4. First Principles
Get an experienced startup attorney!
• The term sheet is just the beginning…
Subsequent investment rounds will want the provisions
that the Series A gets at minimum
Don’t leave provisions up to subsequent rounds
Leverage industry-standard termsheet builders
NVCA:
www.nvca.org/index.php?
option=com_content&view=article&id=108&Itemid=136
Wilson-Sonsini: http://dealbuilder.wsgr.com/dealbuilder.asp
Orrick: https://tsc.orrick.com
Startup Capital Ventures Page 4
5. Investors Care About Ownership &
Control
When Things Go Well...
• Pricing
• Dividends
• Participation
• Conversion Rights
• ROFO (not ROFL…)
When Things Don’t…
• Voting Rights
• Protective Provisions
• Liquidation Preference
• Antidilution
• Drag Along
• ROFR
• Pay To Play
Page 5Startup Capital Ventures
6. On Valuation: Push-Me / Pull-You
or The 60 / 40 Rule
Startup Capital Ventures Page 6
In early stages, you can “push”
your company’s value
• Capital requirement: I call
this the 60/40 rule: Your
“ask” can be $2M or $4M but
the “money” may take 40%
either way – so ask for more
not less
• Avoid overvaluations which
cause down-rounds later
When your company has
revenues, the market will
starts to “pull” your value
• Financial metrics such as
gross & net margins, time to
EBITDA become important
• Financing market becomes
more efficient due to
comparable deals
• Valuations become
calculable
8. “Three On Four” Series A
Amount Raised: $3,000,000 including $250,000 from the conversion
of principal and interest on bridge notes.
Pre-Money Valuation: The Original Purchase Price is based upon a
fully-diluted pre-money valuation of $4,000,000 and a fully‑diluted
post-money valuation of $7,000,000 including an employee pool
representing 17% of the fully‑diluted post-money capitalization.
Price Per Share: $0.20 per share based on the capitalization of the
Company set forth below. (the “Original Purchase Price”).
Startup Capital Ventures Page 8
10. Pricing: Good, Bad & Ugly
The good: straightforward pricing fully funded at closing
The bad: tranched deal based on milestones
The ugly: Founders diluted below 40%
Startup Capital Ventures Page 10
11. Dividends Pay Investors Cost Of
Capital In A “1X” Exit
The Too Good: No dividends (a subsequent round to
may ask for them so address this now)
The Good: The Series A Preferred will carry an annual X
% cumulative dividend payable in-kind in equivalent value
of stock upon a liquidation or redemption. For any other
dividends or distributions, participation with Common
Stock on an as-converted basis.
The bad: Egregious interest rate > 7%
The ugly: Mandatory cash-pay annual dividend
Page 11Startup Capital Ventures
12. Antidilution Protects Investors
Against Down-Rounds
The Good: The holders of the Series A shall be entitled
to anti-dilution protection according to a broad-based,
weighted-average formula, but in no event shall the
holders of the Series A Preferred have less favorable
anti-dilution protection than that enjoyed by any future
class of Preferred Stock
The too good: None (but future rounds will want it so set
a good precedent & get it over with)
The bad: narrow-based weighted average (excludes
common, etc.)
The ugly: Full ratchet where holders of such shares
never get diluted in – but everyone else does (In the long
run rarely succeeds)
Page 12Startup Capital Ventures
13. Liquidation Preference & Participation:
Investors Get Their $ Back Before You
The Good: First pay one times the Original Purchase Price plus
accrued dividends on each share of Preferred. The balance of any
proceeds shall be distributed pro rata to holders of Common Stock.
(Investors get their $ out first in a < 1X exit, otherwise convert to
common)
The (Normative) OK LPF + Participating Preferred: First pay one
times the Original Purchase Price plus accrued dividends on each
share of Preferred. Thereafter, the Series A Preferred participates
with the Common Stock pro rata on an as-converted basis.
The Bad LPF + Capped Participating Preferred: First pay (2 or 3)
times the Original Purchase Price plus accrued dividends on each
share of Preferred. Thereafter, Preferred participates with Common
Stock pro rata on an as-converted basis until the holders of Preferred
receive an aggregate of X times the Original Purchase Price.
It rarely gets Ugly here.
Startup Capital Ventures Page 13
14. Conversion Rights (The Good Bit)
(Normal) Automatic Conversion: Each share of Series A Preferred
will automatically be converted into Common Stock at the then
applicable conversion rate in the event of the closing of a
underwritten public offering with a price of X times the Original
Purchase Price (subject to adjustments for stock dividends, splits,
combinations and similar events) and [net/gross] proceeds to the
Company of not less than $XM (a “QPO”), or (ii) upon the written
consent of the holders of a majority of the Series A Preferred or (iii)
after a date of DD/MM/YY if no other conversion provision has been
triggered
Optional Conversion: The Series A Preferred initially converts 1:1
to Common Stock at any time at option of holder, subject to
adjustments for stock dividends, splits, combinations and similar
events and as described under “Anti-dilution Provisions.”
Page 14Startup Capital Ventures
15. ROFO Ensures Existing Investors Can Maintain
% Ownership In Subsequent Rounds
It Is What It Is: All [Major] Investors shall have a pro rata
right, based on their percentage equity ownership in the
Company (fully diluted), to participate in subsequent
issuances of equity securities of the Company (excluding
those issuances listed at the end of the “Anti-dilution
Provisions” section of this Term Sheet. In addition,
should any [Major] Investor choose not to purchase its full
pro rata share, the remaining [Major] Investors shall have
the right to purchase the remaining pro rata shares.
Page 15Startup Capital Ventures
17. Voting Rights / Board Makeup
The good: The Series A nominates two Directors, the
CEO will be a Director, one Director to be nominated by
vote of Common Stock, and one independent Director as
elected by a majority of all stock classes voting together
The bad: The Preferred shareholders nominate two
Directors, the CEO shall be a Director, one Director to be
nominated by vote of Common Stock, and one
independent Director as nominated by Preferred
The ugly: usually happens when a shareholder vote is
called & the Preferred controls
Page 17Startup Capital Ventures
18. Protective Provisions: What Part
Of “No” Don’t You Understand?
So long as X% shares of Series A Preferred are outstanding in addition to any other
vote or approval required under the Company’s Charter or By-laws, the Company will
not, without the written consent of the holders of at least X% of the Company’s Series
A Preferred, either directly or by amendment, merger, consolidation, or otherwise:
(i) liquidate, dissolve or wind‑up the affairs of the Company, or effect any merger or
consolidation or any other Deemed Liquidation Event; (ii) amend, alter, or repeal any
provision of the Certificate of Incorporation or Bylaws [in a manner adverse to the
Series A Preferred]; (iii) create or authorize the creation of or issue any other security
convertible into or exercisable for any equity security, having rights, preferences or
privileges senior to or on parity with the Series A Preferred, or increase the authorized
number of shares of Series A Preferred; (iv) purchase or redeem or pay any dividend
on any capital stock prior to the Series A Preferred, [other than stock repurchased from
former employees or consultants in connection with the cessation of their employment/
services, at the lower of fair market value or cost;] [other than as approved by the
Board, including the approval of the Series A Director(s)]; or (v) create or authorize the
creation of any debt security; (vi) create or hold capital stock in any subsidiary that is
not a wholly-owned subsidiary or dispose of any subsidiary stock or all or substantially
all of any subsidiary assets; or (vii) increase or decrease the size of the Board of
Directors
Page 18Startup Capital Ventures
19. ROFR Maintains Control Within
Existing Investor Group
Company first and Investors second (to the extent
assigned by the Board of Directors,) will have a Right Of
First Refusal to acquire any shares of capital stock of the
Company proposed to be transferred by Founders or
others, with a right of oversubscription for Investors of
shares unsubscribed by the other Investors.
Before any such person may sell Common Stock, he/she
will give the Investors an opportunity to participate in such
sale on a basis proportionate to the amount of securities
held by the seller and those held by the participating
Investors.
Page 19Startup Capital Ventures
20. Pay To Play: When Things Are
Ugly For Everyone
Ugly for founders: Things have not gone well, most are
probably fired
The VCs are challenging each other: On any
subsequent [usually down] round all Investors are
required to purchase their pro rata share of the securities
set aside by the Board for purchase by the Investors. All
shares of Series A Preferred of any Investor failing to do
so will automatically lose anti-dilution rights, lose right to
participate in future rounds, convert to Common Stock
and lose their right to a Board seat if applicable.
The happy ending: P2P is usually followed by issuing
new stock to then-current management
Page 20Startup Capital Ventures
21. Drag-Along Rights: Investors Can
Force An Exit
Usually means the company lost the plot…
Holders of Preferred Stock and the Founders shall be
required to enter into an agreement with the Investors
that provides that such stockholders will vote their shares
in favor of a Deemed Liquidation Event or transaction in
which 50% or more of the voting power of the Company is
transferred and which is approved by [the Board of
Directors] [and the holders of a majority of the
outstanding shares of Preferred Stock, on an as-
converted basis (the “Electing Holders”)]
Page 21Startup Capital Ventures
23. K.I.S.S.
If it’s over three pages you are paying your lawyer too
much…
Forcing a (speculative) cap price presents challenges
• If the cap is low the company has little incentive to
exceed milestones, and future investors can be upset
at bridge round investors and find dilutive workarounds
• If the cap is high it can signal missed milestones
making future investors wonder about the company
– Sometimes caps are absurdly high making the term a
throwaway – why bother?
Page 23Startup Capital Ventures
24. By Now You Should Recognize
These Terms…
Amount to be Raised: Up to $###,###.
Type of Security: Unsecured convertible promissory
notes (the “Notes”) and warrants.
Closing Date: The Initial Closing of the sale of the Notes
is scheduled to occur on Month 30, 20XX (the “Initial
Closing”). Subsequent sales may occur within 180 days
of the Initial Closing, subject to approval by the Company,
but in no cases on or after a Qualified Financing or
Liquidation Event.
Interest Rate: Interest will accrue on the principal
amount of the Notes at the rate of 5% per annum, to be
paid-in-kind (PIK) in the value of the applicable class of
stock at the time of conversion.
Page 24Startup Capital Ventures
25. Warrants: Tax-Advantaged, Non-
Voting Discount For Early Investors
If can: Investors will receive XX% warrant coverage, consisting of
warrants to purchase the equity securities issued in the Qualified
Financing at the price per share of the equity securities issued.
If can, but try wait: Investors will receive an additional YY% warrant
coverage (for a total of ZZ% warrant coverage) if the Qualified
Financing occurs after 180 days from date of Initial Closing.
If no can: If a Qualified Financing does not occur on or before one
year from the date of Initial Closing, then the warrants shall be
exercisable for Common Stock of the company at the then-current
price per share at that time.
Term: The warrants shall be exercisable for seven (7) years. The
right to exercise the warrants shall terminate upon a Liquidation
Event in which Warrants will have a “net exercise” provision.
Startup Capital Ventures Page 25
26. Maturity & Conversion: The Meat
In The Sandwich
Maturity: Earliest to occur of (i) one year from Initial Closing (ii) the
closing of a Qualified Financing or (iii) a “Liquidation Event” as
defined by either (a) an Initial Public Offering (IPO), (b.) the sale of
substantially all of Company’s stock or assets, or (c.) the initiation of
U.S.B.C. Chapter 11 or any other type of bankruptcy proceeding.
Conversion: Automatically converts to shares of the equity
securities issued upon a Qualified Financing (to be not less than $X.X
million inclusive of bridge conversion, with at least $X00,000 from an
outside institutional investor) (the “Qualified Financing”).
In the event that no Qualified Financing occurs before maturity, either
(a. the bad) the note holder shall have the option to, or (b.the good )
the notes shall automatically, convert into Common Stock of the
company at the then-current price of common stock per share.
Page 26Startup Capital Ventures
27. “Meat’s Not Meat ‘Til It’s In The Pan”
Painting: Charles RussellStartup Capital Ventures Page 27