What to Expect from your Next Venture Capital Term Sheet

Posted by Brian Sathianathan

One of the key documents you’ll deal with as a startup founder? The venture capital term sheet. 

Think of the term sheet as a marriage between your company and its investors. It forms the blueprint for when your lawyers come in and create a legally-binding document. It also covers two key things: the cash you’ll take when you leave and the control once the deal is done. 

The term sheet is a big deal, and it was the topic of the recent panel titled “breaking down the term sheet” at the 151st Startup Battle event in San Francisco organized by the Startup Network.  Iterate.ai’s co-founder, Brian Sathianathan, joined a panel of other board members, VCs and tech execs who talked about the ins and outs of term sheets.

Other panelists included investor Igor Shoifot, an adviser at 100+ startups, Brandon Sanders, a senior associate at tech law firm Orrick; Vince Kohli, general partner at Dream Pitch Ventures; Marisa Alma McGinnis, at Blumberg Capital Fund0ok0o, and Golden Seeds and AlmazCapital investment director, Daniel Stolyarov.

The biggest takeaway? Pick and choose which items to negotiate. Don’t try to negotiate everything, says Sathainathan. Instead, pick two or three things to negotiate. Those battles are best fought around control, replicated rights for subsequent investor rounds, and pre and post option pools.

Luckily, most term sheets are becoming standardized. Most often, you’ll see those with liquidation preferences equalling 1x revenue, no participating preference, board seats, and anti-dilution protection. Remember, too, that this document signifies a relationship between the VC and the founder(s). The fit is important, so pick an investor partner based on fund size, past exit experience, and industry experience.

Now, let’s take a look at a sample term sheet

Securities:

Series A Preferred Stock of the Company (“Series A”).

Investment Amounts:

$[_] million from [__________] (“Lead Investor”)

$[_] million from other investors

Convertible notes and safes (“Convertibles”) convert on their terms into shadow series of preferred stock (together with the Series A, the “Preferred Stock”).

Valuation:

$[_] million post-money valuation, including an available option pool equal to [__]% of the post-Closing fully-diluted capitalization.

Liquidation Preference:

1x non-participating preference. A sale of all or substantially all of the Company’s assets, or a merger (collectively, a “Company Sale”), will be treated as a liquidation.

Dividends:

Conversion to Common Stock: At holder’s option and automatically on (i) IPO or (ii) approval of a majority of Preferred Stock (on an as-converted basis) (the “Preferred Majority”). Conversion ratio initially 1-to-1, subject to standard adjustments.

Voting Rights:

Approval of the Preferred Majority required to (i) change rights, preferences or privileges of the Preferred Stock; (ii) change the authorized number of shares; (iii) create securities senior or pari passu to the existing Preferred Stock; (iv) redeem or repurchase any shares (except for purchases at cost upon termination of services or exercises of contractual rights of first refusal); (v) declare or pay any dividend; (vi) change the authorized number of directors; or (vii) liquidate or dissolve, including a Company Sale. Otherwise votes with Common Stock on an as-converted basis.

Drag-Along:

Founders, investors and 1% stockholders required to vote for a Company Sale approved by (i) the Board, (ii) the Preferred Majority and (iii) a majority of Common Stock [(excluding shares of Common Stock issuable or issued upon conversion of the Preferred Stock)] (the “Common Majority”), subject to standard exceptions. The Preferred Stock will have standard broad-based weighted average anti-dilution rights, first refusal and co-sale rights over founder authorized number of directors; or (vii) liquidate or dissolve, including a Company Sale. Otherwise votes with Common Stock on an as-converted basis.

Drag-Along:

Founders, investors and 1% stockholders required to vote for a Company Sale approved by (i) the Board, (ii) the Preferred Majority and (iii) a majority of Common Stock [(excluding shares of Common Stock issuable or issued upon conversion of the Preferred Stock)] (the “Common Majority”), subject to standard exceptions.

Other Rights & Matters:

The Preferred Stock will have standard broad-based weighted average anti-dilution rights, first refusal and co-sale rights over founder stock transfers, registration rights, pro-rata rights, and information rights. Company counsel drafts documents. The company pays Lead Investor’s legal fees, capped at $30,000.

Board:

[Lead Investor designates 1 director. Common Majority designates 2 directors.]

Founder and Employee Vesting:

Founders: [_______________]. Employees: 4-year monthly vesting with 1- year cliff.

No Shop:

For 30 days, the Company will not solicit, encourage or accept any offers for the acquisition of Company capital stock (other than equity compensation for service providers), or of all or any substantial portion of Company assets.


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