In this post, we summarize the key takeaways from our fourth webinar by Nate Vasel on tips for term sheets. This is the fourth of our ongoing webinar series that addressed different topics across venture, startups, and fundraising. As always, if you’re a founder interested in speaking with us, email any of us directly or the fund at firstname.lastname@example.org. Follow this link to watch the whole webinar.
- SAFEs (Simple Agreement for Future Equity) represent a contract between a company and an investor that allows the investor to purchase shares in a future priced round at an agreed-upon price in exchange for investment dollars today. Valuation caps on SAFEs represent the maximum conversion price for the investment in the future. SAFEs are popular for their simplicity and flexibility.
- Convertible notes are functionally very similar to SAFEs but represent debt with interest rates and maturity dates.
- Priced rounds have fixed valuations with clear ownership percentages calculated from share prices and investment amounts. Most companies receive funding from investors through priced rounds.
Cap Table Math:
- The pre-money valuation represents the company’s worth prior to financing and the post-money valuation equals the pre-money valuation plus the amount raised. Ownership percentages are based on the post-money valuation.
- Founders commonly give up 20–25% ownership in earlier rounds and less in later-stage rounds. For that reason, it’s important to be as capital efficient as possible early on when financing rounds are the most dilutive.
- Many factors drive valuations including metrics, story, and market dynamics. It becomes more metric-driven as a company grows and becomes later-stage.
- For investors, control terms and downside protections can make up for paying a higher price.
- Term sheets represent a non-binding outline of proposed terms in a financing round and lay out important terms like valuation, investment structure, and investor rights. They are negotiated with investors prior to agreeing to the deal.
- It’s good practice to negotiate the terms (like the ones listed below) up front so no surprises when you’re in the legal process.
- Board of Directors: Represents the entity that controls the company and must exist for Delaware corporations. The CEO reports to the board and serves the company on behalf of the board. Lead investors usually want some sort of involvement at the board level.
- Liquidation Preference: Represents an investors’ right to receive their money back before the holders of common stock or convert their shares to common stock during a liquidity event. A non-participating liquidation preference means that investors receive their preferential payment but not an additional pro rata share of the remaining proceeds, while a participating liquidation preference means you receive your money back in addition to your pro rata share of any remaining proceeds.
- Protective Provisions: Represents the decisions about the business that investors can control, such as compensation, new financing rounds, debt issuance, executive hiring, etc. Voting is most commonly a simple majority but there are several variations.
- Terms like anti-dilution, dividends, right of first offer, and sale, redemption, and registration rights can also have practical impact.
Working with lawyers:
- Proper legal counsel that has experience in early-stage VC financings and gives you partner-level attention will save time and headaches. It’s also good practices to have company and investor lawyers agree to fee caps beforehand.
- Investors usually have target returns and ownership percentages but can commonly flex within a valuation range and still make the numbers work to a point. Many term sheet items (preferences, control rights, etc.) have value and can be a trade-off with valuation.
- Focus on partnering with the right investors rather than over-optimizing on terms because poor investor-founder fit is the worst-case scenario regardless of the terms you receive.