Entrepreneurship and StartupsFunding and Investment

1. Definition and Purpose of Term Sheets:
2. Term sheets are preliminary agreements that outline the terms and conditions under which an investment will be made.

3. They are not legally binding, except for specific sections like confidentiality and exclusivity.

4. Components of a Term Sheet:

5. Economic terms include aspects like valuation, price per share, and the amount of investment.
6. Control terms cover things like voting rights, board composition, and protective provisions.

1. Clear Valuation Metrics:
2. Example: The book stresses the importance of understanding pre-money and post-money valuation. If a company is valued at $5 million pre-money and a VC invests $1 million, the post-money valuation is $6 million, making the investor’s share 16.67%.

3. Action: Entrepreneurs should calculate both pre-and post-money valuations beforehand to set clear expectations during negotiations.

4. Negotiating Board Composition:

5. Example: Wilmerding describes a scenario where retaining founder control required negotiating three out of five board seats.
6. Action: Founders should prioritize retaining enough seats on the board to ensure they have significant influence over company decisions.

1. Valuation and Pricing:
2. The importance of getting the right valuation based on the stage of the company and market conditions.

3. Price per share is calculated by dividing the pre-money valuation by the number of existing shares.

4. Liquidation Preferences:

5. Liquidation preference determines how proceeds are distributed in the event of a liquidation, sale, or bankruptcy.
6. Participating and non-participating liquidation preferences affect how returns are distributed between investors and founders.

1. Fair Price per Share:
2. Example: A company valued at $10 million pre-money with 1 million shares outstanding would have a price per share of $10.

3. Action: Entrepreneurs should perform due diligence to find comparable company valuations to justify their proposed pricing.

4. Negotiating Liquidation Preferences:

5. Example: Wilmerding shows an example of a 1x non-participating liquidation preference versus a 2x participating preference.
6. Action: Founders should advocate for a 1x non-participating liquidation preference to align investor and founder interests better.

1. Voting Rights:
2. Voting rights determine who has the power to make significant company decisions.

3. Different classes of shares may have different voting rights (e.g., common vs. preferred).

4. Anti-Dilution Provisions:

5. These provisions protect investors from dilution in future rounds by adjusting conversion prices of preferred shares.

1. Class of Shares:
2. Example: Preferred shares might carry extra voting rights compared to common shares to give investors more control.

3. Action: Companies should clearly outline the rights of different share classes in the term sheet to manage expectations.

4. Full Ratchet vs. Weighted Average Anti-Dilution:

5. Example: Full ratchet adjustment can drastically reduce founders’ equity in down rounds, whereas weighted average is a softer adjustment.
6. Action: Founders should negotiate for weighted average anti-dilution provisions to minimize potential equity loss.

1. Qualitative and Quantitative Factors:

2. Both subjective factors like market potential, team quality, and competitive landscape, as well as financial metrics, influence valuations.

3. Due Diligence:

4. Comprehensive due diligence is critical, including financial audits, customer references, and technology evaluations.

1. Qualitative Assessments:
2. Example: A strong, experienced team might command a higher valuation due to perceived execution ability.

3. Action: Entrepreneurs should highlight their team’s strengths and prior successes during valuation discussions.

4. Thorough Due Diligence:

5. Example: A venture capital firm might discover important insights from customer references that significantly affect valuation.
6. Action: Companies should prepare in advance for due diligence by organizing financial records and securing customer commitments for positive references.

1. Successful Negotiation Tactics:

2. Real-world examples illustrate successful strategies for negotiating favorable term sheets and valuations.

3. Common Pitfalls and How to Avoid Them:

4. Identifying and learning from common mistakes made during term sheet negotiations.

1. Leveraging Multiple Offers:
2. Example: A startup received multiple term sheets and used this leverage to negotiate better terms, such as lower dilution and higher valuation.

3. Action: Founders should seek multiple investors to create a competitive bidding environment, yielding better terms.

4. Avoiding Misalignment:

5. Example: Misalignment between founders and investors on exit strategies resulted in conflicts and a failed venture.
6. Action: Ensure alignment on long-term goals and exit strategies with investors during the negotiation phase to prevent future conflicts.

Entrepreneurship and StartupsFunding and Investment