TERM SHEET GUIDE

Welcome to Docracys Term Sheet Guide. First things first: when youre raising money from
investors, always, always consult a lawyer. Modifying the equity structure of a company is a big deal
with a lot of different legal and tax implications. Dont go DIY, and dont rely on the same counsel
as your investors. That said, you should learn how a term sheet works to make informed
decisions and protect your interests. Understanding the legal side of the process will help you
direct your lawyers efforts and probably save you some money. For this reason, we dissected and
explained all the relevant terms of the term sheet, the core document of any equity investment.
While there are many more legal issues surrounding venture capital investment, we will only focus
on the ones raised by the standard term sheets currently available on Docracy (see full list on the
right). Term sheets are very standardized documents and starting from a known template is a very
good idea. Last but not least, this guide is heavily indebted to Venture Deals, the fundamental book
by Brad Feld and Jason Mendelson and still the best manual on how to navigate a round of VC
financing.
Good to know:
External links are in italics.
Defined terms are underlined.
Sample language from actual clauses is highlighted in a box.
Standard term sheets from reputable investors are listed on the right.

Table of Contents
I. Foreword
II. The Term Sheet
III. Economics
1.
2.
3.
4.
5.
6.
7.
8.
9.

Price
Employee Pool / Option Pool
Liquidation Preference
Dividends
Conversion
Anti-dilution
Right of First Refusal
Pay-to-Play
Vesting

10.

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10. Redemption Rights

IV. Control
1.
2.
3.
4.
5.
6.
7.
8.
9.

Conditions Precedent to Financing

Voting Rights
Board of Directors
Protective Provisions
Information Rights
Co-Sale Agreement / Tag-along
No-Shop Agreement
Assignment
Indemnification

V. Definitions
Capitalization Table
Downside Case
Drag-Along Agreement
Fully Diluted
Liquidation Event
Valuation
Vesting Acceleration
VI. Checklist

I. Foreword
This guide assumes you have basic knowledge of venture capital financing. Venture capitalists
(VCs) are a different type of investor than traditional players like banks, private funds or public
stock offerings. VCs invest in high-risk, high-growth companies. In exchange for more risk, they
receive a number of benefits: a special type of stock, some control in the company (in the form of
at least one board member), and the potential for a higher return.
Before diving in, here are some suggested readings:
Legal checklist for startups by Scott Edward Walker
How to pitch a VC by Mark Suster
Notes on Raising Seed Financing by Chris Dixon
Discuss your plans before signing a term sheet by Nivi
The most common mistakes startups make dealing with VCs by Scott Edward Walker
If you can't buy your investor a beer, don't take their money by Sachin Agarwal

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The Three Terms You Must Have In A Venture Investment by Fred Wilson
Good article about seed financing options (look for links to parts 2 and 3 in the comments)
Short checklist of the typical conditions in a Series A financing agreement (includes a short description of
how the signing/closing process generally occurs)
Interesting take on the timing of financing
Explanation of what preferred stock is

II. The Term Sheet

A term sheet is an outline of the basic relationship between the VC and the company. It's not a
legal promise to invest; the actual investment contract (usually called a Purchase or Investment
Agreement) is drafted later, based on the term sheet. This means that the investors have the right to
walk away even after signing the term sheet.

III. Economics
1. Price
The term sheet's core function is to sell shares to investors in exchange for money, as specified in
the price clause. Price is typically expressed in price per share, making it important to keep in mind
the total number of shares. The price reflects how VCs value the company (see valuation), and
looks like this:
$0.23 = price per share (the Original Issue Price), based on a pre-money valuation of
$3,000,000 including an available option pool of 15%
Learn more:
A good breakdown on how Venture Capitalists calculate a companys valuation (includes a link to a free
spreadsheet to help with the calculations)
Introduction on price valuation by Brad Feld
2. Employee Pool / Option Pool
The option pool or employee pool usually gets mentioned alongside price, as it's included in the
company's capitalization table. Simply put, it refers to a group of shares of common stock set aside
for future employees. The size of the employee pool should be proportional to the number of
employees you anticipate having. A large option pool will make it less likely that the company will
run out of available options, which are important for compensating and motivating the companys

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workforce. Just remember that the size of the pool is taken into account in the valuation of the
company (whenever a calculation is done on a fully diluted basis, it means it takes into account all
of the shares, including the employee stock pool), lowering the actual pre-money per-share
valuation.
Employee Pool: Prior to the Closing, the Company will reserve as the Employee Pool shares
of its Common Stock so that the percentage set forth on page one of the Summary of Terms
of its fully-diluted capital stock following the issuance of its Series A Preferred is available for
future issuances to directors, officers, employees and consultants.
Learn more:
Good explanation of pre and post-money valuations
Rundown of the pros and cons concerning pre and post-money valuations by Fred Wilson
What's a Reasonable Starting Point for an Option Pool by Brad Feld
3. Liquidation Preference
This is a crucial part of the economics of any financing, as it determines the terms of how investors
will get their money back in a liquidity event (see definition).
Composed of:
1. the actual preference - how much preferred stockholders will get per each share of preferred
stock, based on a multiple of the original purchase price:
Liquidation Preference: In the event of any liquidation or winding up of the Company,
the holders of the Series A Preferred shall be entitled to receive in preference to the
holders of the Common Stock a per share amount equal to [x] the Original Purchase
Price plus any declared but unpaid dividends (the Liquidation Preference).
2. Participation - how much of the rest of the money, if at all, preferred stockholders will share
with common stockholders:
Participation: After the payment of the Liquidation Preference to the holders of the Series A
Preferred, the remaining assets shall be distributed ratably to the holders of the Common
Stock and the Series A Preferred on a common equivalent basis.
This means that if an investor buys shares of preferred stock in the company at a price of $P per
share and the company is sold (liquidation event), for each share that the investor owns, he will get
a multiple of the purchase price that is determined by the term sheet: 2xP, 3xP etc. (this multiple is
generally 1 in seed rounds). After the investors get their respective preference, they might also get

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some of the remaining money (along with the common stock owners) if the security allows for
so-called participation. There are three levels of participation:
Fully participating stock will share in the liquidation proceeds on an as-converted basis (as if
the stock were converted into common stock based on its conversion ratio).
Capped participation stock will share in the liquidation proceeds on an as-converted basis until
a certain multiple is reached. This is a way to mitigate the risk that preferred shareholders get
too much of the pie if theres a very good exit.
No participation, as the name says, wont participate, and thats of course the best option for
the entrepreneur.
Learn more:
Introduction to Liquidity Preferences
Explanation of how to set up a liquidation table (with link to spreadsheet)
Short breakdown of liquidation preferences and some things to watch out for by Scott Edward Walker

4. Dividends
Dividends are cash that the company might decide to distribute to its shareholders, pro quota. A
typical dividend clause in a VC investment looks like this:
The holders of the Series A Preferred shall be entitled to receive non-cumulative dividends in
preference to any dividend on the Common Stock at the rate of 8% of the Original Purchase
Price per annum, when and as declared by the Board of Directors. The holders of Series A
Preferred also shall be entitled to participate pro rata in any dividends paid on the Common
Stock on an as-if-converted basis.
There are 3 types of dividends:
1. Cumulative: If a dividend is cumulative, it must either be paid out every year to holders of
preferred stock, or, if the company does not pay out a dividend in a particular year, in future
years it must pay the holders of preferred stock the dividends it owes them. So, for example,
suppose a company issues preferred stock at a price of $100 and a cumulative dividend of 5%
per year ($5). If, in year 1, the company does not pay the preferred stockholders the $5
dividend, in year 2, it must pay them $10 ($5 + $5). Remember companies have no obligation
to pay common stockholders dividends, but any dividends that a company owes to its preferred
stockholders must be paid out before it can pay out any dividends to its common stockholders.
2. Non Cumulative: If a dividend is non-cumulative, holders of preferred stock only get
dividends in years that the company issues them.
3. Automatic: If a dividend is automatic, the preferred stockholders receive it every year
regardless of whether or not the company declares a dividend.

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An 8% non-cumulative dividend is currently the most standard term in seed rounds. Dividends
dont matter a much to early stage investors because they dont provide significant venture returns,
and are rarely issued in companies that prefer to invest all revenues in future growth. However,
they can matter in downside cases (liquidations of the company at lower valuations than the
investors initial investment), especially as the invested capital increases, and generally matter more
as the investment amount increases and the expected exit multiple (the scale of return as compared
to initial investment) decreases. You generally want to ensure that dividends have to be approved
by a majority of your board of directors (and you have that control).
Learn more:
Run-down of why dividends matter to investors

5. Conversion
One item that is almost non-negotiable in deals with VCs is conversion. Preferred shareholders
have the right to convert their shares into common stock at any time, initial conversion rate being
usually 1:1.
Preferred Stock Conversion: Convertible into shares of Common Stock at any time at the
election of each holder. The initial conversion rate shall be 1:1, subject to adjustment as
provided below

Automatic Conversion: Its rare for a VC backed company to go public with multiple classes of
stock - bankers will want to see everyone convert to common stock. When there's an IPO,
preferred stock will convert automatically to common stock upon the closing of a so-called
"qualified" public offering of shares of common stock of the company. Thresholds for automatic
conversion are negotiation material - entrepreneurs want them lower (to have more flexibility),
investors want them higher (so they have more control over the timing & terms of the IPO). Be
sure never to have different automatic conversion terms for different series of preferred stock - that
can cause vetoes over an IPO.
Automatic Conversion: All of the Series A Preferred shall automatically convert into
Common Stock upon the closing of a firmly underwritten public offering of shares of
Common Stock of the Company at a per share price not less than four times the Purchase
Price (as adjusted for stock splits, dividends and the like) per share and for a total offering of
not less than $30 million (before deduction of underwriters commissions and expenses) (a

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Qualified IPO). Any or all of the Series A Preferred shall convert into Common Stock
upon the election of holders of at least [a majority] of the outstanding Series A Preferred (the
Required Percentage).
Learn more:
Short discussion on conversion and automatic conversion

6. Anti-dilution
This is one of the hardest and math-heavy parts of the term sheet. Anti-dilution provisions are used
to maintain the ownership share of earlier-round preferred stockholders in the event a company
issues shares at a lower valuation (see downside case) than in previous rounds by modifying the
conversion price (see Conversion, above) of earlier-round-shares. The practical effect of this is to
increase the number of shares of common stock into which each share of preferred stock can
convert if there is a liquidity event.
Anti-dilution comes in two main types:
Ratchet-Based Anti-dilution - if the company issues shares at a purchase price lower than the
conversion price for the series with the ratchet provision, then the earlier round conversion
price is effectively reduced to the price of the new issuance. This is called full-ratchet
conversion. Other ratchet-types that exist are half ratchet, or two-thirds ratchet (see the "learn
more" links for more details).
Weighted Average Anti-dilution - this is more common than ratchet-based anti-dilution and
takes into account the magnitude of the lower-priced issuance, not just the actual valuation. If a
company sells shares of its stock to someone for a purchase price lower than the previous
conversion price, the previous round stock is repriced in accordance with the number of shares
issued at the reduced price.
In general, ratchet-based anti-dilution provides investors with more control and should be reserved
for smaller-scale investors (angels) when there is more risk of a subsequent down round. The rest of
the time, weighted average narrow-based provisions are preferable.
Don't forget "carve-outs" - exceptions for shares granted at lower prices for which anti-dilution
does not apply. More exceptions are better for the entrepreneur. For example:
The conversion price of the Series A Preferred will be subject to a [full ratchet / broad-based
/ narrow-based weighted average] adjustment to reduce dilution in the event that the
Company issues additional equity securities (other than shares: (i) reserved as employee shares
described under the Companys option pool; (ii) shares issued for consideration other than
cash pursuant to a merger, consolidation, acquisition, or similar business combination
approved by the Board; (iii) shares issued pursuant to any equipment loan or leasing

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arrangement, real property leasing arrangement or debt financing from a bank or similar
financial institution approved by the Board; and (iv) shares with respect to which the holders
of a majority of the outstanding Series A Preferred waive their anti-dilution rights) at a
purchase price less than the applicable conversion price. In the event of an issuance of stock
involving tranches or other multiple closings, the anti-dilution adjustment shall be calculated
as if all stock was issued at the first closing. The conversion price will also be subject to
proportional adjustment for stock splits, stock dividends, combinations, recapitalizations and
the like.
Learn more:
Brad Feld explains anti-dilution
Anti-dilution formulae applied to different scenarios by Nic Brisbourne
A comprehensive treatment of typical anti-dilution mechanisms by Wilson Sonsini (PDF)
Say no to full-ratchet anti-dilution (Venture Hacks)
7. Right of First Refusal
This defines the rights of an investor to buy shares in a future financing; also known as pro rata
right.

Prior to a Qualified IPO, Major Investors shall have the right to purchase their pro rata
portions (calculated on a fully diluted basis) of any future issuances of equity securities by the
Company (with over-allotment rights in the event a Major Investor does not purchase its full
allocation), other than Excluded Issuances.

One thing that can be negotiated is the multiple on the purchase rights. This is often referred to as
a super pro rata right and is an excessive ask, especially early in the financing life cycle of a
company.
A good policy is to make sure that shareholders keep the right of first refusal only if they play in
every subsequent round (see next chapter).
Learn more:
Brad Feld looks at some standard language and what to expect can be negotiated
8. Pay-to-Play
Requires investors to participate in subsequent stock offerings in order to benefit from certain
anti-dilution protections. If the stockholder does not purchase his or her pro rata share in the
subsequent offering, then the stockholder loses the benefit(s) of the anti-dilution provisions. Ideally,
investors who do not participate in subsequent rounds must convert to common stock, thereby
losing the protective provisions of the preferred stock. A sample play-to-play provision:

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[Unless the holders of [__]% of the Series A elect otherwise,] on any subsequent [down]
round all [Major] Investors are required to purchase their pro rata share of the securities set
aside by the Board for purchase by the [Major] Investors. All shares of Series A Preferred of
any [Major] Investor failing to do so will automatically [lose anti-dilution rights] [lose right to
participate in future rounds] [convert to Common Stock and lose the right to a Board seat if
applicable].
Learn more:
Brad Feld explains the pay-to-play provision and reasons for having it
"What is a pay-to-play provision?" by Yokum Taku
Pay to play provisions demystified by Scott Edward Walker

9. Vesting
Vesting refers to the distribution of employee options or founder stock over a set period of time. If
an employee or founder leaves before the vesting period, he/she does not get the full amount of
stock.
Industry standard for early stage companies is four-year vesting with a one year cliff - if you leave
before the first year is up, none of your stock is vested, and at the one year mark 25% of your stock
is vested - after which you begin vesting monthly (quarterly and annually is also possible) over the
remaining three years.
A related concept is the so-called "Reverse Dilution" - when someone leaves the company, their
unvested stock is absorbed and all the shareholders benefit ratably from the increase in ownership.
The stock doesnt get reallocated, but rather it goes out of existence. Since this decreases the total
amount of shares in existence, all the remaining stockholders now own a larger percentage of the
company. Unvested employee options usually go back into the option pool to be reissued to future
employees.
Stock Vesting: All stock and stock equivalents issued after the Closing to employees,
directors, consultants and other service providers will be subject to vesting provisions below
unless different vesting is approved by the Board of Directors (including [the] Series A
Director) (the Required Approval): 25% to vest at the end of the first year following such
issuance, with the remaining 75% to vest monthly over the next three years. The repurchase
option shall provide that upon termination of the employment of the stockholder, with or
without cause, the Company or its assignee (to the extent permissible under applicable
securities law qualification) retains the option to repurchase at the lower of cost or the
current fair market value any unvested shares held by such stockholder.
In certain circumstances, the vesting time is dropped, and all the remaining shares or options are

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vested at the same time. See vesting acceleration below.

Learn more
Brad Fed's primer on the vesting process
Fred Wilson explains stock-options
Fred Wilson's class on Employees' Equity (video)
10. Redemption Rights
Gives investors the right to have their outstanding shares redeemed by the company at a specified
price; usually requires the approval of a majority of shareholders.
Redemption at Option of Investors: At the election of the holders of at least majority of the
Series A Preferred, the Company shall redeem the outstanding Series A Preferred in three
annual installments beginning on the [fifth] anniversary of the Closing. Such redemptions
shall be at a purchase price equal to the Original Purchase Price plus declared and unpaid
dividends.
These rights provide VCs with additional downside protection, particularly in cases where a
company is successful enough to be an ongoing business but not quite successful enough to go
public or be acquired. Also gives VCs a liquidity path, which can be particularly important for a
VC making an investment in year five of the funds 10-year life span.
Beware the so-called "Adverse Change Redemption", which effectively gives the VC a right to a
redemption in the case of a material adverse change to the companys business.
Adverse Change Redemption: Should the Company experience a material adverse change to
its prospects, business or financial position, the holders of at least majority of the Series A
Preferred shall have the option to commit the Company to immediately redeem the
outstanding Series A Preferred. Such redemption shall be at a purchase price equal to the
Original Purchase Price plus declared and unpaid dividends.
As with dividends, make sure redemption rights require a majority vote of all classes of preferred
shareholders.
Learn more:
Brad Feld on the worth - to investors - of redemption rights
"What are redemption rights?" by Yokum Taku

IV. Control
Even though a VC usually has less than 50 % ownership in a company, they may have some

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control provisions that give them a lot of control. Here are the key control terms, explained.
1. Conditions Precedent to Financing
Since term sheets are often non-binding, VCs will load them up with conditions precedent to
financing, which occasionally have additional ways out of a deal for the investor. Try to avoid
conditions precedent to financing as much as possible, and do not agree to pay for the VCs legal
fees unless the deal is completed. A standard condition for a first-time financing is:
Each Founder shall have assigned all relevant IP to the Company prior to closing.
Three conditions to watch out for:
1. Approval by investors partners (or anybody): you should always deal with the decision maker.
2. Rights offering to be completed by company: the VCs want to offer all previous investors in
the company the ability to participate in the currently contemplated financing. Not necessarily a
bad thing, as in most cases it serves to protect all parties from liability, but it does add time and
expense to the deal.
3. Employment agreements signed by founders as acceptable to investors. Be aware of what the
full terms are before signing an agreement, and insist on spelling out key terms such as
compensation and what happens if you get fired before signing a term sheet and accepting a
no-shop clause. Here's a standard employment agreement and an Invention Assignment.
Learn more:
Brad Feld on conditions precedents and some terms to watch out for
2. Voting Rights
Voting rights are very important as they determine who controls the company. When all of a
companys shareholders vote, they often do so in either a common-stock-majority rules fashion
or by some other predetermined threshold. In most cases, preferred stock votes in an
as-if-converted basis. That is to say, the number of votes each share of preferred stock gets is as if
the preferred stock had been converted to common stock; the conversion rate is typically 1:1 at the
time of stock issuance. A favorable conversion rate is preserved through subsequent financing
rounds through anti-dilution measures (see above), and can result in a higher per-share voting
power for preferred stockholders.
The voting rights of stockholders are written in the term sheet. A typical example of how voting
rights are split up:
Series A preferred holders (voting as a separate class) can elect one member of the companys
board of directors.
Common stockholders (usually founders) can elect one member to the board
The remaining directors are selected eiither:
(If the VC controls more than 50% of the capital stock) by both the common and

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preferred, or
(if the VC controls less than 50%) by the mutual consent of the board of directors
See next chapters on Board of Directors and Protective provisions for more ramifications of voting
rights.
3. Board of Directors
The Board of Directors is the corporate organism that controls the direction of the company. A
board that gives the VCs enough influence without giving complete control could be structured as
follows:
1.
2.
3.
4.
5.

Founder
CEO / Founder (VC usually wants 1 board member to be the CEO)
VC 1
VC 2
Outside (independent) member

VCs may want to include a board observer (in addition to/instead of an official member). He wont
have a vote, but he can sway the discussion. In small companies, the Board is only comprised of
three members, for example:
Two directors elected by holders of a majority of common stock, one elected by holders of a
majority of Series Seed.
The board of a mature company (contemplating its initial public offering) would be larger, with
around 7-9 members. Board members are usually not compensated with a salary, but with stock
options. Sometimes they get travel expenses to board meetings.
Learn more:
Quick introduction to Board structure
Fred Wilson series on Board of Directors

4. Protective Provisions
These are simply the veto rights of investors. Ideally you want to have few or none of these
protective provision, but VCs want more and some typical ones often end up in the term sheet.
Protective provisions say that you can not do any of the following, unless the investors agree:
sell the company (liquidation event);
change the terms of stock owned by the VC (e.g., the liquidation preferences: actual
preference, fully participating, etc.);
authorize the creation of more stock (this means that the next round of funding can be vetoed);

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issue stock senior to or equal to the stock held by the VC;

change the certificate of incorporation or bylaws;
change the size of the board of directors;
pay or declare a dividend;
buy back any common stock (which may happen if one of the original employees has founders
stock with a buy-back guarantee and then leaves; the company will buy back the unvested
portion of the stock);
borrow money (it is normal to set a debt threshold).
Votes together with the Common Stock on all matters on an as-converted basis. Approval of
a majority of the Preferred Stock required to: (i) adversely change rights of the Preferred
Stock; (ii) change the authorized number of shares; (iii) authorize a new series of Preferred
Stock having rights senior to or on parity with the Preferred Stock; (iv) redeem or repurchase
any shares (other than pursuant to the Companys right of repurchase at original cost); (v)
declare or pay any dividend; (vi) change the number of directors; or (vii) liquidate or
dissolve, including any change of control.

If there are other financing rounds (e.g. new class of preferred stock after a Series B);
new investors can get their own protective provision, or
Series B investors can vote with original investors as one class of shareholders.
Series B investors will usually ask for a different vote because their interests may be different from
the original investors. It is in your best interest to have a single vote - otherwise there are 2 classes
of possible vetoes
Learn more:
Rundown of some standard, and some not so standard, protective provisions
Brad Feld on protective provisions

5. Information Rights
Define the type of information the VC legally has access to and the time frame in which the
company is required to deliver it. You should run a transparent organization anyway, and if you are
paranoid about information getting out, feel free to insist on a strict confidentiality clause to
accompany the information rights. THis is a very standardized term, and the following wording is
common in a term sheet:
Investors who have invested at least $________ (Major Investors) will receive a standard
information and inspection rights and management rights letter.

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Learn more:
Feld's commentary on information rights and registration rights

6. Co-Sale Agreement / Tag-along

We already covered the right of first refusal on sales of common stock: it defines who can stop the
company or a major shareholder from transferring shares, and it is generally included in the bylaws
of the company.
The co-sale / tag along provision takes this concept a step further: if a founder finds an opportunity
to sell shares (liquidation event), the investors will have the right to sell a proportional amount of
their stock as well. It is unlikely that you can eliminate this clause, but it's fair to ask for a floor to it;
if you want to sell a small amount of stock to buy a house, why should a VC hold it up?
Company first and Investors second (to the extent assigned by the Board of Directors,) will
have a right of first refusal with respect to any shares of capital stock of the Company
proposed to be transferred by Founders [and future employees holding greater than 1% of
Company Common Stock (assuming conversion of Preferred Stock and whether then held
or subject to the exercise of options)], with a right of oversubscription for Investors of shares
unsubscribed by the other Investors. Before any such person may sell Common Stock, he
will give the Investors an opportunity to participate in such sale on a basis proportionate to
the amount of securities held by the seller and those held by the participating Investors.

7. No-Shop Agreement
This clause forces you to stick to a leading VC and work in good faith towards closing a deal. The
no-shop agreement lasts for a set time period - at least 30 days. You should ask that the no-shop
agreement clause expire immediately if the VC walks away, and also consider an exception for
acquisitions, as financings and acquisitions frequently follow each other around (remember I
nstagram's story?).
For a period of thirty days, the Company agrees not to solicit offers from other parties for any
financing. Without the consent of Investors, the Company will not disclose these terms to
anyone other than officers, directors, key service providers, and other potential Investors in
this financing.

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8. Assignment
Gives investors the ability to transfer their shares to partnerships or funds, which agree to be subject
to the terms of the Stock Purchase Agreement and related agreements. Make sure that assignment
without transfer of the obligation under the agreements does not occur, since you need to make
sure that anyone who is on the receiving end of a transfer abides by the same rules and conditions
that the original purchasers of the stock signed up for.
Each of the Investors shall be entitled to transfer all or part of its shares of Series A Preferred
purchased by it to one or more affiliated partnerships or funds managed by it or any or their
respective directors, officers or partners, provided such transferee agrees in writing to be
subject to the terms of the Stock Purchase Agreement and related agreements as if it were a
purchaser thereunder.

9. Indemnification
States that the company will indemnify investors and board members to the maximum extent
possible by law. Generally unavoidable, it means that the company needs to sign an Indemnification
Agreement with each executive. Recommended to have reasonable and customary directors and
officers insurance for yourself as much as for your VCs.

V. Definitions
Capitalization Table
Summarizes who owns what part of the company before and after a financing; includes the
following information for each owner: price per share, number of shares owned, the value of the
ownership stake (number of shares multiplied by price per share), and the size of each ownership
stake as a percentage of the total size of the company.
Free online capitalization table spreadsheet
Another capitalization table
Downside Case
Also called "down round": the situation when actual return on investment is lower than the
projected or expected return, i.e. a company who raises another round of financing at a lower
valuation than the last round.
Learn more:
A nice write-up on managing the downside risk
Drag-Along Agreement
A provision that allow a shareholder (investors or founders) to "drag" the resto of the shareholders

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along to sell the company. You can read it as a reverse tag-along right. You can negotiate:
to have a drag-along right agreeing to follow the vote of a majority of common stock holders
(which would be the founders) instead of the preferred stockholders
to require the drag-along right to be exercised only when there is a supermajority of preferred
stockholders (2/3)
to require the approval of the board of directors in order to be effective (the board would have
to conclude that the sale is in the best interest of the company)
Learn more:
Explanation of why drag-alongs need not be feared
Fully Diluted
Taking into account all of the shares, including those in the employee/option pool.
Liquidation event
A liquidity event in which the shareholders receive proceeds for their equity (money for their
proportionate ownership stake in the company); includes mergers with other companies,
acquisitions by other companies, changes in control and of course IPOs.
Valuation
If an investor mentions a valuation without stating whether it's pre-money or post-money, make
sure to ask him to clarify. A VC will usually mean post-money valuation.
Pre-money valuation: what the investor is valuing the company at today, before investment.
Post-money valuation: the pre-money valuation + the contemplated aggregate investment
amount.
Learn more:
Introduction to valuation and option pool
Vesting Acceleration
Vesting stock options or shares usually occurs gradually, unless special events happen and the
vesting suddenly accelerates so that all options/shares are vested at once.
Double-trigger Acceleration is the most standard type and requires two things to occur: an
acquisition of the company and the employee in question being fired by the acquiring company
without cause.
Single-trigger Acceleration - simply if there's a sale or merger of the company; it doesn't matter
if there's a lay-off.

VI. Checklist

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It will be hard to remember everything, particularly if you're tight with time. Here's a checklist of
the most important things to spot on the term sheet you just received.
I. Economics
Price: Remember that price is expressed in price per share, on a fully-diluted basis, so note the
total number of shares and keep that number in mind in order to have an accurate valuation
amount in mind.
Capitalization Table: Make sure youre clear about all the numbers in the cap table and who
owns what.
Dividends: Standard dividends for seed rounds are 6-8%. Make sure that dividends have to be
approved by a majority of the board of directors, and be aware of when dividends must be
given out, and check that they are non-cumulative.
Liquidation Preference: Make sure that the Actual Preference multiple is a 1x. If its not,
find out why.
Conversion: Remember that preferred shareholders can convert shares to common stock (to
get paid better at liquidation or to control a vote) but they cannot convert back.
Automatic conversion: Thresholds for automatic conversion are essential to negotiate- you
want them lower to have more flexibility. Also remember to never have different automatic
conversion terms for different series of preferred stock or youre going to lose your mind.
Everybody must convert in IPO scenarios.
Anti-dilution: Just make sure youre aware of what kind of anti-dilution is set out, and keep
in mind that more exceptions are better.
Pay-to-Play: The more severe the sanctions are on investors who dont participate in
subsequent rounds of financing, the better.
Employee Pool/Option Pool: Make sure that the size of the pool is proportional to the
number of employees you anticipate having, but not excessively large; 15% is usually a
middle-ground number.
Redemption Rights: Make sure redemption rights require approval by a majority of all classes
of preferred shareholders. Never agree to an "Adverse Change Redemption".

II. Control

Conditions Precedent to Financing: Read these carefully as usually are obligations for the
company. Dont agree to pay for the VCs legal fees unless the deal is completed. Here are 3
things to watch out for:
approval by Investors Partnerships or anybody;
rights offering to be completed by company (usually adds time and expense to the deal);
employment agreements signed by founders as acceptable to investors (be aware of what
the full terms are before signing, make sure to spell out key terms like compensation or

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what happens if you get fired before term sheet signing).

Voting Rights: Remember that voting rights for common stock holders and preferred
stockholders should be specified in the term sheet so that there is a clear procedure for how to
elect the board of directors. In general, be aware of how the voting rights are distributed, since
for many matters, that is how power in the company is allocated.
Board of Directors: Be careful to give the VC enough influence without complete control,
keep in mind that board members can sway the boards vote. Remember that board members
do not get a salary.
Protective Provisions: You want to have fewer or none of these. The VC can veto your
decision to do any of the actions mentioned in the protective provision. Remember to have a
provision that provides for the Series A protective provision to no longer control once Series A
investors control less than a certain percentage of the companys capital stock (e.g., because of
new investors).
Information Rights: Dont argue over information rights, since you should be running a
transparent organization anyway, but if you want to make sure information doesnt get out,
insist on a confidentiality agreement.
Co-Sale Agreement: Make sure there is a limit to how much stock investors can
proportionally sell relative to yours.
Restrictions on Sales: Be aware of who has the power to restrict sales/transfers of stock.
No-Shop Agreement: Should not be longer than 60 days. Should expire immediately if the
VC walks away.
Assignment: Make sure there is no assignment without transfer of the obligation under the
agreement.
Drag-Along Agreement: You can propose a drag-along agreement so that investors will be
forced into selling the company at a certain point or the investors may propose one, where you
would be forced to sell if the majority of preferred stockholders vote that way. You can ask the
investors to compromise by requiring that a qualified majority of the preferred stockholders
need to vote to sell, or by requiring the board of directors to approve the sale.
Further Readings:
Venture Deals by Brad Feld and Jason Mendelson (and their Ask The VC blog)
The Venture Hacks Bible by Venture Hacks
Fred Wilson's MBA Mondays
Quora Term Sheet Board
Startup Company Lawyer by Yokum Taku and in particular his comprehensive comparison of financing
documents
Funders' Fund Guide to Term Sheets (PDF)

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