NOTE: This is the nineteenth and final post in our series about standard terms in early stage equity financings. These posts refer to the model Series A Term Sheet put out by the National Venture Capital Association (NVCA) and available for download here.
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In our very first post we said that our purpose in undertaking this Anatomy of a Term Sheet series was to give our readers the ability to better evaluate financing term sheets. We sincerely hope we’ve been able to shed at least a little light on the subject and we welcome your questions on any topic that is still a mystery. We close the series with a summary of the most important points we’ve covered the past two months and a list of other great blogs with information about financing and other subjects important to entrepreneurs and startups.
Key Takeaways
1. Broadly speaking, the main areas of negotiation between entrepreneurs and investors are: (a) economics of the investment – valuation, dividends, liquidation preference, anti-diultion and redemption rights; and (b) control of the company – stockholder voting and protective provisions, matters requiring investor director approval, composition of the Board, preemptive rights, pay-to-play, drag-along and vesting of founders’ stock.
2. In addition to valuation, dividends and liquidation preference can have a significant impact on the relative economic rights of the founders and the investors. It is important to understand the interplay among these provisions when evaluating proposed terms.
3. The employee option pool should be sufficient to satisfy the company’s need to incentivize employees and other service providers for the foreseeable future. Be sure to understand whether the option pool is included in the pre- or post-money valuation and how this impacts the economics of the transaction.
4. Obtaining approval for corporate actions from the directors designated by the investors is procedurally much simpler than obtaining consent from the investors themselves. Ideally, investors should only get a separate stockholder vote on major corporate actions, such as a sale of the company.
5. Full ratchet anti-dilution is very investor favorable; weighted average anti-dilution is more common.
6. A Pay-to-Play can help mitigate the negative impact of anti-dilution protections in a down-round financing.
7. If the company is paying the investor’s legal fees, try to include a cap on those fees in the term sheet.
8. Don’t try to negotiate-away the investors’ Registration Rights, but do try to include Registration Rights for the founders.
9. Preemptive Rights should not preclude the company from raising money from new investors.
10. A company’s Board of Directors has significant control over its business, so it is important to understand how the composition of the Board and the process of designating directors impact the balance of power between the founders and the investors.
11. It is important to try to negotiate limits on an investor Drag-Along to prevent the founders and other common stockholders from being forced into a fire-sale.
12. If founders’ stock will be subject to vesting following the financing, a portion of the founders’ shares should be vested immediately to account for time-served and founders should seek to have the remainder vest monthly over no more than three years.
Other Blogs Entrepreneurs Should Read
- Brad Feld
- Startup Lawyer (Ryan Roberts)
- Startup Company Lawyer (Yokum Taku)
- Venture Hacks
- Startup Company Blog
- Joseph Ansanelli
- VC Deal Lawyer (Christopher McDemus)