Hello, there!

Getting your first term sheet as a startup founder can indeed be an exciting phase. However, at the same time, it can be challenging as well because term sheets can be complex and confusing.

As a first time founders its pivotal to understand terms comprehensively before proceeding further. Do not sign anything that you don't 100% understand. Please seek advice and support to navigate these crucial documents effectively.

To make the process easier for you, I’m going to share some key terms about term sheets that every founder should know:

The Equity Journey

When you embark on your fundraising journey, you will encounter term sheets at various stages, such as seed, Series A, B, and beyond. It's essential to know what's typical in terms of equity percentages founders give up during each round to set the right context.

Seed Round: Founders usually part with around 10-25% of their equity.

Series A: This often involves surrendering around 20-30%.

Series B and Beyond: Expect to give up approximately 25-40% or more as your company grows.

Remember, these are just rough guidelines, and the specifics can vary based on your company's unique circumstances, the market, and the investors involved. However, a pro tip to follow here is that founders should be very careful about giving up too much equity too early. Doing this can be difficult to gain back control.

The Ins and Outs of Vesting Schedules

Vesting schedules are another crucial aspect of term sheets. A common structure is a "4-year vesting with a 1-year cliff." This means that your equity as a founder gradually becomes yours over four years, but you won't receive anything until you've completed the first year, known as the cliff.

Before the Cliff: If you leave the company before the cliff, you typically walk away with no equity.

After the Cliff: After the cliff, your equity gradually vests on a monthly or quarterly basis. If you leave then, you'll retain the vested portion.

Understanding vesting schedules is vital to protect both your and your investors' interests while ensuring alignment for the long term.

Investor vs. Founder Rights

Term sheets also outline various rights given to venture investors compared to founders and employees. It's crucial to distinguish between economic rights and control rights.

Economic Rights: These involve financial aspects, such as dividends, liquidation preferences, and anti-dilution provisions.

Control Rights: These relate to decision-making power, board seats, and veto rights on significant corporate actions.

It's important to strike a balance between maintaining control over your company's vision and securing the necessary funding for growth.

Founder-Friendly vs. Investor-Friendly Term Sheets

Let's explore the difference between founder-friendly and investor-friendly term sheets using key clauses as examples:

Valuation: This determines the value of your company today. Typical methods include comparing valuations of similar startups, discounted cash flow models, or various multiples.

Founder-friendly terms might result in a higher valuation for your company, preserving more equity for you. Investor-friendly terms might push for a lower valuation to protect their investment.

Liquidation Preference: This determines payout priority if the company is sold or dissolved. Typical preferences are 1x (investor gets their money back first) or 2x+ (investor gets a multiple return first).

A founder-friendly term would favor non-participating preferred stock, while an investor-friendly term could include participating preferred stock, potentially diluting founders in exit scenarios.

Seeking Help and Negotiating

If the terms in your initial offer seem unfair, don't hesitate to negotiate. Here are some constructive, win-win tactics:

Leverage: Highlight your company's strengths, achievements, and growth potential to negotiate better terms.

Consult Advisors: Seek advice from experienced mentors, advisors, or legal services that specialize in startup funding.

Counteroffer: Propose alternative terms that align better with your vision and goals.

Focus on the Long Term: Ensure that the terms support the long-term success and growth of your company.

Other Important Terms in the Term Sheet

Anti-Dilution Protection

This is a clause that protects an investor from losing ownership percentage if the company issues more shares at a lower price.

Typical terms are full-ratchet (investor share % remains constant) or weighted average (share % adjusted via a formula). Broad anti-dilution can significantly reduce founder/employee share value over time.

Board Control

Board control refers to the ability of an investor or group of investors to have a say in the decisions made by a company's board of directors. It can include the right to appoint board members or influence major corporate decisions.

Generally, typical terms give investors 1-2 board seats post-investment. The founder must ensure that they still retain majority control of the board to stay strategic.

Voting Rights

These determine an investor's ability to vote on important company matters. Preferred shares usually have extra voting rights compared to common shares, including veto powers on certain decisions.

Pro-Rata Rights

Pro-rata rights give an investor the option to participate in future rounds of financing to maintain their ownership percentage over time. It may include "super pro-rata" to oversubscribe and increase ownership.

Information Rights

This refers to giving investors regular financial reporting and access to sensitive company information post-investment. It ensures transparency and helps investors make informed decisions about their investment.

Drag-Along Rights

Drag-along rights enable majority shareholders to force minority shareholders to join in the sale of the company.

For example, if a certain % of investors approve a sale, this forces all shareholders to consent to the deal. For founders, it is important to know the threshold percentage that triggers this right. Include a carve-out clause for founder shares if possible.

Remember, term sheets are not set in stone, and negotiation is an integral part of the process. Make sure the terms align with your vision for your company's future.

Understanding term sheets is a crucial step in securing the right funding for your startup. We're here to support you every step of the way. Feel free to reach out if you have any questions or need further guidance.

What am I reading these days?

I started reading Oversubscribed by one of my all time favorite authors, Daniel Priestly. If you run any type of business, you will love this book.

A quote that I really liked:

Imagination is a way of engaging reality, and it is not something apart and hermetic.

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