Term Sheets

Question 1

What is the purpose of term sheets?
What documents are they composed by?
Which rights do they focus on?

Answer 1

• govern rights and duties
• shape incentives
• clarify expectations
• shape risk/reward profiles
• specify interface with external parties
• Corporate charter
• Investor rights agreement
• Stock purchase agreement
• Employment Agreements

1. Cash flow rights
2. Compensation Rights
3. Other terms (Control rights, Future Fundraising, Investor Liquidity rights).

Question 2

What are cash flow rights and how are they exercised?

Answer 2

Who gets how much money in which circumnstance.

• Convertible Preferred Stock
• Multiple Liquidation preferences
• Participating Preferred
• Participating preferred with Cap

Question 3

What are compensation rights and how are they exercised?

Answer 3

Compensation of founders/employees:

• Salary
• Performance bonuses
• Stock Options

Founders share are agreed upon signing of term sheet and allocated according to a “vesting schedule” (linear, cliff period, accelerated).

Stock Options, vesting schedule applies here too. Pool is allocated upon funding. Strike price.
Reporting ownership on a “fully diluted basis”.

Question 4

What are control right and how are they exercised?

Answer 4

Rights that allow the investors to control and profit from their investment.

1. Voting Rights
2. Board of Directors
3. Contractual rights

See Ch. 8

Question 5

What other terms are usually included in the term sheet?

Answer 5

Future fundraising:

1. Protective provisions
2. Anti-dilution
3. Preemption rights
4. Pay-to-play

Investor Liquidity

1. Redemption rights
2. Tag-along and drag-along
3. Registration rights and piggy back rights

Additional Clauses
Information and Visitation rights
Key Man Insurance
Negotiation process clauses: no-shop clause, exploding offer, due diligence conditionality...
Lawsuit insurance

Question 6

What trade-offs exits amongst Valuation and the Term Sheet?

Answer 6

Often Valuation can be inflated due to the presence of favourable cash flow rights control rights and other.

Investors with more downside protection and control rights are willing to higher the valuation.

Question 7

What are convertible notes and when are they used?

Answer 7

Simple debt-like claim that converts into equity once the company raises its first formal round.
Way to postpone valuation, “unpriced” rounds.
Conversion rate is pre-determined with a price discount 10-20%.

Valuation Cap
If company reaches a high valuation, convertible notes get little shares. So sometimes there is a Vcap, which determines the minimum amount of shares that the convertible note holder can get.

Question 8

What are SAFEs and when are they used?

Answer 8

Simple Agreements for Future Equity
Financial instrument in which the investor provides money in exchange for the right to receive preferred stock (or common stock) at the first equity round.
Does not involve debt.