I had good intentions earlier this week to try to crank out the balance of the term sheet series, but it turned into a busy week. Since I’m still muddling through the set of terms that either don’t matter much and/or are hard to negotiate away (e.g. chose you battles wisely), I didn’t expect anyone would be waiting on the edge of their seats for these. However, for completeness, it’s worth going through the stuff that shows up on the last few pages of a standard VC term sheet. Jason and I aren’t quite done, but with this post, we are one (tedious) step closer.
Almost every term sheet we’ve ever seen has a “Restrictions on Sales” clause in it that looks something like:
“Restrictions on Sales: The Company’s Bylaws shall contain a right of first refusal on all transfers of Common Stock, subject to normal exceptions. If the Company elects not to exercise its right, the Company shall assign its right to the Investors.”
Management / founders rarely argue against this as it helps control the shareholder base of the company which usually benefits all the existing shareholders (except possibly the one who wants to bail out of their private stock.) However, we’ve found that the lawyers will often spend time arguing how to implement this particular clause. Some lawyers feel that putting this provision in the bylaws is the wrong way to go and prefer to include such a provision in each of the company’s option agreements, plans and stock sales. Personally, we find it much easier to include in the bylaws.
Next up is the ubiquitous proprietary information and inventions agreement clause.
“Proprietary Information and Inventions Agreement: Each current and former officer, employee and consultant of the Company shall enter into an acceptable proprietary information and inventions agreement.”
This paragraph benefits both the company and investors and is simply a mechanism that investors use to get the company to legally stand behind the representation that it owns its intellectual property. Many pre-Series A companies have issues surrounding this, especially if the company hasn’t had great legal representation prior to its first venture round. We’ve also run into plenty of situations (including several of ours – oops!) where companies are loose about this between financings and – while a financing is a good time to clean this up – it’s often annoying to previously hired employees who are now told “hey – you need to sign this since we need it for the venture financing.” It’s even more important in the sale of a company, as the buyer will always insist on clear ownership of the IP. Our best advice here is that companies should build these agreements into their hiring process from the very beginning (with the advice from a good law firm) so that there are never any issues around this, as VCs will always insist on it.
Finally, a co-sale agreement is pretty standard fare as well.
“Co-Sale Agreement: The shares of the Company’s securities held by the Founders shall be made subject to a co-sale agreement (with certain reasonable exceptions) with the Investors such that the Founders may not sell, transfer or exchange their stock unless each Investor has an opportunity to participate in the sale on a pro-rata basis. This right of co-sale shall not apply to and shall terminate upon a Qualified IPO.”
If you are a founder, you are probably asking why we did not include the co-sale section in the “really matter section.” The chance of keeping this provision out of a financing is close to zero, so we don’t think it’s worth the battle to fight it. Notice that this only matters while the company is private – if the company goes public, this clause no longer applies.