Thread by @paigefinnn

term sheets! are! confusing! if you’re a new founder (or just starting out in VC), here are some common terms and what they really mean... [a thread]

1/ liquidation preferences:

how shareholders will be cashed out in the event of liquidation(IPO/M&A)

2/ participation: it serves as a valuation bridge. investors can offer a higher valuation, but if they include "participating," they'll get a bigger chunk of the pie later. more info: learnvc.com/2008/07/liquid…

3/ participation clauses should always come with a multiple -refers to the amount investors are entitled to before anyone else, protects investors in the case of a subpar exit, but don't matter as much if the exit is great - because they'll just convert to their % of common stock

4/ pay-to-play: common on term sheets; explicitly states investors have to keep investing if they want special privileges (voting/board seats) afforded to investors

5/ pre-emption rights: common on term sheets; means early investors can reinvest at later rounds at the same percentage ownership(sometimes at a discount). this can get expensive for angels/smaller funds which is why they get diluted later on when big money comes in.

6/ employee stock option pools: a class of shares issued to employees. assess vesting schedules, as some founders i know have gotten screwed making a short vesting period for early shares, those shares leave when early employees leave

7/ in making an employee stock option pool: they often get re-upped at every major financing event. you don't have to make space for every future employee in earlier rounds. focus on how many key hires you want to make each round and adjust the option pool accordingly.

8/ employee stock option pools: in the event of a sale, unallocated option pool shares will be distributed pro-rata (at the same percentage of ownership), which means some of that money will go right back into the investors pockets and the founder will be further diluted.

9/ option pool shuffle: one of my FAVORITE learnings in venture math.

a 15-20% unallocated employee stock option pool can be added *immediately before* a VC investment.

10/ option pool shuffle: why should you care?? check out this simple cap table math:

11/ option pool shuffle: for investors, deciding when you add the option pool is EXTREMELY important in your exit calculations.

an investor friend added the option pool at the *same* time of investment and diluted himself - aka costing himself a lot of money

12/ convertible equity: investor can choose either the value of their equity OR their percentage of ownership at liquidity events (IPO/M&A). here's some common terms:

13/ convertible equity is extremely broad, and people have come up with all sorts of interesting financial acrobatics with different instruments of debt/equity. this is worth some googling if you're further interested!

14/ in conclusion!!

as much as fundraising is about adding capital to your balance sheet and negotiating for favorable terms, it’s just as much about finding the right partners who will add implicit value to your company.

15/ "value add" is a running joke in VC, but here's some things to consider that actually can ~add value~

industry connections > customer leads
vc connections > help in future fundraising
aligned investment thesis > experience in your particular area

16/ value add(con't):

former founders/operational experience > priceless advice

platform/ops teams (augmented VC teams) > can help grow/professionalize portfolio co’s sales and marketing, growth and operations *this is a growing area as well that i've done lot of research on

17/ this is not meant to be legal advice, but rather my attempt at contextualizing legalese in a helpful manner for people who aren't deep in the nitty-gritty of this every day

18/ FUN FACT: i spent HOURS putting this presentation together for a fund that simply replied with the below email -

so if you learned something new / you have feedback...let me know!

i would really appreciate it. hope you all have a wonderful day🥰🥰

~ a VC lawyer has joined the chat~

thank you so much to @neelapack for sending me UPDATES!!

would like to add the following notes to this thread:

pay to play: not a common term, would be viewed as aggressive, given the co's financial condition & financing history. but, this may change given the current state of the economy.

preemptive rights: while common, she's never seen them include discounts. they're given to major investors & based on pro rata ownership of the fully diluted cap of the company (assumes the exercise & conversion of all warrants, notes, and option pool) not just outstanding shares

convertible instruments: have features for exits such as an IPO or M&A, but also include interim events that trigger conversion, usually referred to as a “Qualified Financing”

convertible notes: used in “bridge rounds” when companies need to raise money between rounds but want to kick valuation down the road to the actual round

and: Neither SAFEs nor notes require a 409A valuation report!

option pool shuffle(aka an option pool refresh): if the refresh/number of shares added to the pool goes in the pre-money then the existing equity owners are diluted — not the investors. even if not explicit in the term sheet, doing the shuffle in pre-money is the market norm.