Term Sheet

We’re down to our last two sections on a typical VC term sheet. Since they are both things that most entrepreneurs simply live with as part of a financing, we decided to combine them into one post. The first clause is indemnification and usually looks as follows: “Indemnification: The bylaws and / or other charter documents of the Company shall limit board member’s liability and exposure to damages to the broadest extent permitted by applicable law. The Company will indemnify board members and will indemnify each Investor for any claims brought against the Investors by any third party (including any other shareholder of the Company) as a result of this financing.” ...

Earlier this week I did a brief post on the “no shop agreement” that is a common feature in a term sheet. I compared signing a no shop to the construct of serial monogamy in a relationship. I had a couple of comments (one that was intellectual, one that was a little harsher and painted VCs as “duplicitous.”) I was mulling over my obviously (in hindsight to me) asymmetric view when Tom Evslin very clearly and coherently articulated why my analogy was really unilateral monogamy (e.g. the VC isn’t signing up for serial monogamy – only the entrepreneur is.) ...

As an entrepreneur, the way to get the best deal for a round of financing is to have multiple options. If you’ve been a studious reader of our term sheet series, you are painfully aware that there are many other terms – beside price – that help define what “the best deal” actually is. However, there comes a point in time where you have to choose your investor and shift from “search for an investor” mode to “close the deal” mode. Part of this involves choosing your lead investor and negotiating the final term sheet with him. ...

Jason and I are planning to finish strong with some serious stuff in our term sheet series, but we figured we’d put one more term in that has us sniggling whenever we see it (a “sniggle” is a combination “sneer-giggle” – sort of like how I reacted to Kidman / Ferrell in Bewitched last night). The last sniggle term is as follows: “Initial Public Offering Shares Purchase: In the event that the Company shall consummate a Qualified IPO, the Company shall use its best efforts to cause the managing underwriter or underwriters of such IPO to offer to [investors] the right to purchase at least (5%) of any shares issued under a “friends and family” or “directed shares” program in connection with such Qualified IPO. Notwithstanding the foregoing, all action taken pursuant to this Section shall be made in accordance with all federal and state securities laws, including, without limitation, Rule 134 of the Securities Act of 1933, as amended, and all applicable rules and regulations promulgated by the National Association of Securities Dealers, Inc. and other such self-regulating organizations.” ...

I’m going to keep tonight’s term sheet post short and sweet, especially since I’m still reeling from the horrifyingly bad War of the World movie I just saw. Jason and I are almost done with the term sheet series (yeah, we know we keep promising that) but – like the Spielberg tragicomedy I just watched, it’s not over until it’s over (sorry – that cliche just snuck its way in – I was helpless against it – the aliens made me do it.) ...

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. ...

Jason and I are feeling the need for closure on our term sheet series as we’ve started gearing up on our next series (M&A). So – we’re going to knock out the balance of the standard term sheet terms this week. We’re still in the “terms that don’t matter much zone” so we’re including Voting Rights and Employee Pool for completeness. “Voting Rights: The Series A Preferred will vote together with the Common Stock and not as a separate class except as specifically provided herein or as otherwise required by law. The Common Stock may be increased or decreased by the vote of holders of a majority of the Common Stock and Series A Preferred voting together on an as if converted basis, and without a separate class vote. Each share of Series A Preferred shall have a number of votes equal to the number of shares of Common Stock then issuable upon conversion of such share of Series A Preferred.” ...

Today’s “term that doesn’t matter much” from our term sheet series is the Right of First Refusal. When we say “it doesn’t matter much”, we really mean “don’t bother trying to negotiate it away – the VCs will insist on it.” Following is the standard language: “Right of First Refusal: Investors who purchase at least (____) shares of Series A Preferred (a “Major Investor”) shall have the right in the event the Company proposes to offer equity securities to any person (other than the shares (i) reserved as employee shares described under “Employee Pool” below, (ii) shares issued for consideration other than cash pursuant to a merger, consolidation, acquisition, or similar business combination approved by the Board; (iii) shares issued pursuant to any equipment loan or leasing arrangement, real property leasing arrangement or debt financing from a bank or similar financial institution approved by the Board; and (iv) shares with respect to which the holders of a majority of the outstanding Series A Preferred waive their right of first refusal) to purchase [X times] their pro rata portion of such shares. Any securities not subscribed for by an eligible Investor may be reallocated among the other eligible Investors. Such right of first refusal will terminate upon a Qualified IPO. For purposes of this right of first refusal, an Investor’s pro rata right shall be equal to the ratio of (a) the number of shares of common stock (including all shares of common stock issuable or issued upon the conversion of convertible securities and assuming the exercise of all outstanding warrants and options) held by such Investor immediately prior to the issuance of such equity securities to (b) the total number of share of common stock outstanding (including all shares of common stock issuable or issued upon the conversion of convertible securities and assuming the exercise of all outstanding warrants and options) immediately prior to the issuance of such equity securities.” ...

When Jason and I last wrote about term sheets, Jack was still trying to save the world (surprise – he did) and we dealt with a meaty and important issue – vesting. For completeness (and because all good “series” deserve to be finished off), we’re tackling the terms that rarely matter in the next couple of posts. Today we’re starting with Information Rights and Registration Rights. You might ask, “If these terms rarely matter, why bother?” Well – you’ll end up having to deal with them in a VC term sheet, so you might as well (a) be exposed to them and (b) hear that they don’t matter much. Of course, from a VC perspective, “doesn’t matter much” means “Mr. Entrepreneur, please don’t pay much attention to these terms – just accept them as is.” Specifically, if one of these terms is being hotly negotiated by an investor or company, that time (and lawyer money) is most likely being wasted. ...

When Jason and I last wrote on the mythical term sheet, we were working our way through the terms that “can matter.” The last one on our list is vesting, and we approach it with one eyebrow raised understanding the impact of this term is crucial for all founders of an early stage company. While vesting is a simple concept, it can have profound and unexpected implications. Typically, stock and options will vest over four years – which means that you have to be around for four years to own all of your stock or options (for the rest of this post, I’ll simply refer to the equity as “stock” although exactly the same logic applies to options.) If you leave the company earlier than the four year period, the vesting formula applies and you only get a percentage of your stock. As a result, many entrepreneurs view vesting as a way for VCs to “control them, their involvement, and their ownership in a company” which, while it can be true, is only a part of the story. ...