It’s All About Alignment: Key Takeaways From My First Week as a VC
At Underscore, we’ve always wanted to make a difference in the VC industry by bringing the next generation of great entrepreneurs into the business. Our aim is to blow up the black box of VC as it is today, and in doing so share the opportunity for entrepreneurs to become VCs. As part of this effort, we will be sharing learnings regularly from members of our team, starting this week with our newest member of the investing team, Lily Lyman.
This week I participated in my first process of closing a term sheet, specifically for a follow on round with an existing portfolio company (announcement coming soon!). It was my first time on the investor side of the table and I hadn’t run a cap table since starting our own company in B-school over five years ago. In this recent experience, I was most struck by the process of getting to alignment across all parties involved. The focus was on the “what” and the “how” of getting to an end state that all relevant parties are not just on board with, but feel good about.
The process entailed getting in sync on multiple dimensions:
- Lead investor <> CEO
- Board members <> CEO/team
- Current investors/CEO <> future investors
The biggest areas in need of alignment fell into two buckets:
1) Milestones for next funding: what does the company need to achieve with this funding to be set up for success in the next phase? This discussion centered around the key metrics to hit (ARR, new customers, and gross margin targets), as well as the primary hires and product roadmap progress necessary to achieve the target metrics. To get on the same page, we needed to find a common language that was actionable to the CEO and his team, but would also easily translate to current and future investors.
2) The numbers — valuation and option pool allocation. On this topic, we engaged in a discussion to ensure the founders and CEO were set up for success, while also making sure the investment still makes sense for the VCs (and their LPs). Specifically, the session focused on:
- Rewarding and motivating the team — The highest priority topic was to empower the entrepreneurs with what was needed to be successful. Does this valuation demonstrate the progress that the founding team has made from the last round? Does it motivate the team with proper allocation of stock options? Does the option pool allocation ensure the team can attract the right talent to hit the milestones set forth?
- Current investors — Secondary in importance but still a key piece of the puzzle, alignment on the cap table had to match the contribution and ownership expectation of the investors to ensure it was the right investment decision for each fund’s Limited Partners and the institutions they represent.
Most importantly was to ensure the founders were comfortable with where the group landed; after all, the founders invest their lives and their motivation directly drives results, while we invest capital and can offer input, but that’s all. This alignment in incentives and intent (the “what”) underlined the “how” of the discussion — each party was direct and open, using language around “this is what matters to me and here’s why…” For the CEO, what mattered most was team motivation and bringing on talent. For the product-focused investor, it was a milestone on the product engine to support growth. For us as the lead investor, it was team and path to ARR targets. In directly stating our respective intent and priorities, our conversation focused on the goals (shared and individual) and didn’t get distracted by ego. This productive dynamic is likely unique.
My biggest learning in this process was around communication style: state your intent and negotiate with empathy. I’ve heard similar advice offered for marriages. Given that signing a term sheet isn’t too dissimilar to a marriage, this analogous advice makes sense. As investors, this means putting the needs of our founders first. This first term sheet was a relatively easy start because of an amazing founding team and co-investors who all have the company’s best interests at heart and made the right decisions for the founders. I look forward to many more experiences, both the great ones and the tough ones, that help me grow to be the best support I can be for this community of exceptional founders.