Wash Out Defectors

Increasing the likelihood of future venture capital funding through prenuptial agreements.

Tweet

If you're closing in on financing from venture capitalists, don't assume that just because they're hot on you today they'll be eager to bankroll you tomorrow. Lately, a number of venture-backed companies have been deserted by investors who ran out of money to invest or lost their enthusiasm. In some cases, defections have killed companies. How can you increase the likelihood of future funding?

One approach is to persuade the VCs to sign a prenuptial agreement. Before they put the first dollars in, they sign a "pay to play" provision that spells out the investors' responsibility to put up their pro rata share in future financing or suffer getting their current shares badly diluted -- or "washed out." Shares worth $1 might be cut to 1¢. Or investors might be stripped of their liquidation preference. "The idea is to put pressure on the whole investor group," says Dan Finkelman, a lawyer at Testa, Hurwitz & Thibeault, in Boston.

In most cases these days, the terms of financing are proposed by investors. But there's no reason you can't argue for a prenuptial provision. "It won't guarantee that investors stay with you," says Arthur J. Marks, a general partner with New Enterprise Associates, in Baltimore. "But it could encourage people to earmark money for future rounds and make it painful if they don't." -- Bruce G. Posner

Read more:

Sign-up for our Small Business Success Newsletter

Email Address: