Jun 20, 2015 · 6 minutes

On Wednesday, this year’s Pandoland concluded in Nashville in dramatic fashion when the winner of the startup competition, Umano, had to negotiate the terms of its $100,000 award with the panel of venture capitalists that had selected it from the nine other very worthy finalists.

The fireworks began when Jonathan and Alex Torrey, the brothers who founded the designer t-shirt company, gave their first “ask” for the $100K to be part of an uncapped, eventual $500,000 convertible note. When the VC contingent (made up of Spark’s Bijan Sabet, Vegas Tech Fund’s Zach Ware, Jumpstart Foundry’s Vic Gatto, Exhilarator’s Michael Goldstein, TechSquare Labs’ Dr. Paul Judge, and BIP Capital’s James Hamilton) pushed back, August Ventures partner and part-time Harvard Business School lecturer David Hornik jumped onto the stage to stand in as Umano’s council.

And that’s were things really got fun.

“They’re going to build immense value with the $100K that you are going to give them, so what are the terms that you think are rational for them where you are going to get a return and they are going to build a big business, so then they have something to go off of,” Hornik said to the panel.

The sticking point of the whole negotiation rested on whether or not the convertible note, which converts to equity at the next priced equity round, would have a valuation cap, the valuation amount at which the note converts. Umano wanted to have it cap-less, and the VC panel wanted the note to have a $5 million cap.

If you’ve been following the venture capital blogosphere for the past month, you’d know that there has been a pretty loud call coming from some of the VC blogs about what and what doesn’t make sense for entrepreneurs when negotiating the terms of a convertible note. One of the key issues that Upstart Ventures’ Mark Suster broke down had to do with liquidation preferences, advising founders to include a note that their investment will convert to equity at a 1X liquidation preference. Brad Feld followed up Suster’s post to break this down even more, discussion how returns and be affected, and can screw the entrepreneur, whether or not the convertible notes converts at a pre- or post-money valuation.

As Feld said in his blog, “I think we are just starting to see the complexity, side effects, and unintended consequences created by the massive proliferation of convertible notes over the past few years.”

“I’m pretty mellow about them as I’ve accepted that they are part of the funding landscape, in contrast to a number of angels and VCs who feel strongly one way or the other,” Feld added.

At Pandoland, the Umano ask created a unique situation that showed just how nuanced and potentially confusing a problem note negotiation can be On one side, you had a group of VCs acting as angels and on the other, a VC, acting as a founder’s advisor. Almost everyone involved was in some way acting against their usual interests. As Bijan Sabet said, “99 percent of the time, I do equity.”

Vic Gatto started the discussion down the wormhole when he said, “I’m not comfortable with a an uncapped note, and I’m not going to do an uncapped note.”

“My view is that the cap will help you grow the company and build more value. I should get get some benefit from that, putting in money today,” he added.

When asked what he thought would be a fair cap, Gatto responded, “I just want to establish that its not fair to have no cap at all.”

Hornik was quick to respond. “To put it in terms of fairness, It’s not a fairness question,” Hornik said. “Some of the greatest companies we’ve ever seen have had uncapped note. There’s been perfectly fair outcomes in that context.”

“If it’s not something you’ll agree to, that’s a different story,” he said. “That’s fine. It’s not unfair. It’s perfectly fair.”

After conferring multiple times, as moderator Paul Carr said at one point, like a congressional hearing, the the VCs gave a counteroffer.

But then things took another turn. “Bijan knows my rant on capped notes,” said Hornik later in the negotiation. “The reality is that the capped note is a tails you win, heads I lose situation.”

So, seemingly through Hornik’s advice, Umano asked to do a priced round with a $4.5 million valuation. This led Sabet to respond that he thought that it wasn’t a bad idea, but thought it had a major downside because, as compared to the convertible note process, a priced round of funding includes a long, often expensive legal process — the reason that most angels and early stage company’s do convertible notes. “It’s just exhausting,” Sabet said. And he had a point, for the amount of money being invested, a longer priced round process kind of defeats the purpose and usefulness of the entire prize.

To Sabet’s “exhaustive” remark, Hornik — a venture capitalist mind you — said, “I don’t think that’s a legitimate claim. I used to be an attorney, and I think that argument that it’s a bunch of legal work is just bullshit.”

“Then you’ve been ripping us off for year’s then David,” Sabet responded jokingly referring to the legal costs involved in the process.

“This is an argument to justify VCs winning at any instance,” Hornik added.

“This is incredible, it’s like VC on VC violence, or Celebrity Death Match,” Carr interjected.

However, eventually, Hornik and the Torrey brothers agreed that the whole debate had gone above their comfort level. And, the VCs deal of a $100,000 investment, with a cap of $5 million and a 15 percent discount, was accepted.

But the whole thing was surreal, and a peak inside just how confusing the entire negotiation process, involving angel and venture rounds, can be for both entrepreneurs and the investors.

At one point in the proceeding, Bezar’s Bradford Shellhammer grabbed a mic and started humming what sounded like a version of the Jeopardy theme from someone who had never actually watched the show.

“This is one of the most amazing things I’ve seen,” said Paul Carr. “David Hornik, who has no skin in the game, just jumps on stage and he’s advising on the deal.”

“And to think, just last week, he was only an attendee,” added Sarah Lacy pointing out that Hornik jumped into a panel after others had their travel plans thrown to hell by Midwest weather.

“Yeah, I was an attendee, I paid for this experience!” Hornik laughed.

But in the end, the moment was all about Umano, and walked away with $100,000 from a great group of VCs. “We are all very excited about what you are doing,” Bijan Sabet said at one point. “We wouldn’t be doing the deal if we weren’t.”