Adventures with Venture Capital outside the Valley (or how to get screwed): ROSL87

ROSL87: Reflections on startup life, week 87

This is one of the hardest posts I’ve had to write. Not least because it’s a personal, painful series of events. But I’ve tried to remain open and honest about our journey thus far, so within the bounds of what’s reasonable, I shall continue to do so. You’ll note this is a full five days late. Once you hear the story, I hope you’ll forgive me this transgression.

I’ve deliberately not mentioned names and titles have been changed (to make slightly more “Valley” style sense). My goal is not to burn too many bridges, but the story needs to be told. In a world skewed towards VCs doing deals regularly, the one advantage entrepreneurs have is the lessons learnt; it’s not possible / too expensive for us all to learn them ourselves.

The term sheet

Back in late March we were approached by a Chinese VC firm. That’s right — they approached us, not the other way around. The story is simply that over a coffee with one of their portfolio companies, Trunk.ly came up in conversation.

It turns out the CEO of this portfolio company knows Alex really well and had tried to recruit him as a very early employee of what is now a successful and rapidly growing social network in China. This was enough for the junior partner (who was also a Trunk.ly user) to decide to investigate investing in us.

To be blunt, we weren’t sure. Alex is also Chinese, so that’s helpful, but why would a Chinese VC (that has sourced their money from US funds) want to invest in an Australian based startup with visions of moving to the Valley? They assured us that Alex being Chinese was sufficient to meet the fund criteria. They asked how much we wanted, so we set a valuation we felt we couldn’t refuse, they accepted.

We also asked about how involved the Senior Partner needed to be. Don’t worry about it we were told — the Junior Partner was allowed to sign off his own deals up to double the valuation we were seeking.

A term sheet was shortly forthcoming. We didn’t like it and rejected it. We were asked what term sheet we’d like? We picked the YC Series AA as the basis for the term sheet.

We appointed a lawyer (on deferred fees) and after some slight negotiations, the term sheet was signed. By roughly mid-April, we were now the proud owner of a signed term sheet, signed by the Senior Partner. Hooray!

To be clear, it wasn’t a perfect deal, but they wanted to invest and we wanted the money. The obvious issue was that the VC was in a separate country to us, but our conversations with other startups had suggested this wouldn’t be a big issue — these guys know what they’re doing and they are also fairly hands off anyway.

So far so good! Of course, we’re being very cautious still. The deal isn’t done until the money is in the bank, and we didn’t want to make a mistake by getting too far ahead of ourselves.

Mistake 1: We should have insisted on meeting / talking to the Senior Partner ourselves. It may not have changed anything, but it’s one clear thing that with hindsight I wish we’d done at this point. All our dealings were second hand, although this is perhaps not as strange as it seems given he was travelling and we are in separate countries.

Information Memorandum / Request

This was reasonably straight forward — they sent a list of things they needed to see to conduct some due diligence, we sent them back.

The contract drafting

In hindsight, there were plenty of signs here that things were starting to go awry.

Once the Information Memorandum was completed, the first draft of contracts came through and didn’t match the term sheet at all! The term-sheet may as well have not even existed. Despite the Senior Partners signature on it, when we asked why they were so different, the Junior Partner advised us the Senior Partner said he’d never approve a deal that was that favorable to the Entrepreneurs.

It smelt fishy. However after we worked through the contracts and the deal had gone from “very good” to “pretty normal Valley deal” — we decided it was still worth pursuing.

There were around 6 rounds of contract revisions back and forward between us and them. Every one of these is eating into our investment (not only do we have to cover our fees, but theirs as well). It’s incredibly frustrating because we’re now negotiating in fine-print on headline terms. A bad (expensive) idea.

Somewhere here our Lawyer started to make noises suggesting we should look at walking away. We pushed back — even though the deal had changed, we’d probably have signed this if it was the deal we’d been presented with. Besides, we were burning our runway and needed to close this.

Some earlier ground work in seeking some Angel deals was now also beginning to come to fruition and generate some interest. We told them thanks, but no thanks — we were negotiating contracts with an investor and didn’t have room to bring anyone else in.

Mistake 2: Actually we did a good job of dealing with our potential Angels in good faith, still I think we should have kept these negotiations more live than we did. Ultimately we didn’t want to waste anyone’s time.

Mistake 3: We really should have listened to the Lawyer more. With the benefit of this experience, I personally hope that in the future if I find myself renegotiating significant terms part way through that I’ll walk away.

The roadblock

Finally we had a near completed contract set. For those that aren’t familiar with this process, we’d basically taken a two page term sheet and managed to turn it into almost 2 full inches of printed single sided contract language.

Everything went quiet.

We pushed, we hassled, we followed up. Things just took time.

In hindsight once more, this may not actually be that unusual. Still, it felt that the earlier urgency had gone out of the deal and things were dragging.

Eventually we got down to two sticking points in the contract. We resolved these and now the deal was pretty close to ready to sign.

Mistake 4: Had we kept a “warm” pipeline, we might have had some alternatives at this stage; either to speed things along, or to encourage us walk away.

The roadtrip

All of a sudden they need us in China by the end of the week to meet with the Senior Partner.

Why the rush? Why now? We’re told he’s about to go travelling for a few weeks and won’t sign off without personally meeting you both. If we miss the meeting, we’re not able to do the deal for another month.

Fair enough — we felt this should probably have happened earlier, but even so, it was sudden. Alex and I scrape the bottom of our credit cards to get the airfares together and everything else largely goes on hold while we get everything arranged, then set out and travel to China.

The meeting

So after flying in overnight and landing Friday morning (that’s last Friday 8th of July), we rock up to meet the VC on Friday afternoon.

We’re shown to a meeting room where we wait for about 30 minutes or more. Then the Junior Partner comes in. Everything is going fine, meet and greet and all is well. We’re told we need to meet the two Senior Partners. No, there shouldn’t be any problems. Yes, it’s largely just a formality.

The first partner comes in — he’s up front — this isn’t his area, but won’t the fact we are aiming to be a US company be a problem with the fund? This feels like the very obvious point we asked about right at the start of this process. Maybe there is something creative we can do he muses. Perhaps all is not lost.

More of a wait, the most Senior Partner comes in. The meeting now switches to Chinese and I sit as a passive observer. It’s clear to me (although perhaps there are some cultural differences in body language) that the Senior Partner is not interested.

When he starts asking questions, I’m getting the impression through what words I can pick up and Alex translates, that we’re back at square zero. Rather than a meet and greet, this is suddenly turning into a full blown pitch.

The meeting slowly turns around and he seems to get more engaged, perhaps we’re close.

After the conversation is exhausted, we’re told to wait.

The decision

We sat there for almost two hours while they speak in another room.

When the Junior Partner returns, nothing is said but “let’s go to dinner”.

While we are walking to dinner, Alex is being asked in Chinese if it would be possible to vary the valuation. What’s the minimum amount we’d now take to help get the deal done?

At this stage we figure the deal is bust — we just don’t know it for sure. At the end of the dinner, they tell us they are meeting to discuss this again on Monday. We need to ring then to find out what’s happened.

We ring Monday several times, get told we’ll be called back, nothing happens. Ring Tuesday, no answer. Finally on Wednesday we get the answer we’ve suspected now for days. The Senior Partner has veto’d the deal.

Of course, true to form there is no “No”. Just hang in there we’re told, we’ll talk him around. At this point we’ve told them that if they have a firm offer they are willing to make and honor, we’ll be happy to consider it but we’re not waiting around any more. As far as we’re concerned, it’s a firm no.

The cost

There are several significant dollar costs, including the deferred fees which need to be dealt with eventually and the airfares which of course have to be dealt with now.

The biggest cost is the opportunity one. We’ve been doing lots of things that make sense if the investment came through, but are not useful now that it hasn’t. Discussions about who we’d recruit, networking to start meeting some of these potential people, less focus on iteration, more on stability and code quality in preparation for growing the engineering team. In 100 tiny ways we’ve been distracted from the pressing daily problems and invested time in preparing for an event that now hasn’t occurred.

The road forward

I believe a few things are true:

1. As expensive as they are, these were some valuable lessons. We’ll be better prepared next time.
2. What doesn’t kill us makes us stronger. Every time we hit the end of the runway, we find a creative way to stretch it further.
3. Over time we’ll be glad that we didn’t make this deal. You need to trust your investors. Frankly, if they turned around now and offered us the desired valuation at the original terms, I’d like to think we’d walk away. This is not a healthy relationship / partnership.
4. It’s hard to appreciate just how much of a drain investment is. Everyone says it, having got to 95% of the way there, I feel it too. I feel we’ve crested that mountain now and although the view isn’t what I was hoping to see (fields of green perhaps), now the mountain is out of the way, it’s still a pretty good view. We’ve discovered a few more options that we just couldn’t see when the investment mountain was blocking the view and draining our attention.

Final reflection

Despite pushing on several occasions, we have no concrete answer as to what went wrong.

Our best guess is that the Junior Partner perhaps overstepped his mark a bit, yet the Senior Partner DID sign the term sheet. There’s some suggestion they are in a round of fund-raising themselves and that the money is a bit harder to find than they thought. Perhaps this means they’re now less tolerant to risk. Or maybe there was just a misunderstanding. Or all of the above. We really don’t know (and we’ve tried to work it out). We BOTH lost money and time on this deal.

Anyway — this post is really about putting it all down and putting it behind me. There’s more to do.

I’m sure others will point out basics we did wrong or things that smelt bad from day one we should have seen. I’ve tried to get this all in order, but no doubt some facts are out of whack, perhaps some steps missed — the story is the lesson here, but still feel free to share constructive suggestions.

If you take away one success as such, it’s a lesson I’ve read many times before: “No deal is done until the money is in the bank.” Without holding true to this, it could have been a LOT worse.

Our Lawyers have been awesome (I’ll ask if they mind us mentioning them). Get yourself good counsel AND listen to them!

Finally, when the shit hits the fan, it’s great to be surrounded by people who believe in you. Go find some because there are days you need an ear to listen to you and someone that believes.