In a sense, the lower-tier VC firms are a bargain for founders. They may not be quite as smart or as well connected as the big-name firms, but they are much hungrier for deals. This means you should be able to get better terms from them.

Better how? The most obvious is valuation: they'll take less of your company. But as well as money, there's power. I think founders will increasingly be able to stay on as CEO, and on terms that will make it fairly hard to fire them later.

The most dramatic change, I predict, is that VCs will allow founders to cash out partially by selling some of their stock direct to the VC firm. VCs have traditionally resisted letting founders get anything before the ultimate "liquidity event." But they're also desperate for deals. And since I know from my own experience that the rule against buying stock from founders is a stupid one, this is a natural place for things to give as venture funding becomes more and more a seller's market.

The disadvantage of taking money from less known firms is that people will assume, correctly or not, that you were turned down by the more exalted ones. But, like where you went to college, the name of your VC stops mattering once you have some performance to measure. So the more confident you are, the less you need a brand-name VC. We funded Viaweb entirely with angel money; it never occurred to us that the backing of a well known VC firm would make us seem more impressive. [5]

Another danger of less known firms is that, like angels, they have less reputation to protect. I suspect it's the lower-tier firms that are responsible for most of the tricks that have given VCs such a bad reputation among hackers. They are doubly hosed: the general partners themselves are less able, and yet they have harder problems to solve, because the top VCs skim off all the best deals, leaving the lower-tier firms exactly the startups that are likely to blow up.

For example, lower-tier firms are much more likely to pretend to want to do a deal with you just to lock you up while they decide if they really want to. One experienced CFO said:

The better ones usually will not give a term sheet unless they really want to do a deal. The second or third tier firms have a much higher break rate-- it could be as high as 50%.

It's obvious why: the lower-tier firms' biggest fear, when chance throws them a bone, is that one of the big dogs will notice and take it away. The big dogs don't have worry about that.

Falling victim to this trick could really hurt you. As one VC told me:

If you were talking to four VCs, told three of them that you accepted a term sheet, and then have to call them back to tell them you were just kidding, you are absolutely damaged goods.

Here's a partial solution: when a VC offers you a term sheet, ask how many of their last 10 term sheets turned into deals. This will at least force them to lie outright if they want to mislead you.

Not all the people who work at VC firms are partners. Most firms also have a handful of junior employees called something like associates or analysts. If you get a call from a VC firm, go to their web site and check whether the person you talked to is a partner. Odds are it will be a junior person; they scour the web looking for startups their bosses could invest in. The junior people will tend to seem very positive about your company. They're not pretending; they want to believe you're a hot prospect, because it would be a huge coup for them if their firm invested in a company they discovered. Don't be misled by this optimism. It's the partners who decide, and they view things with a colder eye.

Because VCs invest large amounts, the money comes with more restrictions. Most only come into effect if the company gets into trouble. For example, VCs generally write it into the deal that in any sale, they get their investment back first. So if the company gets sold at a low price, the founders could get nothing. Some VCs now require that in any sale they get 4x their investment back before the common stock holders (that is, you) get anything, but this is an abuse that should be resisted.

Another difference with large investments is that the founders are usually required to accept "vesting"-- to surrender their stock and earn it back over the next 4-5 years. VCs don't want to invest millions in a company the founders could just walk away from. Financially, vesting has little effect, but in some situations it could mean founders will have less power. If VCs got de facto control of the company and fired one of the founders, he'd lose any unvested stock unless there was specific protection against this. So vesting would in that situation force founders to toe the line.

The most noticeable change when a startup takes serious funding is that the founders will no longer have complete control. Ten years ago VCs used to insist that founders step down as CEO and hand the job over to a business guy they supplied. This is less the rule now, partly because the disasters of the Bubble showed that generic business guys don't make such great CEOs.

But while founders will increasingly be able to stay on as CEO, they'll have to cede some power, because the board of directors will become more powerful. In the seed stage, the board is generally a formality; if you want to talk to the other board members, you just yell into the next room. This stops with VC-scale money. In a typical VC funding deal, the board of directors might be composed of two VCs, two founders, and one outside person acceptable to both. The board will have ultimate power, which means the founders now have to convince instead of commanding.

This is not as bad as it sounds, however. Bill Gates is in the same position; he doesn't have majority control of Microsoft; in principle he also has to convince instead of commanding. And yet he seems pretty commanding, doesn't he? As long as things are going smoothly, boards don't interfere much. The danger comes when there's a bump in the road, as happened to Steve Jobs at Apple.

Like angels, VCs prefer to invest in deals that come to them through people they know. So while nearly all VC funds have some address you can send your business plan to, VCs privately admit the chance of getting funding by this route is near zero. One recently told me that he did not know a single startup that got funded this way.

I suspect VCs accept business plans "over the transom" more as a way to keep tabs on industry trends than as a source of deals. In fact, I would strongly advise against mailing your business plan randomly to VCs, because they treat this as evidence of laziness. Do the extra work of getting personal introductions. As one VC put it:

I'm not hard to find. I know a lot of people. If you can't find some way to reach me, how are you going to create a successful company?

One of the most difficult problems for startup founders is deciding when to approach VCs. You really only get one chance, because they rely heavily on first impressions. And you can't approach some and save others for later, because (a) they ask who else you've talked to and when and (b) they talk among themselves. If you're talking to one VC and he finds out that you were rejected by another several months ago, you'll definitely seem shopworn.

So when do you approach VCs? When you can convince them. If the founders have impressive resumes and the idea isn't hard to understand, you could approach VCs quite early. Whereas if the founders are unknown and the idea is very novel, you might have to launch the thing and show that users loved it before VCs would be convinced.

If several VCs are interested in you, they will sometimes be willing to split the deal between them. They're more likely to do this if they're close in the VC pecking order. Such deals may be a net win for founders, because you get multiple VCs interested in your success, and you can ask each for advice about the other. One founder I know wrote: