Imagine a Baskin Robbins where you can get any flavor you want, as long as it is vanilla. Based on recent data provided by the National Venture Capital Association in partnership with Aumni, the market for venture capital deal terms seem to be that kind of store.
In connection with the release of an updated version of its Series A Model Term Sheet last year, the NVCA included survey results provided by Aumni based on data from “100,000 venture transactions, representing over 40,000 investors with a combined network of over $1 trillion in assets under management.” This summer, Aumni released an updated version of the data companion that includes 2020 data and more data fields.
Roughly 40% of the data fields included in the Aumni survey relate to the frequency with which certain deal terms are found in financing transactions. For example: “What is the frequency of 1x preferences?” The results are reported by funding round. While most experienced players in the space likely already know the market norms for each of these deal terms, what is truly striking is the degree of conformity. Most deal terms are present in 80-90%+ of financings.
In the chart below, I summarize the deal terms findings of the survey with respect to frequency, as well as the 2020 findings compared to the historic numbers.
- Well Defined Playing Field – The venture capital playing field is a well defined playing field. Since the early 2000’s the industry has coalesced around a standard set of deal documents that, with relatively minor modification, are used in the overwhelming majority of venture equity financings in the United States
- Little Deal Term Variability – Even within a well defined field, deal terms have narrowed even further so that on key terms, many of which influence return economics, in most cases 80-90%+ of financings include the same terms.
- Company Favorable Terms – Where terms can reasonably be viewed as more pro-company or more pro-investor, the deal term norms skew heavily in favor of the company friendly alternatives. Although the survey does not break out years except for 2020 (and also does not disclose how far back the survey data goes), from my experience, the same survey a decade ago would have shown much more variability.
- Minimal Variation by Round – The lack of variability by financing round is striking. Early on it can be hard to clearly pick winners and losers. By later stages some ventures clearly establish themselves as stars and others as struggling. While this distinction still influences valuation, it does not seem to be influencing deal terms in most financings.
- Changing Basis for Evaluating Investors – I used to give a talk entitled “Not all Term Sheets Are Equal.” This was directed to entrepreneurs and encouraged them to focus not just on valuation, but on other deal terms that could impact economics. Giving that talk today, I would retitle it “It’s the Valuation Stupid” – because all the other deal terms are likely to be pretty much the same. Actually, I would still give the talk under the same title, but now focus on what else the investors bring to the table in terms of expertise, experience and network, rather than deal terms.
- Covid, What Covid? – Turns out that Covid had a minimal impact on deal terms and to the extent it did, it was usually company friendly. This reflects the reality of venture finance over the last 18 months, where after a short initial stutter, pretty much every segment of the venture industry moved upwards and to the right.
Deal terms serve at least two purposes. First, they provide a means of mitigating risk and enhancing reward to investors. For example, increasing the liquidation preference to 2x increases (but far from guarantees) the likelihood that an investor will emerge from an investment with at least a 2x return. Second, deal terms are a way for investors to distinguish themselves from other investors in competitive situations – by accepting more risk and eliminating investor enhancements.
In the current “Lake Wobegon” market, where “all the terms sheets are above average” in terms of their company friendliness, founders have the luxury of focusing on valuations and collateral benefits offered by different potential investors. On the investor side, offering company-friendly uniform terms to companies of all stripes should have the effect of depressing valuations of many companies since these terms on the whole offer fewer investor protections and enhancements. Of course, depressed valuations are not exactly a “thing” in the current venture market. It will be interesting to see how this combination plays out going forward for investor returns.
Frequency Across Series
(only changes +/- 2% or more noted)
|Frequency of Non-Cumulative Dividends||92.8-96.2%||Ventures were never actually going to pay dividends. However, even exit payouts that include an interest component are rare.||4% decrease in Series D (94.3%-90.5%)|
|Frequency of 1x Liquidation Preference||95.8%-99.1%||While preference multiples were never common, their rarity is striking. Would be interesting to see a time series of this data.||3.9% decrease in Series B (97.3%-93.5%)
3.8% decrease in Series C (96.0%-92.4%)
|Frequency of Participating Preferred||2.3%-13.1%||Looked at another way, even in Series C where it is most common, 87% of the deals do not have participating preferred||Substantial decrease in all Series (from an already low base)|
|Frequency of Broad Based Anti-Dilution||87.8%-99.1%||Every series was above 98%, except for Series Seed.||5% increase in Series Seed (87.8% to 92.3%)|
|Frequency of Play-to-Play Provisions||0.2%-5.9%||With cash readily available, ensuring future co-investment does not seem to be a priority. Alternatively, investors may be assuming that if the need arises they may be able to implement retroactive pay to play provisions. See https://www.crowdfundinsider.com/2020/05/161238-retroactive-pay-to-play-coming-to-a-venture-theater-near-you/||Substantial increase in all Series (from a low base)|
|Frequency of Redemption Rights||4.5%-17.6%||As one would expect, this provision becomes more common with each funding round, but even in later stages is not present in more than 80% of transactions||Substantial decrease in all Series|
|Frequency of Registration Rights||65.1%-99.4%||Series Seed is the outlier here, with the remaining rounds at 96.5% or above. I suspect that the lower number for Series Seed reflects, in part, a lower percentage of deals done on the NVCA form documents. However, from a documentation perspective, Series Seed financings increasingly have become relabeled Series A financings and the standard NVCA documents include registration rights. I also assume that the data set does not include fundings completed through convertible instruments (Notes/SAFEs) because several of the statistics related to Series Seed likely would look different||Substantial increase in Series Seed. May reflect increased migration to NVCA form documents.|
|Frequency of Pro-Rata Rights for All Investors in the Round||9.3%-17.9%||The critical term here is “all.” The NVCA form includes limiting this right to “Major” investors as an option. I suspect the percentage of deals where the Major investors have a pro rata right is much higher.||Substantial decrease in all Series|
|Frequency of the Right of First Refusal||74.5%-95.9%||Series Seed is the outlier here, with the remaining rounds at 92.0% or above. The NVCA default provision here is that the RoFR rights extends to employee/founder stock. In some cases that right is extended to the investors. From my experience that has become less common over time, but would be interesting to see some data on this point.||Substantial increase in Series Seed.|
|Frequency of Drag Along Rights||89%-92.2%||The prevalence of this deal term is not surprising and I suspect has held relatively steady over time. The “action” here is on the approval requirements for a drag along.||Substantial increase in all Series but from a very high starting point.|
Dror Futter is a partner in the Rimon, PC law firm. Dror’s practice focuses on representing startup companies in their financing and merger and acquisition transactions and their intellectual property, IT and internet agreements. He also advises companies with respect to Initial Coin Offerings and other blockchain legal issues. Dror was the co-founding chair of the PLI VC Law program and hosted their first blockchain legal program. He is a frequent speaker and writer on blockchain legal topics. He is a member of the model forms drafting group of the National Venture Capital Association, the legal advisory board of the Angel Capital Association and the legal working groups of the Wall Street Blockchain Alliance and the Digital Chamber of Commerce. Dror can be reached at [email protected]