Term sheets: economic terms

Question 1

Pre-money valuation

Answer 1

The company’s value before it receives an investment

Question 2

Post-money valuation

Answer 2

The company’s value including any investment

Question 3

Option pool

Answer 3

Unissued stock held back to compensate or motivate staff. The option pool factors into the pre-money valuation, so if VC negotiates an increased option pool, that will lower the pre-money valuation and ownership stake of the existing shareholders (as a larger chunk of the shares are now owned by nobody, yet).

Question 4

Fully diluted

Answer 4

Taking into account all outstanding shares, including future rights to acquire stock such as warrants and employee options

Question 5

Warrant

Answer 5

The right for an investor to purchase a certain number of shares at a predefined price (usually discounted) for a certain number of years.

Question 6

Liquidation preference

Answer 6

The terms dictating who gets what in a liquidation event. They might say, for example, that investors should get 100% of their investment back before the founders get anything. Usually, the preference multiple is 1 (100% of the investment), but it can be higher in later-stage or distressed financings. Liquidation preference can refer to preference and participation.

Question 7

Participation

Answer 7

Dictates how much return (if any) an investor sees after receiving their liquidation preference.

Question 8

No participation

Answer 8

Where the preferred stock does not participate after receiving its preference. Also known as ‘simple preferred’ or ‘nonparticipating preferred’. Used to provide downside protection (if you bought a 20% stake for £5m and the company sells for £100m, you can just convert it to common and sell for £20m).

Question 9

Preferred stock

Answer 9

Stock with certain additional rights such as liquidation preference. Can be converted to common stock at any point, typically on a one-for-one basis

Question 10

Full participation

Answer 10

Stock that receives its preference, and then a share of its participation on an as-converted basis. If you had bought a 20% stake for £5m and the company sells for £100m, you would your £5m back, plus 20% of the remaining £95m for a total of £24m, you jammy bastard.

Question 11

Capped participation

Answer 11

Stock that receives its preference, followed by a share of liquidation proceeds on an as-converted basis until a certain multiple of the purchase price is reached. Say your £5m investment was capped at 300%, the most you’d receive would be £15m, including your preference

Question 12

Liquidation preference overhang

Answer 12

The amount of money that needs to be cleared before common stockholders see any proceeds from a liquidation

Question 13

Stacked preferences

Answer 13

Where follow-on investors stack their preferences on top of one another, so Series B receives theirs, then Series A and so on

Question 14

Blended preferences

Answer 14

Where investors from different series receive their preferences pro-ratably. Also known as pari-passu

Question 15

Pay-to-play

Answer 15

Where an investor must keep investing pro-ratably in future financings in order to prevent their stock being converted into common stock automatically. This is often waived when the company is doing well, to free up space for new investors in future rounds. Not suitable for investors who specialise in early stage.

Question 16

Vesting

Answer 16

A mechanism that dictates when staff receive their stock. For example, you might have a one-year ‘vesting cliff’ where you receive 25% of your stock after a year, then in monthly instalments thereafter.

Question 17

Reverse dilution

Answer 17

When an employee leaves and their unvested stock disappears, increasing everyone elses’ stake by default. Similar to unawarded options in a liquidity event.

Question 18

Single trigger acceleration

Answer 18

When an employees stock vests automatically in the event of a merger or other event

Question 19

Double trigger acceleration

Answer 19

Vesting that requires two events, such as a merger followed by the employee being fired.

Question 20

Exercise period

Answer 20

The time a departed employee has to buy their shares at the option price after leaving the company

Question 21

Weighted average antidilution

Answer 21

Down-round protection that takes into account the magnitude of the lower-priced issuance, so the number of shares issued at the reduced price is considered when repricing the earlier round. This can be broad based (taking into account preferred stock and options) or narrow (common only).

Question 22

Ratchet based antidilution

Answer 22

If a company raises a down round, this protection lowers the effective price of the original round to that of the new one, meaning that you’ll own a larger stake as the quantity of shares you bought goes up automatically

Question 23

Carve out

Answer 23

When investors opt to exempt a financing from antidilution provisions to avoid diluting common stock holders