But does India’s recent “online gaming law” also ban prediction markets? Does it ban crypto derivatives? There is definitely something to discuss here since Probo, an Indian prediction market, has suspended activity in response to the ban.

This is my two step conclusion:

Step 1: Online lotteries, sports betting, and stock derivatives are not banned by the online gaming law since they are not covered by the key definition of “online money games”; the reason: “online money games” means only literal “games” which involve betting/gambling, i.e. the RMG sector.

Step 2: If online lotteries, sports betting, and stock derivatives are not covered, then it logically follows that prediction markets are not covered, since they are not “games” either. The same conclusion should apply to crypto derivatives.

It almost seems absurd to say that the new online gaming law does not ban sports betting, but bans “fantasy” formats like Dream11. However, this is actually the right conclusion (imho) if you faithfully apply the rules used to interpret laws.

Under the online gaming law, “online money games” are defined as: “an online game, irrespective of whether such game is based on skill, chance, or both, played by a user by paying fees, depositing money or other stakes in expectation of winning which entails monetary and other enrichment in return of money or other stakes; but shall not include any e-sports”.

This is a pretty wide definition, so let’s try to interpret the definition by looking for a limiting principle, i.e., what is not covered by the definition?

To me, the main limiting principle is: to be an “online money game”, it has to be a “game”. Not “scheme”, not “arrangement” (which are the words Parliament or regulators usually use when they want to capture a wide category of things), it has to be a “game”.

So - are online lotteries covered by the ban? Is online betting on sports covered? Are stock market derivatives covered? These are clues to interpret the word “game”.

If these formats are considered “games”, then they would be banned by the online gaming law. However, they should not be considered “games” because:

> It cannot be the intent to cover lotteries in the definition of “online money games”, since online State-run lotteries are explicitly permitted under the Lotteries (Regulation) Act 1998. If you read the word “game” in the definition of “online money games” to include lotteries, then you have two laws in direct conflict with each other. When courts see the conflict, they will conclude: “the lottery regulation law is more specific, so we cannot read the online gaming law (which is more general) to override the lottery regulation law”. In other words, it would be absurd for Parliament to intend that the Union-sanctioned and State-run online lottery business be banned overnight, unless Parliament said so explicitly (and…they did not). Parliament would either have carved online lotteries out of the “online money game” definition explicitly (which again they did not), or never intended to cover it in the first place.

> Similarly, it cannot be the intent to cover stock market derivatives in the definition of “online money games”. The derivatives market is very active, it is an important part of corporate finance and retail investment in India, and it is actively regulated by SEBI. Derivatives contracts (even though they are otherwise potentially invalid wagers) are specifically blessed as valid contracts under another law, the Securities Contracts (Regulation) Act, 1956. Again, it cannot have been the intent to ban the derivatives market overnight. Again, Parliament would have either carved the  derivatives business out of the “online money game” definition explicitly (which they did not), or never intended to cover it in the first place.

> Sports betting is already banned under the Public Gambling Act, 1867 and various State laws that adopt/replace it. How do we read “overlapping bans” like this? There are two key points: (i) Parliament is presumed to be aware of existing laws, and (ii) when interpreting laws, you should give meaning to both overlapping laws without creating redundancy. Parliament’s intent is not to ban the already banned (and heavily policed) sports betting sector, but to clarify its stance on the RMG sector (which has grown enormous due to enabling court rulings and massive VC funding, and which Parliament sees as an emergent social evil). This being Parliament’s intent, the only way to give meaning to both these laws is by reading “games” in the online gaming law to exclude sports betting.

The above establishes that there is some limit to the “online money games” definition: derivatives, lotteries and sports betting are not considered a “game” under the online gaming law. Result: Parliament did not ban regulated derivatives (i.e., regulated under the Securities Contracts (Regulation) Act, 1956) and online State-run lotteries (i.e., lotteries run under the Lotteries (Regulation) Act 1998) under the online gaming law. A more aggressive interpretation is that under the online gaming law, Parliament did not ban any derivatives or lotteries, whether previously regulated or not.

Now, how do we discover the limiting principle, make further sense of the word “games”, and conclude that the more aggressive interpretation is correct?

Step 2 of the analysis applies further legal interpretation rules which clearly demonstrate that “games” means only literal “games” and not financial transactions like trading derivatives:

> The online gaming law criminalizes running of “online money games” (i.e., not only can you be fined, you can go to jail if you break the law). Words in criminal laws must be interpreted strictly and narrowly, and cannot be given expansive interpretations; any ambiguity must favor the accused. So “games” should be read to be quite literally just “games”. The normal meaning of the word “games” does not cover investing in a financial instrument.

> We have to assume Parliament drafted carefully and with intention when drafting criminal statutes. If it wanted to ban every kind of online wagering under the sun, Parliament could have simply said that “wagering transactions in an online context are now banned”, and carved-out regulated derivatives, State-run lotteries etc. But Parliament did not do so - instead, it described wagers in a roundabout way, and only banned them if they come up in the context of online “games”.

> The scheme of the online gaming law is clearly all about literal “games”: it draws a line between kosher games where people are actually playing a game and competing, with no betting/gambling involved (i.e., e-sports) and other games, where there is an element of betting/gambling.

> It is very apparent from its recitals that when the online gaming law refers to “games”, it means literally “games”. For example, in the very first recital of the law, it says that online gaming is one of the “dynamic and fastest-growing segments of the digital and creative economy” - is the unregulated derivatives market part of India’s “digital and creative economy”? A few recitals later, it is recorded that the “games” in question “often use manipulative design features, addictive algorithms, bots and undisclosed agents” - does it sound like they are describing a derivatives transaction between a crypto hedge fund and a trading desk? I am yet to see derivatives marketed using “celebrity and influencer endorsements”, as another recital describes the marketing of online games. Based on these clues, it is clear that the “games” which the online gaming law wants to put a stop to is the addictive kind of online game which you find on RMG platforms, not financial activity.

> A press release by the Indian information & technology ministry causes some confusion by claiming that the online gaming law bans online lotteries, but also claiming that the bill is intended to “protect the youth from online RMG apps” (which is a very specific industry jargon, and based on the industry context, again indicates that they only intend to ban literal “games”). Note such that press releases are given low weightage by courts when interpreting laws.

Since crypto derivatives are easy to characterize as financial transactions and not “games”, and since prediction markets are conceptually closer to derivatives marketplaces than to “games”, my take is that the online gaming law does not ban them.

To conclude, we must ask: is this just a case of sloppy drafting? Did Parliament intend to ban crypto derivatives and prediction markets, but just fail to communicate it properly? It’s quite likely. However, in a society of laws, Parliament should not be allowed to benefit from its own sloppy drafting (i.e., “I wrote X but I actually meant Y”). In reality, the threat of jail time will scare founders away from taking aggressive legal calls on this front. A spirited constitutional challenge to the online gaming law is brewing as we speak, and will hopefully make this blog post academic.

Part I: Why MFN?

An investor using an MFN simply says:

“If you give a future investor a sweeter deal than the deal you gave me, then you have to let me upgrade my deal to the sweeter deal”.

Example 1

2023: Investor A invests in Company X through a SAFE at $50M valuation cap with an MFN.  

2024: Investor B invests in Company X through a SAFE at $25M valuation cap. 


The result? Investor A’s valuation cap is reduced to $25M due to the MFN.
 


Example 2  

2023: Investor A invests in Company X through a SAFE at $25M valuation cap with an MFN.  

2024: Investor B invests in Company X through a SAFE at $25M valuation cap but with Investor B’s shares converting at a 20% discount to the series A round price if the series A round size is larger than USD $25M. 


The result? Investor A can get the same 20% discount that Investor B gets.  

Note that Investor A is getting an economic upgrade here. It could also be a rights/governance upgrade.

For example, if Investor B had information rights but Investor A did not, Investor A would get information rights too, because of the MFN. So there are two kinds of MFNs - MFNs on economic terms and MFNs on governance terms.  

When an MFN applies to economic terms, it is a zero-sum game between the investor and the founder - in the above example, the founder gets more diluted because of the MFN. An MFN on governance terms is similarly zero-sum for the founder, but the damage is less “obvious”.  

There can be a few impulses behind an investor’s ask for an MFN. I have broken them down into two broad “themes”.  

The “Uncertain Terms” Theme  


#1 “I am investing very early & I am founder-friendly so I recognize that we don’t have the time to negotiate terms. I’m going to live with no/minimal/founder-friendly terms now, but when you raise more capital later on and negotiate terms with your next investors, make sure I am treated as well as they are”.



#2 “It’s super-early and hard to price this deal now…how about we price it now at the SAFE cap you want, but give me an MFN? That way, if another VC sets a price that is lower than my SAFE cap when you go to the market again, I should get the same price as that VC gets”.  

Note: The “classic” example of MFN in #1 is YC’s standard deal - $125,000 for 7% of the project’s stock and a further $375,000 on an uncapped SAFE (but with an MFN, meaning this SAFE could convert at the lowest pricing the project gets after entering YC). The MFN in #2 is a strong downside protection and it has become a standard feature of pre-seed SAFE financings because they are highly risky and hard to price - more on this below.  

The “Fairness” Theme 




#3 “We have spent the last 3 weeks fighting tooth & nail over every single investor right in this side letter. I don’t agree with your position, but I can give up all these points in order to close. You better give me an MFN though, so that if you give these rights to other investors in this round, I get equal treatment!”.  

#4 “We’ve had a long negotiation and there is still a big bid-ask spread. I really want to get into this round so let’s close at your suggested price. But if you give another investor a better price next month, I will look like a schmuck. So give me an MFN as schmuck insurance”.  

#5 “I am going to commit early for a significant portion of your pre-seed round. But I don’t want to a situation where you are looking for a lead, say 2 or 3 months later, and then a tier 1 VC wants to lead at a lower valuation than the one you gave me, and you end up saying yes. If that happens, I should get the same pricing that the lead does, since I took the most risk by committing early on”.
 


#6 “We’re significant investors in this round/project/fund and we believe all investors should be treated the same (or at least, all investors with the same cheque size). As a matter of fairness, if you treat any other investors more favorably, we should receive the same treatment. So give me an MFN”.  

Note: The MFN in #5 is squarely applicable to the most common round structure for crypto pre-seed deals - a “rolling close” over months with a big group of investors, featuring more than one lead and some “almost” leads. The MFN from #6 is most commonly seen between investment funds and their LPs - this subset of MFNs deserves its own post and in fact, most of the literature on MFNs is actually about MFNs in investment fund side letters.  

Part II: Fair Enough?

Zooming out - MFNs try to bridge the gap between two investors who are being treated differently at different points in time (which differential treatment may seem subjectively “unfair” to the investor receiving less favourable treatment).  

But this begs the question - should investors be treated equally or fairly?

Since investor rights and the founder’s interests exist in a zero-sum game, the founder’s incentive is (rationally speaking) not to treat investors fairly, but to be able to offer different deals to different investors. This means founders (and investors!) will seek differential treatment depending on the commercial scenario.

Let’s map some of these scenarios.  

Scenario #1: The investor who brings the most benefit to the founder/project gets the best deal, and the investor who brings the least benefit gets the least favourable deal (for example, if Coinbase Ventures is investing into a wallet/on-ramp project, they can ask for better terms due to the semi-strategic nature of their deal by dangling the carrot of integrations). In other words, strategic investors can (and very often do) cut better deals for themselves.  

Scenario #2: The investors who invest the highest amount/have the largest stake are able to get a better deal than the investors who invest less/have a smaller stake - this is self-explanatory.  

Scenario #3: An investor who takes more risk will want to be treated better than (or at least the same as) an investor who invests at a more de-risked point (see: Paul Graham’s seminal “High Resolution Fundraising” blog post).  

Note: Assuming growth is up and to the right, as a general principle the earliest investors who take the most risk get the best terms (i.e., lowest entry valuation) and later investors who invest at progressively less risk levels get worse terms (i.e., more expensive valuation). Viewed from this lens, an MFN on economics for early investors is simply a tool to ensure that this general principle is respected across a certain time frame - more on that below.  

Scenario #4 When a founder has a lot of negotiating leverage, he/she is able to command terms and offer differential deals to investors; when the founder has less negotiating leverage, the tables are turned and an investor with strong negotiating leverage can command differentiated terms (for example, an investor providing bridge financing when runway is low, or a marquee VC leading a big round when competitors have recently also raised big rounds in a “winner takes all” market).  

Note: This scenario has a time aspect - as a project matures, the founder’s negotiating leverage increases (especially against smaller investors, who are basically just happy to receive valuation mark-ups). You can see this playing out in investment docs for series A deals - investors are divided into two classes, the “Major Investors” and the others, each having different rights. It gets more pronounced in growth stage investment docs, where you see fine-grained distinctions between various classes of investors based on their stake/capital invested, and the rights available to these classes. Series A & later investment documents almost never have MFNs, because by this point, unequal treatment of investors (in the context of governance rights) becomes an immutable law of physics.  

This brings us to an interesting point: MFNs on economics function as downside protection and they seem standard in seed/pre-seed SAFE deals, yet you rarely see an MFN on economics in any series A or later deal.

Why? I think the answer is two-fold.  

Firstly, in priced/preferred stock funding rounds, the “market” & customary investor protection when a down round happens is a broad-based anti-dilution right.
MFNs on economics are deviations from this “market” standard and are hence unacceptable.

Note: From a founder perspective, a SAFE with an MFN on its valuation cap is almost identical to the most aggressive form of anti-dilution protection - the much-loathed “full ratchet”. See Example 1 in Part I above.  

Secondly, in the context of pre-seed & seed, the market sees a series A deal as a de-risking event. Before series A, there is a lot more risk, so stiffer downside protections are accepted, and post series A, downside protections revert to the customary broad-based anti-dilution right.  

Part III: SAFE + MFN = Max Dilution

An interesting point is that the anti-dilution right is intended to do exactly that - protect an investor from excessive dilution caused in a down round by giving the investor a small top-up.

But it is well-known that when successive rounds of SAFE financing happen, even if some are down rounds, early investors do not get diluted by the new SAFEs - only the founding team and stock option pool get diluted. So an MFN tied to a SAFE’s valuation cap does not function as a downside protection for investors. It is more like a safety net for the investor’s pricing judgment when more data (i.e., an externally set benchmark) becomes available  

That said, if an MFN is triggered when a project does a down round with successive SAFEs, the dilutive impact on the founder’s stake is quite heavy. See illustration below.  

Early Investors: Investor A invests $800,000 & Investor B invests $1M at $22.5M cap SAFE, each with MFN.
Initial Cap Table: Investor A holds 3.55%, Investor B holds 4.44%, and Founder holds 92.01%
Later Investors: Investor C invests $700,000 and Investor D invests $500,000 at $14M cap SAFE
New Cap Table: Investor A holds 5.7%, Investor B holds 7.14%, Investor C holds 5%, Investor D holds 3.57% and Founder holds 78.59%

What are the implications of this?  

Implication #1 Founders should very carefully think about the risk of raising through successive SAFEs with MFNs at excessive valuations that the project cannot grow into or maintain – it’s possible they may get significantly diluted if there is a correction/down round. This is a risk call, ofc (you might be leaving significant value on the table if you let downside risks like future MFNs issues dictate your pricing).

Implication #2 Early investors, on their part, should consider waiving MFNs when triggered in such down rounds – early investors don’t get diluted anyway, and it is not in the investors’ interests to have founders heavily diluted and poorly incentivized. For example, if there have been significant & unforeseen regulatory headwinds + the project has pivoted and is now raising a new round for a new business model more than 2 years after the initial raise, founders might be justified in asking early investors to waive their MFNs.  

A quick drafting tip here to ensure an MFN is founder-friendly – if a group of investors is given an MFN, the founder should be allowed to waive the MFN for an entire group as long as the majority of the investors (by $ value invested or implied stake) consent to it, and as long as the waiver is equally applied to that entire investor group. MFN waivers usually occur in the course of a crucial funding round in a project’s lifecycle - this waiver mechanism ensures that a minority of investors in group do not hold-out, re-trade, or derail the funding round.  

Part IV: MFNs & Token Rights

There are two important differences between crypto pre-seed/seed & similar web2 deals:
 


#1 Investors use SAFEs for successive rounds of funding, and

#2 Investors get tokens rights, with the investor’s token allocation typically calculated as a fraction of the investor’s equity stake (this called a token conversion ratio – for e.g., 1% of the token supply for each 3% block of an investor’s equity stake is a 3:1 token conversion ratio).  

Investors often view the token as the primary exit mechanism. Accordingly, token rights are subject to a push and pull of two competing incentives - investors want the largest possible token holding, yet at the same time,  tokenomics cannot be “insider heavy”, they have to be sustainable i.e., the founding team should be well-incentivized, the airdrop should create a broad-based liquid market, and the project should have a healthy token treasury for its business needs.  

Given the tokenomics concerns and the correlation between an investor’s equity stake and an investors’ token rights, founders need to be sensitive to the MFN’s potential impact on tokenomics (i.e., if an investor’s MFN on SAFE economics is triggered, that investor will also get more tokens).

This is not only a founder concern, but sophisticated investors also focus on this – balanced tokenomics is important for the project as a whole, especially at a time when the market hates “low float, high FDV” TGEs.  

Investors also ask for MFNs on the token rights themselves (as opposed to SAFE economics or governance rights).  

Here’s an example of an MFN on token rights at work: if Investor A has a 3:1 token right and an MFN, and Investor B gets 2:1 token rights in the next funding round, Investor A can now claim 2:1 token rights too. Similarly, if Investor B has a more favorable unlock schedule (or an ability to stake unlocked tokens), Investor A gets these benefits too.  

MFNs on token rights are sometimes hotly contested in negotiations!

Founders push back because they want the flexibility to entice Investor B with a sweeter deal on the token side (for e.g., what if Investor B is extremely deep-pocketed, bullish on the space, and is willing to invest a huge slug of capital at a very friendly valuation?). This will not be possible if they need to extend the same terms to their earlier investors too, resulting in dilution across the board.

Founders also push back because they need to give differentiated token rights to market makers, KOLs, CEX venture arms, integration partners who might bring in TVL etc. while building out the project and preparing for a successful TGE. They don’t want to give the same token rights to multiple early investors too!

Founders push back because they do not want to keep going back to a large set of early investors to waive their MFN for each such deal (reminder: every instance where the founder needs to request a waiver exposes the founder to hold-outs, re-trading, delayed responses, and similar hurdles to deal-making). They ask investors to trust their judgement and let them act in the project’s best interests.

Founders also fear that this kind of MFN can have a cascading effect in a down round - multiple early investors suddenly get more tokens and this may result in unbalanced tokenomics. 


On the other hand, early investors might be willing to live with some carve-outs to their MFN on token rights but generally insist that (as a matter of fairness) later-stage investors who take lesser risk should not get more favorable token rights.  

How should this negotiation resolve?  

In my view, early investors should be willing to live without an MFN on the token conversion ratio because their economics are protected through their own token conversion ratio (3:1 or 2:1 or whatever it may be). In other words, the absolute number of tokens they receive will not change simply because someone else is given a better deal. The absolute number of tokens an early investor receives is a function of how much dilution their equity stake suffers as the project raises funds. This means that equity valuations are the relevant metric, not token conversion ratios.  

As a result, early investors should give founders the flexibility to strike deals with more favorable token conversion ratios with other stakeholders because these “more favorable” deals usually come at the expense of the founder (thereby incentivizing the founder to be tightfisted, not generous).  

That said, early investors should not give founders the flexibility to give later investors shorter unlock periods or the ability to stake locked tokens – while it’s a subjective take, in my book this is patently unfair to early investors.  

Part V: Conclusion

The private funding market in crypto is volatile. The early years of a project’s life could see a bull market and a bear market in quick succession, with the founder’s negotiating leverage oscillating wildly – meaning that MFNs are often “in play”. Equity dilution, MFNs, and tokenomics are tightly correlated, so it is important for a founder to navigate this thoughtfully.

PS: Apologies for the length! Needless to add, the views I have expressed here do not reflect the views of my employer.

So with nothing else to do, here’s my take on why founders shouldn’t give investors veto rights over new fundraises in early stage deals when the investor group holds 25%< of a company. It’s a pretty standard veto right, but imo, this is a significant legal point that founders should fight for.

Context

The smoothest deal-making experience is a first cheque / pre-seed deal with a SAFE. There are usually no or “lite” investor governance rights.

A little further down the line you get seed / pre series A / series A deals with leads or “Major Investors” demanding a veto over the company’s next fundraise - this is quite bad from a founder perspective.

Usually the veto reads like this:

“The company shall not change its capital structure without the Lead Investor’s consent”.

Two legal points to bear in mind here:

• 1/ Usually founder(s) can change the company’s capital structure (including green lighting a new fundraise) since he/she/they own >75% of the voting shares & control the board.

• 2/ As a corollary, investors holding >25% of the voting shares can block a change to the company’s capital structure - so they can block a new fundraise.

With this background, let’s look closely at a hypothetical new fundraise assuming this pre-closing cap table:

Founders - 75%
Option Pool - 10%
Existing Lead Investor - 10%
Smaller Angels / Pre-Seed - 5%

Three “key” decisions need to be made regarding the new fundraise: pricing, round size, and new investor(s) profiles & allocation.

In our hypothetical, founders can unilaterally make the “key” decisions when structuring the new fundraise - unless the Existing Lead Investor has the veto on new fundraises.

Incentives

To understand who should ideally make these decisions (or, who should be able to block the decision) we must first ask - what are the incentives / dynamics at play?

Both the founder and the Existing Lead Investor have the same primary incentive - getting as high a valuation in the new fundraise as possible so they are both diluted as little as possible.

What the Existing Lead Investor ideally should want here is an “external” lead investor to come in - ie ideally a top tier VC should diligence the company, price the round at a generous mark-up, and lead the round (note this is not necessarily a consensus view, and of course there are exceptions).

Existing Lead Investor’s secondary incentive is that showing a big valuation mark-up from an external investor looks good in front of their existing and prospective LPs.

The Existing Lead Investor would also expect / want to participate in the new fundraise using its pro rata pre-emptive right (rationale: follow-on in rounds with an externally priced mark-up also looks good in front of existing and prospective LPs + the famous power law). In fact, the founder would want this too, because the external investor would get comfort from seeing the Existing Lead Investor doing their “pro rata” and showing continued conviction.

When the Existing Lead Investor is not participating in the new fundraise, a third incentive that both Existing Lead Investor and founders share is: to balance dilution (the bigger the round size, the more the dilution) against the temptation to raise a bigger round to fuel aggressive growth and reduce insolvency risk.

Based on the above incentives / dynamics, imo the Existing Lead Investor can and should be very deeply involved in structuring the new fundraise, but they should not have a veto on it.

Rationale

But why?

Firstly, while there are many shared incentives, there are also some misalignments between Existing Lead Investor and the founders. In the presence of these misalignments, the Existing Lead Investor may use the veto to shape / influence the new fundraise to serve it’s own interests - making the veto dangerous.

To give some examples of the misalignments:

• 1/ If the Existing Lead Investor wants to lead the new fundraise, their incentive is not to give a fantastic mark-up but to give a slightly lower valuation so that they get a higher stake.

• 2/ If the Existing Lead Investor wants to invest again to keep their stake at the same level, they may want the round size and / or valuation to be low enough to ensure they keep their desired stake while using their available / earmarked dry powder as per their own internal portfolio construction requirements.

• 3/ If Existing Lead Investor is not participating, they may object to the new round size being huge (even though founder’s business judgment is that more capital is needed) to limit their dilution.

• 4/ The Existing Lead Investor may simply want more than their pro rata share of the new fundraise and object to a bigger slice of the new fundraise being given to an external lead. This would make it difficult for to negotiate with the external lead (many of them have a “minimum stake” requirement), or force the founder to take more dilution to accommodate the Existing Lead Investor’s ask and the external lead’s ask.

• 5/ The Existing Lead Investor may want to dictate the investor profiles & allocation for the new fundraise - for example, giving a big allocation to one of their own LPs because they are eager to please the LP by giving the LP a co-invest right in a “hot” company.

• 6/ I should also note some “strategic” founder incentives when selecting a lead for the new fundraise - these are potential zones of misalignment where the Existing Lead Investor may not be a good “fit” to get more than their pro rata share or a lead allocation for the next fundraise: 


  
  > founders want deep-pocketed investors who can support them repeatedly across a few rounds,


  
  > founders want investors who provide very patient capital & governance support unquestioningly in hard times (this is something the Existing Lead Investor may not always like :P), 


  
  > founders want investors who help the founder with operator expertise or similar benefits whenever required,


  
  > founders want investors who have powerful or strategic LPs who can step in and help the founder if needed,


  
  > founders might not want to concentrate too much power in the hand of one large investor on the cap table but keep it distributed amongst a group of investors (again, this is not a consensus view).

Secondly, the Existing Lead Investor is adequately protected no matter how the new fundraise is structured by customary rights such as the pro rata pre-emptive right (ie their minimum allocation is assured) and the anti-dilution right (ie their shareholding gets topped up if the new fundraise is a down round, and anyway the founder has no incentive to do a down round so this is not something an investor needs governance protection against).

Thirdly, it is fair and correct for the founder to have a determinative say over who the new investors are - for example, the founder may decide to take a lower valuation deal from a niche investor who is wiling to be more patient + makes concentrated bets + has more deep operator sector expertise, instead of a higher valuation deal from the Existing Lead Investor - while debatable, this is a legitimate business call that the founder should be allowed to make freely, as long as the founder has >75% of the voting shares.

In short, the Existing Lead Investor could end up misusing the veto on fundraising, is well-protected through other rights, and should not have a determinative say on the matter anyway.

Criticisms

There are obviously some criticisms and “it depends” situations. Noting three of them.

• 1/ It’s arbitrary to say that it’s okay for investors holding >25% to have a veto on fundraising, but if an investor group holds 25%<, they should not have the veto. The 75/25 threshold comes from law, not necessarily from commercial logic. In situations where the Existing Lead Investor put in significant capital (say, 15M in a pre-series A round) the sheer size of the cheque should give the investor more decision making power.

• 2/ In reality, Existing Lead Investors are unlikely to hold up a fundraise to demand more favourable terms for itself since that would cause a huge reputation issue. It would be considered “bad behaviour” which is untenable in an industry where players are playing a collaborative long-term game with each other repeatedly. Generally, existing investors are very keen to see an externally led mark-up and won’t detail the process. However this criticism gives rise to the counter-argument that if this is the case, then the Existing Large don’t need the veto anyway…

• 3/ There are some situations where it is actually okay for an Existing Lead Investor to use the veto to block a new fundraise: (a) if the new fundraise is being done at a lowball price by a related party of the founder, or (b) if the new fundraise involves a strategic investor or semi-competitor that is getting rights it shouldn’t have like detailed info rights, board seats, ROFNs, sensitive blocking rights, or (c) where the company plans to issue shares with a senior liquidation preference to the external lead - this is self-explanatory, or (d) where a very large stop option pool is being created before the new fundraise - this might benefit founders but will dilute existing investors.

Conclusion

While these criticisms are relevant, fundraising is such an important (almost existential) matter for a company that it should not be dictated by a stakeholder with potential misalignments who can live with a more narrowly tailored protection.

Obviously, arguments made above apply to companies where investor shareholding is around 20%. Once the investor group’s shareholding becomes larger, the company becomes board controlled (as opposed to founder controlled) and structuring a new fundraise becomes a board matter.

Btw the profile pic is my beautiful new NFT, Yumemono #4307 :)

There are 2 relationships at the core of a VC deal that the VC lawyer must pay attention to:

#1 the relationship between VC fund’s partner/associate who is leading the deal and the founder; this relationship is many-layered and evolving, and it is both personal and professional (sometimes very business-like, sometimes emotionally close and friendly, sometimes distant and resentful); partners and associates devote a lot of time to keeping this relationship strong as a tool to ensure the fund gets good allocation, so as a VC fund’s lawyer, you must not sour this relationship.

#2 the institutional + fiduciary relationship between the VC fund and LPs; the lawyer’s duty is to steward the LP’s capital by doing adequate due diligence and insisting on “market” legal protections, but it is easy to get paralyzed with this idea and become underweight an even more important duty - maximizing the LPs’ returns by taking calculated legal risks if needed.

When you’re in-house counsel for a VC fund you have to look at every negotiation through the lens of these relationships, and to do so you need to have better context on these relationships - how the relationship was formed, who holds the upper hand, what are the expectations/needs of the relationship, what is the state of the relationship, etc. The more context, information and background, the better informed the call you can take when a sticky negotiation point or risk call comes up.

And now here are a few anecdotes.

Anecdote #1 I was watching a panel at a crypto conference and one of the speakers was the GC of one of the Tier 1 crypto VC funds. During the Q&A, I asked her “What happens when a super-hot deals comes across your table, but you can’t diligence the founder because the founder is anon? How do you do a background check, how do you get comfort that the founder will be well-behaved because of social accountability in the small crypto VC world?”. She thought for a second and said “Well honestly, I think our LPs signed up because they want the alpha that comes from oftentimes anon founders in crypto so - they are ready to accept this risk, and I’m not too fussed about anon founders”. I was struck by how her answer was simply based on a super-pragmatic reading of the VC fund < > LP relationship - nothing more needed.

Anecdote #2 We were negotiating a side letter in a pre-seed deal. I wanted the founder to promise not to sell his stock and to be personally on the hook if he did. The founder pushed back hard and threatened to walk away (such founder lock-in terms are not standard in US VC deals, something which shocks me given how much hate founder secondaries get). The founder had a super credible background, this deal was right in the sweet spot of our fund’s mandate, and this deal was important to show our fund’s continued expansion and expertise in a new (but super promising) geographical area. We thought about it and we decided that the founder’s incentive was to keep maximal equity ownership until the project had some value, so he was unlikely to sell down before the series A round (at which time hopefully investors with more negotiating power would step in and implement a founder lock-in). That’s not to say we did not have negotiating power in this deal (we were co-leads in a pre-seed round), but the consensus was that it was more important to capture upside by closing the deal than to protect for this kind of downside.

All of this to say, reading context is matters a lot when negotiating a VC deal.

The VC fund I work at is not one of the funds that gets to pick and choose deals - we have to fight to get into competitive rounds. The dynamic in competitive rounds is that the founder has an oversupply of capital, so the founder can often pick and choose VCs who get to invest in the round. We can’t really dictate legal terms of these rounds to such founders - we may not be able to push too hard and might simply have to take what’s on offer, or else we might miss out on the deal - and that means missing out on the upside, which is an intolerable outcome for a VC fund. You need to really put yourself in the GP’s shoes and answer imaginary questions from the LPs: “What?! We missed out on THAT deal because the founder did not agree to XYZ legal term?”. Not a nice conversation to have…

Of course, this is not to say a VC lawyer should never push hard for reasonable legal protections (you miss 100% of the shots you don’t take), but you can never be predatory or unreasonably harsh (word gets around fast and we often desperately want to be seen as “founder friendly”). You also definitely cannot hold up a deal for unreasonably long (the company has a bunch of competitors and needs to focus time and money on building).

In addition, unless there is a really nasty red flag, the VC fund’s lawyer should not kill a deal.

Why should you never kill a deal? Mostly because of allocation. The VC game is essentially an access game. You have to get access to the best deals. Getting this access is quite hard. The fund works hard to convince the founder to take their money, citing their expertise, brand name, ability to help with BD, etc. etc. If it’s not a “hot” or competitive deal, the VC fund’s partner / associate has gone to significant lengths to zero in on the deal, often selecting a deal from hundreds of inbound decks, diligencing it over weeks, steering it through the IC. By the time this process is done and we get to the legal diligence and investment docs, you can be damn sure that this is where they want to put their money. Thus, the allocation is precious and valuable, especially in a “hot” oversubscribed round. At this juncture, the fund’s lawyer should not kill the deal and throw away the dearly won allocation.

Since we’re living in the “It Depends” Dimension, I have to backtrack a bit on that - you can kill a deal in select situations.

There was one project where the founders refused to provide details of management’s stock comp or confirm that management had entered into employment agreements with the company. Founders were super-slow in responding to legal DD questions and basically had a “take it or leave it” attitude. Founders insisted the stock option pool would be created post-closing, enriching management but diluting the VCs. Everyone got bad vibes very quickly and we passed on the deal.

Another anecdote (this time shared by a friend). The VC fund she worked at had finalized a deal and legal negotiations were ongoing. There was a big strategic already invested in the company. The VC fund asked that the strategic’s veto powers and governance rights be scaled back (makes a lot of sense since the strategic and the VC fund would be very misaligned on pricing the company and possibly even strategic direction). The founders and the strategic refused, and the VC fund passed on the deal. This is maybe one of the only examples I’ve heard of a deal falling through because of legal terms.

Okay, stream of consciousness over =)