Having a front-row seat to startup-investor deal negotiations means that lawyers get a good overview of who holds the cards in the startup ecosystem.
Amid the record-breaking deal frenzy of 2021, that was founders. But as new rounds have slowed down and shrunk in size in 2022, the power shifted back to investors, according to a new analysis by Orrick, Europe’s most active law firm in VC deal financing.
Based on an analysis of more than 500 deals worth over $12bn that Orrick completed in 2022, here’s what’s happening to term sheets.
As the prospect of downrounds grows, investors upped their anti-dilution protection
Anti-dilution rights make sure investors are still compensated if a startup raises at a lower valuation than the one they invested at. In the context of public tech valuations tanking and a handful of dramatic downrounds among European startups, investors began negotiating more aggressive anti-dilution protections in 2022 to mitigate against a fall in the value of their investments.
Orrick only started tracking the numbers for the types of protections this year, but its partners say there’s been a considerable uptick in investors getting "creative" with different strategies.
Historically, investors wanted more aggressive protections at early stages, when business models aren't proven and companies aren't generating revenue.
“But interestingly, this year we’ve seen investors get more creative with introducing protections at Series C and D stage, where a company has been around a long time,” Orrick partner Jamie Moore tells Sifted.
In 2022, 35% of seed-stage deals featured no anti-dilution protections at all, a figure that Moore tells Sifted was “much much higher” in the 2021 deal frenzy, with “more people prepared to chuck money at companies without much intelligence on them”.
Fewer drag-along clauses at early stages give founders less power
In 2021, founders negotiated more power through drag-along clauses, and last year, the trend reversed.
These clauses give majority shareholders the ability to force minority shareholders to participate in a sale or liquidation. They can include a stipulation that the founders have to consent to starting the drag-along process, but in 2022 those veto rights became rarer; only 31% of clauses at seed and Series A included veto rules, compared to 40% in 2021.
Founders under more pressure from investors demanding more warranties
Warranties are seen as a particularly un-founder-friendly investor protection as they involve making founders personally liable for their company’s performance. And when we say liable, we mean suable by investors.
Over the past few years there’s been a growing movement towards rewriting the way that warranties work, so they're less about who’s liable if a company’s performance doesn’t live up to its investment-stage forecasts and more about lifting the hood so investors can see more company metrics when they invest.
In 2022, founders were required to stand behind warranties in 44% of venture deals — a figure that Moore says has dramatically increased from around 0-10% in 2021. He also says that most of these warranties came into play around Series C stage, while companies at Series D and beyond didn't have founder warranties.
“As companies struggle and investors get more cautious, there’s a degree of not wanting to be completely exposed on these metrics,” Moore says.
He does, however, expect this 2022 trend to reverse, after the BVCA (British Private Equity and Venture Capital Association) recently published fresh guidance on model documents for venture deals that states the market standard should be no founder warranties at Series A and B stage. Instead, it proposes making company metrics more available to investors to make due diligence easier when closing deals.