Term sheets, bro.
Now, there are two things to be aware of: Economics and Control. In this first part, I’ll talk about Control Terms.
Control is what allows investors to exercise some type of influence and grants them decision-making power inside the company.
So, this post is sort of a clue card for you. When reading your Term Sheet, look for the following key words:
- Board of Directors:
- This point is crucial. Remember when you were a kid and you were deciding who to invite to your birthday party? Well this is almost as delicate! Most VC’s will ask you to include a board member of their choice (especially when they’re a lead investor or their share is significant enough), and it’s most-likely going to be one of the fund’s partners (hopefully). This could be quite helpful if the person has expertise and value to add and it is not just occupying a seat in the room. Having multiple board members is okay, as long as the parties are in balance (founders, investors, and even external members).
- Protective Provisions:
- As the name implies, these are risk-mitigating actions for the investors. They’re also known as veto rights, and they involve things such as: selling the company or issuing equity, changing the size of the Board, getting debt or taking money out of the company.
- There are other terms that aren’t that usual, but they exist in special cases such as; hiring and/or firing of executives, acquiring debt over a certain (high) amount, purchasing physical assets, etc.
- Some useful terms to know:
- Drag-along: This is a special clause, that is quite fun. It allows investors to drag all the minority investors when a sale opportunity is presented. So for example, if Wal-Mart came and offered to buy your startup, the majority of investors will force the rest of them to sell their shares to Wal-Mart for a full exit.
- Tag-along: Just like the child’s game, this is fun too. If Wal-Mart offered to buy a stake of the company, investors with tag-along rights would be able to adhere to this transaction and sell some of their shares as well. Isn’t that fun? 😀
- This is closely related to the Economic terms of the agreement (which I’ll talk about in my next post), but basically conversion rights allow the VC’s to convert their preferred stock into common stock, if they feel like a deal is going to give them better returns if they do so, depending on their Liquidation Preferences. But don’t worry about that just yet, just keep in mind the the basic concept of Conversion.