Funding through a venture capital firm is an option many startup businesses peruse. There are many difficulties and challenges in gaining the attention of a venture capitalist. If you do get far in to the process, then you will eventual be presented with a VC term sheet to complete the deal. Understanding all the sections of the term sheet will be essential in getting a deal that works for your business.
This is by far the most important term on a term sheet. The valuation will be formed by a combination of past performance, projected turnover and profit, and the perceived value of any intellectual property.
Your final valuation figure will be a key metric that will determine the amount of capital you can expect to raise. It also helps dictate the equity share of your company, which is crucial when it comes to the liquidation preferences.
Always aim to get a “fair” deal rather than the “best” deal. You really want to create a win-win situation for all parties involved. Generally there isn’t much quibbling over the valuation numbers, as long as all sides aim for fairness.
Board of Directors
Any significant investors and venture capitalists will generally expect a secure seat at the board position. This allows an investor to protect their investment, by having an active voice in the big decisions and direction of the business.
It is important to not allow investors to take full control of the board. The best performing boards are those who find an even balance between the company founders, investors, and outside individuals (such as an industry expert).
This decides how the company’s pie gets split and who gets which slice after the acquisition or merger. Investors are given priority so they can recoup their investment. Next come shareholders, who will get a payout based on the percentage of ownership in the company.
Anything you gave away earlier will be asked for later on, and probably even more so. Don’t overcomplicate this section. Just keep it simple and to the point.
The provisions will list all the things that you can’t do without the prior approval of the investors. However, luckily the details of the protective provisions aren’t a major topic for negotiation. You just need to understand what each provision means, so you know what your company can quickly get done without unnecessary holdups.
Company founders should always strive to be as smart (or smarter) than their investors and attorney. But in this case, having a consultation with your lawyer is always a good idea.
This sets the amount of stock that your company will put aside for future employees, directors, officers and consultant. Keep in mind that this comes out of your own portion of the company, i.e. the founder’s portion, not the investor’s portion. Have enough reserve stock to make any required hires, though not so much that you end up over-diluted.
Always consider what your long-term vision is for the company. Make sure your hiring needs will be shared by the investors.