| If you have successfully sold your business concept | | | | then the founders and the VCs split the remaining $2 |
| to a venture capitalist, the next step will be the term | | | | million 50/50. In this case, founders get $1 million. |
| sheet. This is basically the offer letter stating how | | | | 2. Sale price: $10 million. VC's get their $5 million back, |
| much the VC will buy, at what price, and under what | | | | then the founders and the VCs split the remaining $5 |
| terms. Term sheets can be incredibly simple, one to | | | | million 50/50. Founders get $2.5 million. |
| two page documents or incredibly complex and | | | | In this case the company has to be sold for over $5 |
| lengthy. | | | | million for the VCs to make any return - a much |
| If you receive an incredibly complex and lengthy | | | | lower hurdle. |
| term-sheet, reconsider that VC as a potential | | | | The multiplier part is the amount the VCs want to |
| investor. If this is the first document you are getting | | | | get back before any gets split between the |
| from them, imagine how complex the actual investor | | | | shareholders. In the above case, if the investment |
| rights and subscription agreements will be. This will | | | | was 1.5x participating return, the VCs would require |
| mean an expensive legal bill which, by the way, will | | | | $7.5 million be paid to them first, then the remaining |
| be sent to you. | | | | amount would be split between the VCs and the |
| Basics of the offer: | | | | founders. |
| Closing date - an estimated date upon which they | | | | Voting rights - this lays out how the VC is allowed to |
| expect to have the legal work wrapped up and you | | | | vote his shares. Usually, they set it up so that even if |
| will receive your money. | | | | they have a minority share, they have the majority |
| Investors - who will be joining the party. You may | | | | of the votes when it comes to anything important |
| have more than one venture capital firm invest in | | | | ("protective provisions"). |
| your company (especially at later stages). | | | | Protective Provisions - the VC wants to make sure |
| Amount raised - how much they will be giving you. | | | | that they can protect their investment. They will |
| Price per share - what they plan on paying you per | | | | want the right to be able to say whether they sell |
| share. | | | | the company or not, whether there is any conversion |
| Pre-money valuation - what they deem your | | | | to common, add board members, borrow money, |
| company is worth without their money. Capitalization | | | | etc. |
| - this is often split into pre- and post-valuation terms. | | | | Anti-dilution Provisions - another tool for the VC to |
| It states how many shares there are outstanding | | | | protect his investment. Let's say the VC owns 40% |
| prior to the investment and how many shares will be | | | | worth $4M and you own 60% worth $6M. You need |
| outstanding after the investment. | | | | to raise more money ($4M), but you can only find a |
| Basics of the terms: | | | | pre-money valuation of $8M. If dilution was allowed, |
| Dividends - the stock that the venture capitalist will | | | | the end result would be VC2 gets 33.3%, your share |
| want will either be preferred or | | | | would be reduced to 40%, VC1's share would be |
| participating-preferred. At some point when your | | | | reduced to 26.6%. If anti-dilution provisions are in |
| company is successful, the VCs will want to convert | | | | place, the end result would be VC2 gets 33.3%, your |
| their stock to common stock - for sales purposes. | | | | share would be reduced to 26.6%, VC1's share would |
| They want to make sure that they have the same | | | | stay at 40%. Ouch. |
| dividend rights that common stockholders have. In | | | | Redemption Rights - what happens if your company |
| some cases, they want to have dividend rights that | | | | becomes one of the living dead. If you build a decent |
| the common stockholders don't have (nice, huh?). | | | | company and you're making a nice living, but the |
| This will also be listed here - try to negotiate away | | | | company is not growing at a rate that will attract a |
| from cumulative dividends as this is an unpaid dividend | | | | buyer or make possible an IPO,the VC is eventually |
| that accumulates to the preferred shareholder and is | | | | going to want his money back. This gives them the |
| payable upon liquidation or redemption. It's a way to | | | | right to get it back (plus any dividends accrued). This |
| give a higher valuation to you feel good, but actually | | | | usually kicks in after the fifth year and is payable |
| get more of your company without putting in any | | | | over a few years. |
| more money. | | | | Representations and Warrantees - the escape clause. |
| Liquidation preference - This is what happens when | | | | They will say that you have represented certain |
| you either (1) liquidate the company or (2) sell it/IPO. | | | | things to them, such as revenue growth, customers, |
| In general, you would think that the VC owns 40% | | | | etc. After you have signed the term sheet, they will |
| of your company, they would get 40% of the profit. | | | | comb through your books and records and if they |
| Well, if they have straight preferred, this is true, but | | | | don't like what they see, they will back out. |
| they have come up with a special construct to make | | | | Conditions to closing - another escape clause. This |
| sure they get a little bit more: participating preferred. | | | | should note that the offer is made predicated on |
| See the example below for an explanation. | | | | beliefs that may change after they look after you |
| Liquidation Preference Example: | | | | books. It also contains some legalese about meeting |
| In the old days, VCs would invest $5 million in a | | | | appropriate filing and legal requirements. |
| company worth $5 million pre-investment and get | | | | This pretty much covers the basics of the easy |
| 50% of the company of preferred shares. | | | | term-sheet. A more extensive term-sheet is likely to |
| At the time of sale, the VCs would get money back | | | | contain the investor rights terms which continues on |
| in this way: | | | | in the protective vein, making sure that the VC has |
| 1. Sale price: $7 million. VC's get their $5 million back, | | | | the first shot of their shares being sold if the |
| the founders get $2 million. (This is the preferred part | | | | company goes public, that the company (not the VC) |
| - they get their money back before the common | | | | pays for the registration of shares, what sort of |
| shareholders get a payout.) | | | | information rights the VC has, whether the VC has |
| 2. Sale price: $10 million. VCs convert to common and | | | | the right to participate in future rounds, what requires |
| the VCs get half and the founders get half (each $5 | | | | investor approval, and any required non-disclosure and |
| million). | | | | non-compete provisions. |
| In this case the company has to be sold for over $10 | | | | The term-sheet will also most likely contain an |
| million for the VCs to make any return. | | | | expiration date and a no-shop provision to ensure |
| In the days of the internet boom... VCs realized they | | | | that you are unable to find another term-sheet to |
| were throwing their money behind some pretty | | | | have as a comparison. You goal in this case is to |
| crappy stuff, thus some clever MBA financial engineer | | | | have several potential investors who all give you |
| introduced the participating preferred shares. Same | | | | term-sheets at the same time. |
| example: VCs invest $5 million in a company worth $5 | | | | Your job is to negotiate your deal to your best |
| million pre-investment and get 50% of the company | | | | advantage. Do not spend too much time worrying |
| of preferred shares. However, the participating part | | | | about the valuation, but instead pay attention to the |
| means they get their money back before the rest is | | | | control provisions and negotiate those. |
| split up according to ownership. | | | | Good luck! |
| 1. Sale price: $7 million. VC's get their $5 million back, | | | | |