expectations upfront.

Stock restrictions and vesting schedules

Frank: I need to be clear with you as soon as you put your money in. I can count on you for the next round, or maybe the round after that. We should just be on the same page. So the last few questions are on governance. Let’s talk about stock restrictions. What are they and how should I think about them?

Scott: This is one that comes up more often because companies are staying private longer. It used to not be a big deal because the median time to go public was about 6 or so years from founding. Now, it’s 10 or 12 years. 

There are two things that you want to think about as a founder. Number one is what are my investors going to do? Often, you will see that investors will have restrictions on their ability to sell shares. Those come in lots of different flavors and you can read about them in the book. The other is, what do you do about employees? You’re probably going to have employees whose shares have fully vested shares, some of whom will have left the company.

This one is a tough one to navigate. On one level as a CEO, you want to give your employees flexibility, particularly the ones who are still at the company and doing great work. You want to be careful that those shares don’t take up demand that would otherwise exist for people to buy shares from the company where the cash would come in and allow you to raise money and grow the business. There may be a finite amount of dollars that investors are willing to put in this company. If you have employee share sales competing with sales that you’re making as the company tries to raise money to put into your own coffers, there can be tension.

Today we generally see fairly restrictive provisions. Most companies say, “If you’re going to sell as an employee, you need the consent of the company,” so you have more control over the timing and the volume of these purchases.

Frank: I have friends who are doing longer vesting schedules or back-loaded employee options. Instead of 148 over 4 years, they’re doing 10, 20, 30, 40 to incentivize people to stay longer. How should I think about those types of employee incentives?

Scott: There’s lots of discussion on this right now. The short answer is I’m not sure there’s been a real change yet. I think most people are still doing the straight 4 years. The big change that you may have heard about is this: Normally when you leave the company and you’re vested, you typically have about 90 days to either exercise your shares or you have to forfeit them. Because companies are staying private longer, a lot of companies have now extended that period. They may say, “We’re going to give you 1-2 years because we recognize that without an IPO there’s not a liquid market to be able to sell them, and we know it’s expensive for you to exercise your options out of pocket.” There’s probably more creativity happening on that side and less creativity on changing the vesting schedule to reflect the fact that companies are staying private longer.

Frank: I want to be as employee-friendly as possible, so I’d extend the time so people can choose to exercise their options.

Scott: Some companies have done that. The only thing to think about there is that those shares will be what’s called an “overhang,” meaning that they’re sitting out there and you don’t really know if they’re going to be exercised or not. Sometimes people might not exercise them and those shares could be returned to the company and the company could use them to issue new options to people. There’s a very emotional and deep debate on this but, to be employee-friendly, you would extend it out as long as possible to give people the maximum time period.

Frank: Thanks for talking to us about economic and governance terms. The term sheet can be very intimidating, so I’m glad you went through it and demystified it.