Negotiating a Term Sheet — Part 5: The Final Pieces
Jamie Goldstein
Partner at Pillar
Just got a term sheet from a VC firm?
Congratulations — that’s no small feat.
In this series, we are looking at the “standard” VC term sheet to understand each of the terms and conditions, why the VC might care and why you should as well.
In this final part, we close out the remaining terms you are likely to see.
Voting Controls
The standard VC deal has voting controls that require the investors (typically a majority or supermajority) to approve important decisions: 1) Raising another round, 2) selling the company, 3) taking on a substantial amount of debt.
If you have the right VC, one who wants the best outcome for founders, employees and investors — these shouldn’t be a problem. But if you have the wrong investor, they could hold up the company — prevent it from raising money (debt or equity) or even selling.
Yes, “fiduciary duty” rules apply — but by the time a lawsuit makes its way through the courts, your startup will be a distant memory.
Room to Negotiate?
Some.
Limits on how much debt can be taking on are a point of negotiation — though typically in the $250K-500K range. More typically for a capital equipment or working capital line. Not enough to be a viable way of funding your company.
Limits on selling the company could expire if you sell above a threshold (eg 3x for investors).
Limits on approval of a future financing round could be limited to rounds that are senior in Preference to the existing round — enabling you to sell equity that is pari passu. Or again, could expire if the valuation is above a threshold (eg 2x the last round).
Mandatory Conversion
A sneaky little term that doesn’t get much attention. Often written as something like “Preferred shares will automatically convert if the company goes public at a valuation > 3x and raises at least $50M”. It sounds like a company-friendly term (and it is) but it highlights the possibility of an investor NOT converting. We have seen situations where a later stage investor was not going to get a 3x to the midpoint of the IPO range and refused to convert — holding the company hostage for more shares.
Room to Negotiate?
Yes. Reduce the multiple, reduce the IPO proceed amount. If the mandatory threshold is not met, allow a voluntary conversion based on a vote of all series of the Preferred voting as a single class (making it harder for a single shareholder to hold you hostage) — requiring a simple majority.
Dividends
Preference enables an investor to get their money back — but investors aren’t in the game of just getting their money back with zero return. Some deals include a dividend — that is the amount of Preference will grow at, say, 8% per year. In a downside scenario, the investor gets their capital back, having grown at the interest rate.
Room to Negotiate?
Dividends are less common than they used to be. This is a purely economic question that presents itself only in downside scenarios. I’d suggest you consider putting your energy into other matters.
And, that’s it.
Increase to the Pool, Preference, Anti-Dilution, Board, Voting, Conversion and Dividends. None of them are showstoppers but each has drawbacks worth understanding. Study up — and if you want to have the best shot of negotiating successfully, make sure you have two investors you love to compete with each other.
