A Deep Dive into Clubhouse's Series A Led by a16z
I review publicly available VC fundraising documents and analyze the deal terms.
Clubhouse recently raised on a $100M valuation from Andreessen Horowitz within a few weeks of launching their product.
This was a hot round and competitive in all respects. Benchmark and a16z pulled out all the stops to win the deal (even a personal favor from Kevin Hart!).
But how did Clubhouse fair on the deal terms? And how much leverage did they have after signing a term sheet with a16z? Let’s jump in.
This series is dedicated to reviewing the terms of recent venture capital deals. I’ll analyze key deal terms, assess founder/VC leverage, and shed light on how competitive the round was compared to other deals I’ve seen.
First, let’s go over a few key metrics for assessing a deal:
Economics.
Valuation: What was the increase in valuation from the prior round?
Ownership: How much ownership did the founders give up?
Liquidity: What is the potential for founder liquidity upon exit after taking into account investor liquidation preference?
Governance/Control.
Board Control: How much board control do the founders have?
Investor protections:
What can the founders do without having to go back to their VCs for approval?
Can they sell the company at whatever price they want?
Can they raise a round of funding from a new VC without approval (i.e., what if Clubhouse wants to go with Benchmark for the Series B)?
Can they still control employee compensation?
A few caveats before I dive in: I base this assessment on publicly available documents filed with the state of incorporation for each company. This is not the full set of terms for the round and there may be other terms that I don’t have access to. This article does not contain any third party insights or insider information.
Clubhouse: Series A Key Takeaways
Clubhouse received highly favorable founder-friendly terms and a16z only got basic protections.
Board Control.
The founders retained complete control with a 3:1 Board (three founders to one a16z director). This is extremely founder-friendly. VCs will often want an evenly distributed board between founders and investors such as a 2 founder/2 investor/1 independent board structure. This ensures that the VC always has the opportunity to win the vote at the board level. *Note that it’s possible Clubhouse has additional independent seats that are not listed in the public document.
An “independent” on the board is typically a person mutually agreed upon by the company and VC. Although this arrangement may seem fair, it’s common for an independent to side with the VC (not the company) on key decisions given their fiduciary duties to the stockholders. Companies should also be cautious of board observers. While board observers may not have a formal board vote, they can have the power to influence how the board votes on key decisions.
Why is this important?
The board has veto power over acquisitions and financings, approves equity grants, and hires/fires the management team. If you don’t want to get fired from your own company, push for board control. This will also give you more operational freedom to make decisions without running into roadblocks.
Investor Protections. a16z received fewer investor protections than a typical venture deal.
Normally, VCs negotiate for a laundry list of protections. These are things the company can’t do without investor consent, including selling the company, changing the board structure, taking on debt, increasing the equity pool, and raising future funding rounds.
How was Clubhouse’s deal different?
The founders have almost complete control over future fundraising rounds and have the power to raise money from any investor and at any valuation without a16z’s consent so long as it’s not “senior” to a16z (meaning the new investor can’t get paid out before a16z in an exit). This is rare. VCs usually fight to have a veto on future fundraises because they know they can use it as leverage at the next fundraising round to secure their spot as the lead and get favorable terms.
The founders have almost complete control to sell the company when they want to on favorable economics. a16z can get their money back or share in the proceeds with the founders, but they can’t veto the acquisition. This is extremely founder-friendly. VCs usually ask for a blanket veto to prevent sales that don’t provide them adequate returns. Alternatively, VCs may ask for a minimum valuation for the sale before they can veto. a16z has neither.
The founders have great operational flexibility. There are no vetoes on debt, equity grants, or other day-to-day functions that most VCs ask for.
a16z still received some basic protections. The founders can’t take money off the table without a16z’s consent and they can’t increase their employee equity pool without giving a16z an adjustment in ownership for 18 months (this protects a16z’s ownership in the company). The lesson here: the company can’t go on a hiring spree and should be mindful of the size of equity grants for new hires.
Note however that in most financings, these protections are based on a simple majority approval of the investors. Companies typically negotiate it this way so that no one investor has veto power. Here, it’s approval of a simple majority, but that majority must specifically include a16z, which is unusual and could give a16z a lot of power. This tells me that a16z had some leverage and negotiated for additional rights that are likely in the non-public deal documents. Note that it’s also only for a limited period of time.
Valuation.
The Series A investors paid 7.8x more per share than the Series Seed investors. Nice step-up for the early investors!
Ownership.
The investors own approximately 30% of the company (not counting any secondaries). This gives Clubhouse ample dilution room to raise more capital in the future. Founders typically give up ~15-30% in each fundraising round. Clubhouse should have given up 30-60% by now given that they did at least one prior round. They were able to retain more ownership in the Series A because of the high valuation ($100M) relative to a16z’s investment amount ($10M).
The deal leaked two weeks before it officially closed on May 29, 2020. Clubhouse was able to successfully negotiate a founder-friendly deal and retain ownership and board control while a16z maintained some basic protections.
Last note: Keep in mind that founders will lose some control with each funding round as the company gets more mature, especially as they raise money from large check late-stage investors who expect more investor protections and balance at the board level. That’s why it’s important for founders to give extremely careful consideration to who they select to be on their board so that they have allies in the board room. This will also give them more flexibility when negotiating terms.
If there are other companies you want me to look at, please comment below.
Last caveat: None of this should be considered legal advice and all opinions are my own.
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