SM
Anatomy of a Term Sheet
July 18, 2002
Starter Fluid, L.P.
Robert von Goeben, Managing Director
[email protected]
http://www.starterfluid.com
Anatomy of a Term Sheet
2) Operating Terms
1) Vital Parts
•Board Composition
•Shares issued
•Voting Rights
•Investors and amounts
•Founders vesting
•Capitalization table
3) Financial Terms
•Valuation
•Liquidation Preferences
•Antidilution Provisions
•Dividends & Redemptions
•Legal Costs
Part One: Vital Parts
• “Deal at a glance”
• Designed to save time and limit legal
expenses
• Always have cap table included on
term sheets
• Clearly spell out investors, counsels
and amounts invested
Part Two:
Operating Terms
Board of Directors
• Most institutional investors push for board
seat, some angels also
• Typical series A board size is 5
– 2 series A
– 2 common (one must be CEO)
– 1 outside agreeable to A & common
• Good practice to name board members on
term sheet
• Strive for “balance of interest”
Founders Vesting
• Founders typically seek credit for “past
work, investors want to tie founders to
company
• 25% of stock can immediately vest
depending on past work
• Remainder on 4-5 year vesting schedule,
with 6 month or 1 year cliff
• Acceleration for termination w/cause or
double-trigger for acquisition
Voting Provisions
• Very important to control factors that
affect a class of stock
• Typical provisions:
– Transfer of control or liquidation
– Any adverse change in rights to class
– Creation of senior security
– Change in size of board
– Declaration of dividends
Part Three:
Financial Terms
Valuation
• Some say “valuation is all that matters”
• “All deals are A rounds”
– Current market has valuation equal to
financing amount
– Today seeing 50% dilution to company
• Q1 2002 valuation stats*
– 57% down rounds
– 10% flat from previous round
– 33% up-rounds
*Source: Fenwick & West LLP
Liquidation Preferences
• Who gets money in what order
• New investors are getting in the front of
the line
• Q1 2002 Stats*
– 62% of deals had senior liquidation prefs to
earlier round
– 58% had multiple preferences
– Of multiple preferences:
• 66% were 2X
• 27% were 3X
• 7% were greater than 3X
*Source: Fenwick & West LLP
Antidilution Provisions
• Two types of antidilution:
– Ratchet – “Price protection”, share price
reduced to new round price within 6-12 mos.
– Weighted Average – Formula on how stock
gets repriced
• Q1 2002 Stats*
– 29% ratchet antidilution
– 69% weighted average antidilution
– 2% no anti-dilution
*Source: Fenwick & West LLP
Dividends & Redemption
• 2002 stats on redemptions*
– 36% of the financings provided for
mandatory redemption or redemption at
the option of the investor
• Dividends have historically been
“when and if declared by board of
directors”
• Non-cumulative, not mandatory
*Source: Fenwick & West LLP
“Pay-to-Play”
• Current trend to “wash out” previous
investors over and above dilution
• New investors pushing tough “pay-toplay” provisions
• Q1 2002 Stats*
– 20% of financings had pay-to-play
– 56% converted non-participating to
common
– 22% converted to “shadow preferred”
– 22% blend of common and shadow
*Source: Fenwick & West LLP
Legal Costs
• Company usually pays investor legal
expenses
• Company pushes hard to put cap on
expenses
• Typical seed deals: up to $10K
• Later stages: up to $25-50K
• Depends on fees in geography
Other Terms
1. Right of first refusal on new-issue and
founders selling shares
2. Information rights is key
– Make sure your # shares falls within limits
3. Key-Person insurance on founders
4. Employment, confidentiality and invention
agreements with founders
5. Registration, piggy back rights, demand
rights: get standard terms through
attorneys
Good Terms Sheet Practices
• Short (2-4 pages)
• Designed to reduce legal fees
• Don’t go it alone: get good legal
counsel
• Term sheet is mostly business terms
• Be aware you’re setting precedent on
terms for later investors!
Starter Fluid
Starter Fluid is one of the only
professionally-managed,
institutionally-backed pure seed funds.
• Closed $32M - June 2000
• $100-500K initial investments, up to $3M total
• Investors:
– Institutions: Univ Chicago, Searle Trust, FLAG Venture
Management, Tucker Anthony, Compaq Computers,
Crossroads Ventures, and others
SM
Anatomy of a Term Sheet
July 18, 2002