The dreaded liquidation preference and other VC terms |
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The dreaded liquidation preference and other VC terms
Pre-money valuations in millions (Source: Cooley Godward)
It's getting ugly out there. Two surveys released by law firms this week show that venture capitalists are demanding strict terms before they part with any money.
Of the 128 companies surveyed by Fenwick & West, 41 percent of the deals included liquidation preferences -- special rights that allow VCs to cash out first if the startup is acquired. That's about the same level as the previous quarter. Even more interesting, is that VCs increasingly got liquidation preferences that required two to three times of the initial investment. Fenwick found that 23 percent of VCs got multiple liquidation preferences last quarter, up from 16 percent in the third quarter. That's bad news for entrepreneurs, since if a positive sale occurs there can be little leftover for the founders who conceived the business.
The finding was backed up in a separate report by Cooley Godward Kronish, which noted "a significant increase in the percentage of transactions with greater than 1x liquidation preferences." Cooley said many of those deals occurred in later-stage transactions.
Not surprisingly, both reports also found that "down rounds" increased substantially during the fourth quarter. Fifty two percent of the venture rounds showed valuations that were flat or down during the fourth quarter, which compared to 28 percent for the first three quarters of last year, according to Cooley.
Valuations took a sharp dive across all stages of investment. Series A valuations fell from $8.75 million during the first three quarters of last year to $7 million during the fourth quarter, holding up better than the later-stage deals. For example, the median pre-money valuation for series C plummeted from $38.5 million to $24 million. Meanwhile, series D deals were cut in half.
The surveys, for the most part, focused on financing deals in Silicon Valley, so it would be interesting to hear what Seattle area entrepreneurs and venture capitalists are seeing. Are multiple liquidation preferences increasing? Are any up rounds getting done?
A number of Seattle entrepreneurs I've been talking to have said the same thing: Avoid raising capital right now if you can.
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