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Understanding VC Financings – Overview and Sample Term Sheet

Posted in For Entrepreneurs and Companies, For Investors and Fund Managers, Fundraising, Startups, VC & Private Equity

Having a basic understanding of key venture capital terms and mechanics can be a great value to entrepreneurs looking to raise capital. In particular, it can be easy to get tripped up by the volume of foreign terminology and acronyms and the speed at which they are thrown around by venture capitalists and startup lawyers. This semantic minefield can put otherwise highly sophisticated entrepreneurs at a disadvantage in negotiating with venture capitalists and can cause them to enter into deals on unfavorable terms or force them to lean too heavily on their attorneys, increasing legal costs.

In this series, we have prepared a form of venture capital term sheet and will be providing commentary on the various deal points (i.e., what they mean, what is “market”, what to watch-out for, etc.).

We will be adding new posts with more detail regarding various key portions of these terms.

Readers may access a Word version of the sample term sheet here: Sample Series A Term Sheet.DOC

The National Venture Capital Association also has created its own form of term sheet.

 

MEMORANDUM OF TERMS FOR THE PRIVATE PLACEMENT OF SERIES A PREFERRED STOCK OF

Company Name, Inc. (the “Company”)

This term sheet summarizes the principal terms of the proposed Series a financing (the “Financing”) of the Company Name, Inc.  [Except as provided below under confidentiality and  exclusivity, which are legally binding,],  this term sheet is for discussion purposes only and there is no obligation on the part of any negotiating party until definitive securities purchase agreements are signed by all parties.  The Financing contemplated by this term sheet is subject to the satisfactory completion of due diligence and the negotiation of mutually satisfactory legal agreements.  This term sheet does not constitute either an offer to sell or an offer to purchase securities.

Amount to be Raised:

$_______ through the issuance of Series A Preferred Stock (the “Series A Preferred”).  At the Closing (as defined below), the Investors will be as follows:

 

Investors

Cash Amount

Shares

 

xyz Venture Partners, L.P. and affiliated funds (“XYZ”)

$[________]

 

 

 

 

 

 

[Conversion of Outstanding Bridge Notes (“Bridge Note Holders”)]

$[_____, equivalent to $___ with 20% note discount]

[DISCUSS DISCOUNT VS. WARRANT COVERAGE]

 

 

 

 

 

[Other Investors]

$[_____]

 

 

 

 

 

 

Total

$[_______]

 

Series A Pre-Investment Valuation:

$[_________]

 

Series A Price Per Share:

A price per share for the Series A Preferred (as adjusted for any stock split, recapitalization or the like, the “Series A Purchase Price”) is equal to $[________] per share assuming (i) the pre-investment valuation set forth above, (ii) the pre-investment capitalization as set forth on Exhibit A hereto, (iii) increasing the available-to-grant (unissued) option pool immediately prior to Closing to represent approximately 15% of the fully diluted shares of the Company immediately following Closing, and (iv) conversion of the existing Bridge Notes into Series A Preferred, [including the applicable discount as set forth in the Bridge Notes.]

 

Consideration:

The Series A Purchase Price will be paid in the form of either cash or immediately available funds[and conversion of the Bridge Notes].

 

Post-Financing Capitalization:

A proposed post-financing capitalization based on the foregoing is set forth on the attached Capitalization Table (Exhibit A).

 

Closings:

The closing of the sale of the Series A Preferred (the “Closing”) is anticipated to occur on or before _________, _____ (the “Closing Date”).

 

Conditions to the Closing:

The Closing will be subject to the following conditions precedent:

  • Satisfactory completion of due diligence by the Investors;
  • Increase to pre-money option pool consistent with foregoing;
  • Execution by all employees and contractors of confidentiality and proprietary rights assignment agreements in forms satisfactory to the Investors;
  • Execution of vesting and repurchase agreements for the options or equity shares held by the following founders and/or executives: ________________ [and employment agreements with ________________ and ____________], in each case satisfactory to the Investors;
  • Negotiation and mutual execution and delivery of mutually satisfactory Series A Preferred investment agreements;
  • Delivery of a legal opinion of counsel to the company, including customary opinions for venture capital deals, including an opinion regarding the outstanding capitalization of the Company; and
  • Payment of the legal fees of XYZ as set forth below.

 

Use of Proceeds:

The proceeds from the sale of the Series A Preferred are anticipated to be used for working capital and operating costs.

 

SERIES A PREFERRED TERMS

 

Series A Terms:

The rights and preferences of the Series A Preferred will be as set forth herein.

 

Dividends:

The holders Series A Preferred will be entitled to receive non cumulative dividends in preference to the holders of the Common Stock of the Company (the “Common Stock”) at a non-compounding annual rate of 8% on their respective original issue prices (as adjusted for any stock split, dividend, recapitalization and the like).  Such dividend will be payable as and if declared by the Company’s Board of Directors (the “Board”). 

No dividend will be paid to the holders of Common Stock unless a dividend of equal amount is first distributed to each holder of Series A Preferred.

 

Liquidation Preference:

In the event of any liquidation or winding up of the Company, the holders of Series A Preferred will be entitled to receive in preference to the holders of Common Stock an amount equal to [____] times the original purchase price of the Series A Preferred (as adjusted for any stock split, recapitalization or the like), plus all accrued and unpaid dividends (the “Initial Series A Preference”).

After payment of the Initial Series A Preference, the remaining assets of the Company will be distributed ratably to the holders of Common Stock [and Preferred Stock], on an as-converted basis.  [The holders of Preferred Stock may elect to convert the Preferred Stock into Common Stock immediately prior to a distribution upon liquidation.]

A sale, conveyance or other disposition of all or substantially all of the property or business of the Company, or a merger or consolidation with or into any other corporation, limited liability company or other entity, other than (i) a merger effected exclusively to change the domicile of the Company; (ii) an equity financing in which the Company is the surviving corporation; or (iii) a transaction in which the stockholders of the Company immediately prior to the transaction own 50% or more of the voting power of the surviving corporation following the transaction (collectively, a “Change of Control Transaction”), will be deemed to be a liquidation for purposes of the liquidation preference.

 

Voluntary Conversion:

Each holder of Preferred Stock will have the right, at the option of the holder at any time, to convert shares of Preferred Stock into shares of Common Stock at an initial conversion ratio of one-to-one, subject to adjustment as described herein.

 

Automatic Conversion:

The Series A Preferred will be automatically converted into Common Stock, at the then applicable conversion rate, in the event of either (i) the election of holders of at least a [majority] [DISCUSS BASED ON PORTFOLIO COMPANY CAPITALIZATION] of the then-outstanding Series A Preferred or (ii) the closing of an underwritten initial public offering of the Company’s Common Stock pursuant to a Registration Statement under the Securities Act of 1933, as amended (a ”Public Offering“) with aggregate proceeds of at least $30 million at a public offering price of at least [five] times the Series A Purchase Price (a ”Qualified Public Offering“).

 

Antidilution Provisions:

The conversion price of the Series A Preferred will be subject to proportional adjustment for stock splits, stock dividends and the like.  The conversion price of the Series A Preferred will also be subject to adjustment on a broad-based weighted average basis for subsequent issuances of Company equity at a purchase price less than the then‑effective conversion price for the Series A Preferred (“Dilutive Issuances“).  No adjustment to the conversion price of the Series A Preferred will occur for any future issuance of shares above the Series A Purchase Price.

Price-based anti-dilution adjustments to the conversion prices of the Series A Preferred will be subject to the following exceptions (provided that each is approved by the Board): (i) the issuance of securities of capital stock to employees or consultants, pursuant to a stock option or restricted stock plan, approved by the Board, including the XYZ Director (as defined below); (ii) the issuance of securities in connection with acquisition transactions, commercial credit arrangements or equipment financings approved by the Board, including the XYZ Director; (iii) shares issued upon conversion of the Series A Preferred; (iv) the issuance of securities in a Qualified Public Offering; (v) the issuance of securities pursuant to options, warrants, notes, or other rights to acquire securities of the Company outstanding as of the Closing; (vi) stock splits, stock dividends or similar transactions for which proportional adjustments are made to the conversion price of the Series A Preferred; or (vii) shares of capital stock or other securities which are explicitly excluded by the affirmative vote or consent of the holders of at least a [majority] of the then-outstanding shares of Series A Preferred.  The carve outs set forth in subsections (i) through (vii) are “Permitted Additional Securities.”

 

Voting Rights:

The holders of Series A Preferred will be entitled to vote as a single class on all matters except as described below or as required by law.

The holders of shares of Series A Preferred will be entitled to that number of votes on all matters presented to stockholders equal to the number of shares of Common Stock then issuable upon conversion of such shares.

Except as provided herein, the Certificate of Incorporation will deny any separate common or preferred class or series voting rights to the maximum extent allowed by law.

 

Protective Provisions:

Without the approval of the holders of at least a [majority] of the then-outstanding shares of Series A Preferred voting together as a single class on an as-converted basis, the Company will not take any of the following actions: (i) a sale, conveyance or other disposition (including the dissolution, liquidation or voluntary reorganization) of all or substantially all of the property or business of the Company; (ii) the merger, consolidation or reorganization of the Company with and into another company or entity, or of any other company or entity with and into the Company (including the merger with a wholly-owned subsidiary); (iii) the acquisition of a substantial portion of the assets or business of another company or entity or any other acquisition of material assets; (iv) amend the Certificate of Incorporation or the Bylaws of the Company; (v) increase the number of authorized shares of Company stock of any class or series or authorize the issuance of equity securities (including securities convertible into or exercisable for equity securities) having rights, preference or privileges superior to or on a par with the Series A Preferred; (vi) authorize any distribution by the Company other than the preferential dividends with respect to the Series A Preferred; (vii)  adopt or amend any incentive compensation plan; (viii) materially change the business of the Company; (ix) redeem or repurchase shares of stock of the Company (excluding Common Stock repurchased at not more than cost upon termination of an individual or entity pursuant to a restricted stock purchase agreement or the Company’s stock option plan); (x) change the number of authorized members of the Board; (xi) undertake any transaction or expenditure or series of expenditures involving an obligation or liability in an amount in excess (individually or in the aggregate) of $[50,000] [TO DISCUSS BASED ON STAGE OF COMPANY] unless approved by the Board, including the XYZ Director; (xii) sell, license, transfer, lease, sublease or otherwise dispose of assets having a value in excess of $[50,000] outside of the ordinary course of business, unless approved by the Board, including the XYZ Director; or (xiii) make loans or advances in an amount in excess of $10,000 to any employee, director or consultant without the prior approval of [both Investor Directors].

 

Registration Rights:

Registrable Securities:  All shares of Common Stock issuable or issued upon conversion of the Series A Preferred will be deemed ”Registrable Securities” and entitled to customary demand, Form S-3 and piggyback registration rights. 

Approval RequiredThe granting of additional registration rights on a pari passu or senior basis will be subject to the approval by the holders of at least 30% of the Registrable Securities.

 

Market Standoff:

In connection with a Qualified Public Offering, each holder of registration rights will be required not to sell or otherwise dispose of any securities of the Company (except for those securities being registered) for the lesser of (i) 180 days or (ii) such period requested by the underwriters following the effective date of the registration statement for such offering if so requested by the underwriters of such offering, in each case provided that all officers, directors and 1% and greater holders of the Company’s outstanding stock have entered into similar agreements.

 

Information Rights:

The Company will deliver to Major Holder (as defined below), at least 30 days prior to the beginning of each fiscal year, copies of its annual budget and business plan for the upcoming fiscal year and, within [90/180] days following the end of each fiscal year, audited financial reports, prepared in accordance with generally accepted accounting principles (“GAAP”).  During each fiscal year, the Company will submit unaudited, but reviewed, quarterly financial reports, no later than 45 days after the end of each of the first three fiscal quarters.  During each fiscal year, the Company will also submit unaudited and unreviewed monthly financial reports, no later than 30 days after the end of each month.  The Company will also deliver to each Major Holder such other information relating to the financial condition, business, prospects or corporate affairs of the Company as such Major Holder reasonably requests, unless the Company in good faith determines such information to be a trade secret or similar confidential information.  The Company will allow each Major Holder reasonable access, during normal business hours, to the Company’s premises and records and reasonable opportunity to discuss the Company’s affairs, finances and accounts with the Company’s officers; provided, however, that the Company will not be obligated to provide access to any information that it reasonably considers to be a trade secret or similar confidential information, unless a customary confidentiality undertaking is signed.  The obligation of the Company to furnish such information and access will terminate on the earliest of  the closing of a Public Offering, at such time as the Company becomes subject to the reporting provisions of the Securities Exchange Act of 1934, as amended, or a liquidation of the Company.

 

Right of First Offer:

Each Major Holder will have the right in the event the Company proposes to offer equity securities, or any securities convertible into or exchangeable for equity securities, to any person (other than Permitted Additional Securities) to purchase that number of such equity securities necessary to maintain its pro rata percentage ownership of the Company, on a fully diluted and as converted basis.  Such equity securities will be purchased upon not less than 20 days notice from the Company and on the same terms as they are purchased by other third party purchasers of the equity securities.  To the extent that any Major Holder elects to not acquire its full pro rata share of the offered securities as determined above, each Major Holder electing to acquire it full pro rata portion will have the first right to acquire any remaining shares not subscribed by other Major Holders.  The term “Major Holder” will mean each holder of Preferred Stock that holds at least 5% of the Company’s issued and outstanding capital stock (on an as converted basis and as adjusted for any stock split, recapitalization or the like).

This right of first offer will terminate immediately prior to (i) a Qualified Public Offering or (ii) a Change of Control Transaction.

 

Co-Sale Right and Right of First Refusal on Common Stock:

 

Each holder of Series A Preferred will have first refusal rights with respect to all transfers (except for (i) transfers to the Company at cost pursuant to an agreement approved by the Board providing for repurchase of shares upon certain events, (ii) certain customary intra-familial transfers and (iii) transfers to an entity wholly owned by the transferor) of shares of Common Stock now or hereafter acquired by other stockholders, to the extent such rights are not exercised by the Company.  In addition to the foregoing, all Major Holders will have co-sale rights (on a pro rata basis) with respect to such transfers of shares by the Company founders and management.

This right will terminate immediately prior to a Qualified Public Offering or a Change of Control Transaction.

 

[Redemption Rights:

 

The Series A Preferred shall be redeemable from funds legally available for distribution at the option of the holders of at least a [majority] of the Series A Preferred commencing any time after the fifth (5th) anniversary of the Closing at a price equal to the Series A Purchase Price plus all accrued but unpaid dividends.]

 

Common Stock Option Valuation:

Within 90 days of the Closing, Company will provide the Board with a completed 409A valuation report produced by an independent valuation firm.  Following Closing, all common stock options or the equivalents such as common stock warrants will be granted at fair market value as determined by the Board with reference to such 409A valuation report, or an updated valuation report.

 

GOVERNANCE AND MISCELLANEOUS TERMS:

 

Board of Directors/Observers:

The Company will have ______ (__) members on its Board elected as follows:

  • One (1) seat occupied by the then-current Chief Executive Officer of the Company, initially __________ (the “CEO Director”);
  • For so long as XYZ owns at least [__________] shares of the outstanding Series A Preferred or Common Stock issued upon conversion of the Series A Preferred (as adjusted for any stock splits, stock dividends and the like), XYZ will be entitled to designate one (1) member of the Board, who initially will be [__________] (the “XYZ Director”);
  • ________ (_) member[s] designated by the mutual consent of the other directors, initially _____________.

The Board will meet at least monthly (with telephonic participation allowable), unless otherwise approved by the XYZ Director.  The bylaws will provide, in addition to any provisions required by law, that the XYZ Director may call a meeting of the Board.  Board members will be entitled to reimbursement of reasonable expenses related to the Company.  In addition to its director appointment, XYZ will be entitled to have one non-voting observer attend each meeting of the Board, and to receive all materials submitted to the Board in connection with each such meetings, who will initially be [_________________].

 

Insurance:

 

The Company will provide its directors with indemnification to the fullest extent permitted by law and as of the Closing will have entered into indemnification agreements with the members of the Board in a form acceptable to the Investors.  The Company will procure and maintain Directors and Officers Insurance in such amounts as determined appropriate by the Board, but no less than $2,000,000.  The Company will procure and maintain key person life insurance policies, payable to the Company as beneficiary, on the life of __________ in the aggregate amount of at least $1,000,000.

 

Confidential Information and Invention Assignment, Non-Competition and Non-Solicitation Agreements:

Prior to the Closing, each employee and consultant of the Company will have entered into a Confidential Information and Invention Assignment Agreement with the Company in form and substance delivered to the Investors and attached hereto.  Additionally, the Company will require all future employees and consultants of the Company to enter into such agreements.

Additionally, the Company will require all present and future employees and consultants of the Company to enter into a non-competition and non-solicitation agreement (covering a one-year period following employment termination) in form and substance reasonably satisfactory to the Investors.

 

Vesting and Acceleration of Executives’ Common Stock:

Common Stock issued to [_______________ certain executives] shall be subject to vesting over a [three year] period as follows:  (a) 25% of the Common Stock issued will be fully vested on the Closing and (b) the remaining [75% will vest in equal monthly installments over the next succeeding 36] month period.  Vesting of such Common Stock shall be subject to acceleration only upon the following terms: (i) [fifty percent (50%)] upon termination (including constructive termination) of such executive’s employment within 12 months of a Change of Control Transaction; or (ii) [fifty percent (50%)] upon termination (including constructive termination) of such executive’s employment without cause.

 

Option Pool:

The total number of pre-closing authorized stock options issuable and available for grant under the Company’s plan will be equal to 15% of the fully diluted shares immediately following the initial Closing of the Financing assuming all authorized shares are sold.  All grants will be subject to the recommendation and approval of the Board.

Unless otherwise approved by the Board, all stock options or restricted stock awards granted after the Closing will vest on a standard four year, one year cliff vesting schedule and acceleration of vesting will occur only if both (i) a Change of Control Transaction is consummated, (ii) the option is not assumed by the acquirer, and (iii) no more than 50% of the unvested shares subject to the option will be accelerated..  The Company will retain a right of first refusal on transfers of all shares of Common Stock issued upon the exercise of options until the closing of a Public Offering.

 

Purchase Agreement:

The sale of Series A Preferred as described above will be made pursuant to a stock purchase agreement mutually acceptable to the Company and the Investors, which agreement will contain, among other things, appropriate representations and warranties of the Company and the Investors, covenants of the Company reflecting the provisions set forth in this term sheet and appropriate conditions to closing which will include, among other things, qualification of the securities to be sold under applicable Blue Sky laws, and the filing of the Amended and Restated Certificate of Incorporation. 

 

Counsel to the Company:

[_______________] 

 

Counsel to XYZ:

DLA Piper LLP (US)
701 Fifth Avenue, Suite 7000
Seattle, Washington 98104

 

Finders:

Each party will represent to the other that there are no finders’ fees applicable to this transaction.  The Company and the Investors shall each indemnify the other for any finder’s fees for which either is responsible.

 

Expenses:

As a condition to Closing, the Company will pay the fees and expenses of one special counsel to XYZ, not to exceed $xx,000. [TO DISCUSS; DILIGENCE; DOCUMENT STATUS; OTHER FACTORS (TIME ABLE TO BE DEVOTED BY COMPANY COUNSEL, MULTIPLE LOCATIONS, CORPORATE CLEANUP ISSUES)]. 

 CLICK HERE TO READ OUR DETAILED POST ON THIS ISSUE

 

Confidentiality:

Except as required by law, the Company will not, without the written consent of XYZ, discuss the terms of this term sheet or the transactions contemplated hereby with any person other than key officers, members of the Board or the Company’s accountants or attorneys.  In addition, the Company shall not use an Investor’s name in any manner, context or format (including reference on or links to websites, press releases, etc.) without the prior approval of such Investor.

 

Exclusivity:

From the date of last signing of this Term Sheet until [_____________, ____ 30 to 45 days forward], the Company agrees not to solicit, encourage others to solicit, or accept any offers for the purchase of any capital stock of the Company, or any proposals for merger or consolidation involving the Company, and that it will not negotiate or enter into an agreement with respect to any such transaction, other than the transaction proposed by XYZ under this term sheet.  The parties intend for this Exclusivity provision to be legally binding

As of this ___ day of _________, 20__, the undersigned hereby acknowledge that the terms of this Memorandum of Terms are acceptable as a basis for negotiating an investment by the Investors, [and that other than with respect to the Confidentiality and Exclusivity provisions,] none of the parties shall be bound until a definitive purchase agreement has been executed by all parties.

Except as required by law, the Company will not, without the written consent of , discuss the terms of this term sheet or the transactions contemplated hereby with any person other than key officers, members of the Board or the Company’s accountants or attorneys.  In addition, the Company shall not use an Investor’s name in any manner, context or format (including reference on or links to websites, press releases, etc.) without the prior approval of such Investor 

 

 

 

 

 

 

 

 

 

 

  • http://wac6.com William Carleton

    Trent, it’s awesome of you guys to tackle this. I’m looking forward to the series!

  • http://www.theventurealley.com/authors/asher-bearman.html Asher Bearman

    Thanks Bill! We’d love to have a guest from you if there is a provision that you find particularly interesting (in light of the current environment or otherwise). Next up is a post on deal expenses, which I know you’ve written about recently as well.