March 25, 2005
VC Term Sheets: Dividends
Posted by Gordon Smith

Brad Feld is turning out the analysis faster than I can link to it! I am temporarily skipping his post on pay-to-play provisions to focus on his thoughts about dividend provisions. I thought he had skipped dividends altogether because, as he observes, "many venture capitalists –- especially early stage ones -- don’t really care about dividends." This is surprising to some people, but easy enough to understand. Venture capitalists are not investing for dividends, they are investing for capital appreciation.

Nevertheless, (almost) every venture deal specifies dividend rights, and some deals have very elaborate provisions. Dividend provisions have two main functions: (1) the dividend preference requires the company to pay specified amounts to the venture investors before the common stockholders get anything, thus deterring opportunism by the entrepreneurs; and (2) a cumulative dividend provision provide extra return to the venture capitalists in the event a downside liquidation, though not without some financial and psychic costs.

Finally, here is a nice tidbit from Brad: "Mathematically, the larger the investment amount and the lower the expected exit multiple, the more the dividend matters. This is why you see dividends in private equity and buyout deals, where big money is involved (typically greater than $50m) and the expectation for return multiples on invested capital are lower."

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