Am going for a VC case simulation. Anyone able to shed some light on some of the important features and key points during a VC term sheet negotiation?
As VC investors, how do you ensure fairness in adopting/rejecting any proposed terms?
What are some common sources of deadlock (eg. Anti-dilution Full Ratchet?), and how would you maneuver around it?
Any other noteworthy points I should take note of?
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As a VC the most important thing to do is to ensure that you are thinking of what's best for the fund first:
a. What terms ensure that the deal doesn't bite you in the ass later?
Anti-dilution, preference, etc. are just the tip of the iceberg.
Stuff like ensuring you gain VCOC exemption are important. If you've raised money from pensions funds in the US, then you have to make sure you receive management & information rights to at least 50% of your investments to gain VCOC exemption. Otherwise you'll be subject to ERISA rules as an ERISA fiduciary.
If you're a fund based outside of the US, and your partners are non-US citizens, then the Committee on Foreign Investment in the United States (CFIUS) can limit what you can invest in - essentially barring you from investing in companies that can impact national security. One of the ways that this can be skirted is by declining board seats.
b. The other part is making sure that you are negotiating terms that will still allow the startup you're investing in to raise capital down the road & for the founders to remain sufficiently motivated to keep working. For example, you have to agree with the founders on their vesting schedule. You have to negotiate the liquidation preferences of your preferred stock - if you're negotiating for 3x participating preferred, even if you get it, other investors are much less likely to invest in the company because the waterfall distribution will be unfairly favorable to you.
Full ratchet anti-dilution terms are not very common anymore, it's a well-known red flag in negotiations. Broad/narrow weighted-average is standard. Thus anti-dilution terms are not debated for too long. Board seats, ROFO/ROFR, drag-along, pre-emption, redemption, registration, co-sale rights, pay-to-play, anti-dilution carve outs, etc. are also fairly standard terms that take some time to negotiate but are not overly onerous for VCs to do so. The actual legal work is done by counsel anyway.
1-2 page termsheets are the best. Popularized by Sequoia. Move fast and get deals done.
Thanks for the insight. Just a quick question on ESOP on pre-post raise. Assuming I (investor) want an ESOP 10% on post money, does the entire amount of the ESOP comes from my capital or do I split the ESOP contribution with the Founder's pre money?
It will typically dilute the founders/existing investors shareholding, not your own as a new investor.
read Brad Feld's Venture Deals if you have time to
Came here to recommend this. Great book.
Another +1 for Venture Deals. It's a great book for getting to know the lay of the land.
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