Term Sheets

What the greatest technology investors say about Term Sheets

TERM SHEET POSTS (16 posts)

The following is a list of the post titles by author under this topic.  Scroll further down this page to find the actual blog post by your selected author.   Author’s posts appear in reverse alphabetical order except for the “Term Sheet Comments” post which appears towards the beginning of the page.  For the others for example, following this list, Mark Suster’s posts appear towards the beginning of the blog page, and Jeffrey Bussgang’s posts appear towards the end of the blog page.  

JEFFREY BUSSGANG (2 posts)

Jeffrey Bussgang: Be Wary of Term Sheet Tactics

Jeffrey Bussgang:  Relationship between Option Pool Size & Price

CHRIS DIXON  (1 post)

Chris Dixon:  The Company’s Stage: Weighing  Investor Quality vs. Valuation

BRAD FELD  (1 post)

Brad Feld:   The Math behind the Valuation Calculations

JOSH KOPELMAN  (2 posts)

Josh Kopelman:   The Unwritten Term on the Term Sheet

Josh Kopelman:   High Valuations Can Limit Exit Opportunities

JASON MENDELSON  (2 posts)

Jason Mendelson:  Investors Only Care about Two Things

Jason Mendelson:  Investors Only Care About Returns & Control

BABAK NIVI   (2 posts)

Babak Nivi:   The Biggest Mistake Entrepreneurs make when Raising Money

Babak Nivi:  The Option Pool Lowers your Effective Valuation

BASIL PETERS  (1 post)

Basil Peters:   Why VC's Block an Exit

MARK SUSTER   (4 posts)

Mark Suster:  Dilution Benchmarks & Fundraising

Mark Suster:  Fundraising Terms Pile Up with Later Stage Investors

Mark Suster:  VCs Want Big Outcomes & May Block a Sale

Mark Suster:  The VC Assumes there’s an Option Pool

TERM SHEET COMMENTS  (1 post)

Term Sheet Comments

This site provides various investors’ opinions, thoughts and perspectives on term sheets rather than a substantive explanation of their specific terms.   For the latter, this site recommends an excellent reference on topic,  Brad Feld’s book VENTURE DEALS & his blog posts on topic. 

The VC Assumes there’s an Option Pool

Mark Suster Partner Upfront Ventures and former entrepreneur

“The VC assumes [there will be] an option pool [] to hire and retain talent to grow [the] company. [] The more senior members [the company has], then the [fewer] options [needed] and vice versa.  Industry standard post [the] first round of funding will be 15-20% [for the option pool].  [Suster] say[s] “post” funding because [one will] need more than this amount pre-funding to get to this number after funding. [] 

[It’s standard] that the VC wants the options includ[ed] before [he] funds [].”  The option pool dilutes the founder’s percent ownership, not the investor’s.  The option pool suffers the same percent dilution the founder suffers when a VC invests his money. 

“Note that the term sheet [says “Pre-Money” valuation and nowhere does] the term sheet [say] “true Pre-Money” or “effective Pre-Money”– that’s for [the founder] to calculate.”   True or effective pre-money is based on a lower price/share due to options increasing the number of shares incorporated in the calculation. The result is a lower true pre-money than pre-money, the latter which is also called “nominal” pre-money valuation.  Mark Suster Want to Know How VC’s Calculate Valuation Differently from Founders, July 22, 2010;    http://www.bothsidesofthetable.com/2010/07/22/want-to-know-how-vcs-calculate-valuation-differently-from-founders/

VCs Want Big Outcomes & May Block a Sale

Mark Suster Partner Upfront Ventures and former entrepreneur

“VCs want big outcomes.  [VCs] will demand a veto right over [a company sale].  [A founder] might be very happy selling [his] business for $9 million and owning 50% of the company.  [A] VC is not necessarily going to be happy getting $3 million for his 33% stake for which he invested $1 million.

[While that’s] a 3x return [] it’s still just $3 million and if the VC has a $300 million [fund] it is just 1% of the money [needed] to reach his “hurdle rate” of when he’s entitled to earn carry (e.g. big bucks).  It’s just too much time to spend [] for such a small total return.  Many VC’s would still let [a founder] sell []” but some would block the sale.  Mark Suster  Do You Really Even Need VC? July 22, 2009; http://www.bothsidesofthetable.com/2009/07/22/do-you-really-even-need-vc/

Fundraising Terms Pile Up with Later Stage Investors

Mark Suster Partner Upfront Ventures and former entrepreneur

“[] any [early stage terms] will certainly be asked for by future investors in [] later funding rounds so all of these terms pile up [after] 3-4 rounds of funding over a 5 year time frame. And by the time most companies get to an exit [which realistically is still 8-10 years,] often the founders own very little of the economic upside."  Mark Suster, Want to Know How VC’s Calculate Valuation Differently from Founders?  July 22, 2010

http://www.bothsidesofthetable.com/2010/07/22/want-to-know-how-vcs-calculate-valuation-differently-from-founders/

Dilution Benchmarks & Fundraising

Mark Suster Partner Upfront Ventures and former entrepreneur

Negotiations between entrepreneurs and investors include dilution and other fundraising terms.  “[] the “fairway” of [investor’s equity] is 25-33% per round [i.e., entrepreneurs’ dilution]. [] If [the entrepreneur is] “super hot” or “super experienced”, [he] can end up with much less dilution –in some cases 12-15%.  But this is the exception, not the rule.”

“[] [These] dilution numbers don't take an option pool into account [].  Options are additional dilution.”

“[] [Valuation can be driven up] ONLY if there’s [] competition [for] a deal.  [Investors stay honest when entrepreneurs] talk with multiple parties.”

Fundraising also requires considering how many future rounds are needed and expected total future dilution.  It’s not an arbitrary spreadsheet-driven exercise reflecting attaining profitability.  It requires “understanding [industry norms necessary] to build a successful Internet business and where [the company falls] on that spectrum given [its business type].”  Mark Suster,  8 Questions to Help Decide if You Should be Raising Money Now, February 17, 2011 and comments;  http://www.bothsidesofthetable.com/2011/02/17/8-questions-to-help-decide-if-you-should-be-raising-money-now/

Why VC's Block an Exit

Basil Peters angel investor and Principal Strategic Exits Corporation

“Most entrepreneurs don’t even know that a VC is likely to block an exit when they accept the VC’s money. [] VCs design their investment agreements to give them the power to block exits.”

“[] VCs will almost always block a sale where they only make a 3-4X return on their investment.  This could have easily been a 10X return for the angels and a 100X return for the entrepreneurs.

[] The winners [must] produce at least 10-30X return for the [VC] fund to perform respectably.

[] This propensity to block exits is one of the reasons that every company needs a clear exit strategy before [it approaches its] first investor.”  Basil Peters, How VCs Block Exits, August 28, 2010, http://www.exits.com/blog/how-vcs-block-exits/; Why VCs Will Block Good Exits;  http://www.angelblog.net/Why_VCs_Block_Good_Exits.html

The Option Pool Lowers your Effective Valuation

Babak Nivi Co-Founder AngelList and Venture Hacks and angel investor

“The option pool lowers your effective valuation.  Your investors offered you a[n] $8M pre-money valuation. What they really meant was, “We think your company is worth $6M. But let’s create $2M worth of new options, add that to the value of your company, and call their sum your $8M ‘pre-money valuation’”. [] Slipping the option pool in the pre-money lowers your effective valuation to $6M. The actual value of the company [] is $6M, not $8M. [] The [option ‘shuffle’] puts pre-money [valuation] into your investor’s pocket. [] the option pool only dilutes the common stockholders.  [] [The] investor’s norm is that the option pool goes in the pre-money.”   Nivi recommends using a specific hiring plan to more accurately determine option pool size vs. allocating some arbitrary percentage.  Babak Nivi  The Option Pool Shuffle  April 10, 2007;  http://venturehacks.com/articles/option-pool-shuffle

The Biggest Mistake Entrepreneurs make when Raising Money

Babak Nivi Co-Founder AngelList and Venture Hacks and angel investor

Nivi says “the biggest mistake entrepreneurs make when [] raising money” is that “[they] focus on valuation when they should be focusing on controlling the company through board control and limited protective provisions.   (Protective provisions let preferred shareholders veto certain actions, such as selling the company or raising capital.)

Valuation is temporary, control is forever.  For example, the valuation of [a] company is irrelevant if the board terminates [the founder] and [he] [loses his] unvested stock.

The easiest way to maintain control of a startup is to create good alternatives while [] raising money. If [the founder is] not willing to walk away from a deal, [he] won’t get a good deal.  Great alternatives make it easy to walk away.

Create alternatives by focusing on fund-raising: pitch and negotiate with all [] prospective investors at once. This may seem obvious but entrepreneurs often meet investors one-after-another, instead of all-at-once.

Focusing on fund-raising creates the scarcity and social proof that close deals.  Focus also yields a quick yes or no from investors so entrepreneurs can avoid perpetually raising capital.”  Babak Nivi, What’s the biggest mistake entrepreneurs make? , October 14th, 2007  http://venturehacks.com/articles/biggest-mistake; Why do investors want protective provisions? August 2nd, 2007;  http://venturehacks.com/articles/understand-protective-provisions

Investors Only Care About Returns & Control

Jason Mendelson venture capitalist and Managing Director Foundry Group

Generally investors only care about returns and control when making investments.

“[Entrepreneurs] should focus on terms like pre-money valuation, liquidation preferences, board of director elections, drag-along rights and protective provisions.   Most [other standard term sheet terms] aren’t really all that important.  [] Many of these terms have interdependencies and it’s important [to] understand how terms such as option pools, warrant grants and  the election of independent board members will affect returns and control.” Jason Mendelson, Do More Faster  by David Cohen & Brad Feld  copyrt 2011, Get Help with your Term Sheet  pg 238

 

Investors Only Care about Two Things

Jason Mendelson Venture Capitalist and Managing Director Foundry Group

“In general, there are only two things that investors really care about when making investments: returns and control.  Returns refer to the end-of-the-day financial return the investor will get and the terms that have direct impact on these economics.   Control refers to mechanisms that allow the investors to either affirmatively exercise control over the business or to veto certain decisions the company can make.”  Mendelson says that if an investor resists terms that don’t impact returns or control,  it may be a negotiating tactic, he may not be savvy or could just be a jackass.  Jason Mendelson, Do More Faster  by David Cohen & Brad Feld  copyrt 2011, Get Help with your Term Sheet  pg 238

High Valuations Can Limit Exit Opportunities

Josh Kopelman Partner First Round Capital and former entrepreneur

Kopelman advises that entrepreneurs who “[] try to maximize valuation [] in many cases [] might be shortsighted” because high valuations can limit exit opportunities.  “[] too many founders are not aware that they are shutting off the majority of exits -- and therefore increasing risks -- when they accept a high valuation.”  “[] the “unwritten term in the term sheet” [means] few VC’s will willingly part with a “winning company” (i.e., a company that is executing/performing well) for less than a 10x return.”  Thus, a VC could block an exit that could have been a fabulous payout for entrepreneurs and angels.  Josh Kopelman The Unintentional Moonshot, July 10, 2007, http://redeye.firstround.com/2007/07/the-unintention.html;  When the music stops... March 10, 2006;  http://redeye.firstround.com/2006/03/as_a_little_kid.html

The Unwritten Term on the Term Sheet

Josh Kopelman Partner First Round Capital and former entrepreneur

 “When a company gets a term sheet with a high valuation, [the entrepreneur] need[s] to pay attention to the unwritten term on the term sheet.”  The entrepreneur should be ok “with [an] exit multiple that would generate [] returns [] to satisfy [] VC[‘s]. While every situation is unique, here's a simple rule of thumb:

Series A – 10X
Series B – 4-7X
Series C – 2-4X ”

“[] the “unwritten term in the term sheet” [means] few VC’s will willingly part with a “winning company” (i.e., a company that is executing/performing well) for less than a 10x return.”  Josh Kopelman The Unintentional Moonshot, July 10, 2007, http://redeye.firstround.com/2007/07/the-unintention.html; file Josh Kopelman Unintent Moonst Unwrt;      http://redeye.firstround.com/2006/03/as_a_little_kid.html

The Math behind the Valuation Calculations

Brad Feld venture capitalist and Managing Director Foundry Group

“I’ve found that even sophisticated entrepreneurs didn’t necessar[ily] grasp how valuation math (or “deal algebra”) worked. [] Recognize that this is about the math behind the calculations, not the philosophy of valuation [].

[] The key trick to remember is that share price is easier to calculate with pre-money [valuation] numbers, and fraction of ownership is easier to calculate with post-money [valuation] numbers; you switch back and forth by adding or subtracting the amount of the investment. It is also important to note that the share price is the same before and after the deal [].”Brad Feld, Venture Capital Deal Algebra, July 7, 2004;  http://www.feld.com/wp/archives/2004/07/venture-capital-deal-algebra.html

The Company’s Stage: Weighing Investor Quality vs. Valuation

Chris Dixon General Partner Andreessen Horowitz, angel investor and former entrepreneur

 “The earlier stage your company is the more you should weight quality of investors vs valuation.  For a Series A, you are truly partnering with the VCs.  You should consider taking a lower valuation from a top tier firm over a non top tier firm (but probably any discount over 20% is too much).  If you are doing a post-profitable “momentum round” I’d just optimize for valuation and deal terms.”  Chris Dixon, Best practices for raising a VC round, May 4, 2011;  http://cdixon.org/2011/05/04/best-practices-for-raising-a-vc-round/

Relationship between Option Pool Size & Price

Jeffrey Bussgang  venture capitalist and General Partner Flybridge Capital Partners and former entrepreneur 

 “This relationship between option pool size and price isn’t always understood by entrepreneurs, but is well understood by VCs.”  Bussgang lost a deal because the founder believed he got a better price (higher pre-money valuation) from a competing venture capitalist.  However because Bussgang’s competitor required a larger option pool, the founder received less stock than under Bussgang’s offer.  The founder took the competitor’s deal because he didn’t understand how the option pool calculation affected his ownership.

“[In response, Bussgang’s firm instituted a policy] to talk about the “promote” for the founding team rather than just the “pre”[-money valuation].  The “promote” [] is the founding team’s ownership percentage multiplied by the post-money valuation.”  The “promote” offers an “apples-to-apples” comparison of competing offers even if one offer has a lower pre-money valuation and  smaller option pool.  Jeffrey Bussgang, Mastering the VC Game –A VC Insider Reveals How to get from Start-up to IPO on your terms book, pg 131-133, copyright 2010

Be Wary of Term Sheet Tactics

Jeffrey Bussgang venture capitalist and General Partner Flybridge Capital Partners and former entrepreneur 

“The term sheet is essentially a preliminary, nonbinding document between the entrepreneur and the VC [summarizing key financing terms].  Some VCs issue a term sheet early [] to lock up the deal – and keep the entrepreneur from going elsewhere []. Entrepreneurs need to be wary of these situations and not be afraid to push the VC to define more clearly whether the term sheet  represents a real commitment or merely a discussion document. [] Most VCs issue a term sheet [] only when they have made a final decision []. [] [Be wary of] the “exploding term sheet” [expiring within 24 hours, which is a red flag].  [] Neither side should pressure the other [].” Jeffrey Bussgang, Mastering the VC Game –A VC Insider Reveals How to get from Start-up to IPO on your terms (book), copyright 2010, pg 127-128