Thread: Term Sheets Explained
If, like me, you’re new to VC you’ll know there’s plenty of terminology to get your head around. The same is true if you’re an entrepreneur embarking on your first fund raise. Here are some key terms to get started.
Thread below 👇
If, like me, you’re new to VC you’ll know there’s plenty of terminology to get your head around. The same is true if you’re an entrepreneur embarking on your first fund raise. Here are some key terms to get started.
Thread below 👇
It is worth pointing out that this is by no means an exhaustive list: there are plenty more terms that will crop up and lots more detail or nuances to each of them.
Over the next few weeks I’ll be adding a few more industry related threads, but for now: term sheets.
Over the next few weeks I’ll be adding a few more industry related threads, but for now: term sheets.
1. Liquidation Preferences
Liquidation preferences determine how shareholders will receive funds when a company is acquired, merging or winding down. They offer investors downside protection by prioritising them ahead of common stockholders.
Liquidation preferences determine how shareholders will receive funds when a company is acquired, merging or winding down. They offer investors downside protection by prioritising them ahead of common stockholders.
2. Vesting
Vesting is the process where a founder or employee earns shares over time. Rather than awarding the equity immediately, the option holder will need to earn their shares over a fixed time period.
Vesting is the process where a founder or employee earns shares over time. Rather than awarding the equity immediately, the option holder will need to earn their shares over a fixed time period.
Why’s this good? It protects a company and its investors from giving up too much equity to someone who spends only a short amount of time there.
3. Anti-Dilution Provisions
Anti-dilution provisions provide downside price protection for investors. That is, an original investor would be protected from the dilution of value if the company issued stocks at a lower valuation than a previous funding round.
Anti-dilution provisions provide downside price protection for investors. That is, an original investor would be protected from the dilution of value if the company issued stocks at a lower valuation than a previous funding round.
4. Employee Stock Options
A block of shares set aside for employees, designed to compensate and motivate a company’s workforce. These shares are set aside and, if offered, gives the employee the right to buy company stock at a set price for a fixed period of time.
A block of shares set aside for employees, designed to compensate and motivate a company’s workforce. These shares are set aside and, if offered, gives the employee the right to buy company stock at a set price for a fixed period of time.
N.B. In the event of a liquidation when the pool isn’t fully distributed, the shares will be distributed at the same proportion of existing ownership.
5. Convertible Notes
A convertible note is an investment in the form of an initial loan. It contains the provision that allows the $/£/€ invested plus accrued interest to be converted into equity at a later date, typically at the next funding round.
A convertible note is an investment in the form of an initial loan. It contains the provision that allows the $/£/€ invested plus accrued interest to be converted into equity at a later date, typically at the next funding round.
One advantage of a convertible note is that it does not require a specific valuation of the company to be agreed upon at the time of borrowing. In the next thread I will discuss the pros and cons of convertible notes vs a standard stock purchase vs SAFE.
6. Redemption Rights
Redemption rights allow investors to sell their shares back to the company for a guaranteed return, typically the purchase price. This is designed to provide a guaranteed exit path for the investor, perhaps if a start up has not been as successful as hoped.
Redemption rights allow investors to sell their shares back to the company for a guaranteed return, typically the purchase price. This is designed to provide a guaranteed exit path for the investor, perhaps if a start up has not been as successful as hoped.
In practice, redemption rights are fairly uncommon. Why? Companies that aren’t doing well enough for a desirable exit are generally unlikely to be able to afford the share buy back.
7. Warrants
Similar to the employee stock options mentioned earlier but for investors or other third parties. Warrants give investors the right, but not the obligation, to buy a specific number of shares in a company at a predetermined price for a set amount of time.
Similar to the employee stock options mentioned earlier but for investors or other third parties. Warrants give investors the right, but not the obligation, to buy a specific number of shares in a company at a predetermined price for a set amount of time.
8. Pay to Play
Requires preferred stock holders to buy the firm’s new stock issues to avoid it being converted to common stock. This incentivises investors to participate in future raises to avoid losing their benefits such as anti-dilution.
Requires preferred stock holders to buy the firm’s new stock issues to avoid it being converted to common stock. This incentivises investors to participate in future raises to avoid losing their benefits such as anti-dilution.
9. No-Shop Agreement
A no-shop agreement prevents the company/founders from seeking investment from anyone other than the investor with whom the agreement is with for a period of time. Simply put, the company must pause negotiations/enquiries with other investors and proposals.
A no-shop agreement prevents the company/founders from seeking investment from anyone other than the investor with whom the agreement is with for a period of time. Simply put, the company must pause negotiations/enquiries with other investors and proposals.
10. Drag-Along Agreement
Drag-along provisions grant a majority shareholder or shareholders the right to force minority shareholders to vote a certain way, typically to do with the sale of the company.
Drag-along provisions grant a majority shareholder or shareholders the right to force minority shareholders to vote a certain way, typically to do with the sale of the company.
While this is just a quick starting point to term sheets it provides some context to what is often detailed. If you'd like to discuss any of the above or let me know any other info you'd like to see in a future thread, just reach out!
#VC #TermSheet #Definition #Thread
#VC #TermSheet #Definition #Thread
