5-minute primer on VC Term Sheets


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A short introduction to Venture Capital Term Sheets, and in particular the concept of liquidation preferences. Leo Dirac's talk from Ignite Seattle 4. For more detail, see http://embracingchaos.com/business

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  • Hi everybody. My name’s Leo, and I’m going to explain a few things about venture capital term sheets. And I’ll try to talk a little slower than I did last time I was up here. Hopefully you’ll be able to follow along a little better.
  • 5-minute primer on VC Term Sheets

    1. 1. Venture Capital Term Sheets or How you can make millions of dollars and keep none of it for yourself Leo Parker Dirac UW Business School MBA Candidate Supporter of the Robot Revolution
    2. 2. What you’ll learn <ul><li>What is Venture Capital </li></ul><ul><ul><li>When it’s appropriate </li></ul></ul><ul><li>What are Term Sheets </li></ul><ul><ul><li>A few things to watch out for </li></ul></ul><ul><li>VC’s are not the enemy </li></ul>
    3. 3. How VC’s work Investor Investor Investor VC fund Investor Startup Startup Startup
    4. 4. When VC is appropriate <ul><li>Good for Big Opportunities </li></ul><ul><ul><li>Need lots of cash to take advantage of </li></ul></ul><ul><li>Must have “exit” within a few years </li></ul><ul><ul><li>Way for VC to get their money back, e.g. </li></ul></ul><ul><ul><li>Acquisition </li></ul></ul><ul><ul><li>IPO </li></ul></ul>
    5. 5. VC is not for… <ul><li>Slow-growth companies </li></ul><ul><li>Lifestyle businesses </li></ul>Zombies!!! Image by Dubb http://www.subdivisionmodeling.com/forums/showthread.php?t=1133
    6. 6. What is a Term Sheet <ul><li>Negotiated before actual contract </li></ul><ul><li>Lays out the important terms </li></ul><ul><li>Short and readable </li></ul><ul><ul><li>At least, compared to legal contract </li></ul></ul>
    7. 7. What’s in the Term Sheet <ul><li>Numbers </li></ul><ul><ul><li>Amount of money to invest </li></ul></ul><ul><ul><li>Number of shares </li></ul></ul><ul><ul><li>Valuation </li></ul></ul><ul><ul><li>Liquidation Preference </li></ul></ul><ul><ul><li>Dividends </li></ul></ul><ul><li>Other terms </li></ul><ul><ul><li>Who’s involved </li></ul></ul><ul><ul><li>Board of Directors </li></ul></ul><ul><ul><li>What happens in future rounds </li></ul></ul><ul><ul><li>Etc. </li></ul></ul>
    8. 8. Valuation <ul><li>How much is company worth? </li></ul><ul><ul><li>Determines share price & ownership % </li></ul></ul><ul><ul><li>Somewhat arbitrary for startups </li></ul></ul><ul><li>Post-money = Pre-money + Investment </li></ul><ul><ul><li>$8m = $6m + $2m </li></ul></ul><ul><li>Value = Share Price * Number of shares </li></ul>
    9. 9. Common Stock Payout Management’s Share VC’s Share
    10. 10. Liquidation Preference <ul><li>When there’s a Liquidation event, </li></ul><ul><ul><li>Acquisition </li></ul></ul><ul><ul><li>Sold off for parts :( </li></ul></ul><ul><li>VC’s get Preference . </li></ul><ul><ul><li>Investors get all their money back before anybody else gets anything </li></ul></ul><ul><ul><li>Sometimes 2x or 3x their money </li></ul></ul>
    11. 11. Liquidation Preference: At low valuation, VC’s take all
    12. 12. At high valuation, payout % approaches ownership %
    13. 13. Liquidation Preference Multipliers
    14. 14. Is this Fair? <ul><li>Us entrepreneurs are getting screwed! </li></ul><ul><li>They’re taking advantage of us with all these terms! </li></ul><ul><li>Why can’t they just be regular shareholders? </li></ul>
    15. 15. Preferred Shares are necessary <ul><li>If investors held common stock, they would have no control </li></ul><ul><li>Preferred stock is necessary to avoid mischief </li></ul>
    16. 16. Dividend Mischief <ul><li>Monday : VC’s invest $2m for 25% common equity share </li></ul><ul><ul><li>Check deposited into bank. </li></ul></ul><ul><li>Tuesday : I call shareholder meeting to vote on dividend. </li></ul><ul><ul><li>75% vote Yes </li></ul></ul><ul><ul><li>25% vote HELL NO!!! WTFOMGBBQ!!! </li></ul></ul><ul><ul><li>Motion passes </li></ul></ul><ul><li>Wednesday : Dividends dispersed. </li></ul><ul><ul><li>VC’s get $500k dividend check </li></ul></ul><ul><ul><li>I’m off to Thailand with my $1.5m dividend </li></ul></ul><ul><li>Perfectly legal </li></ul>
    17. 17. VC’s are not Evil <ul><li>They are protecting their investments </li></ul><ul><li>Without VC your idea is not a company </li></ul><ul><li>Don’t like the terms? </li></ul><ul><ul><li>You can walk away </li></ul></ul><ul><ul><li>Try to find a better deal </li></ul></ul>
    18. 18. Cumulative Dividend <ul><li>Increases LP payout value over time </li></ul><ul><ul><li>Minimum investment return increases </li></ul></ul><ul><ul><li>E.g. 8% per year </li></ul></ul><ul><li>Motivates Management to Exit </li></ul><ul><ul><li>Aligns incentives with VC </li></ul></ul>
    19. 19. Final Tips <ul><li>Talk to people who’ve been through it </li></ul><ul><li>Get the waterfall chart </li></ul><ul><ul><li>Shows payout at different valuations </li></ul></ul><ul><li>Understand motivation behind terms </li></ul><ul><ul><li>Think collaboratively, not adversarially </li></ul></ul>
    20. 20. Thanks! <ul><li>Professor Lance Young </li></ul><ul><li>Slides, Spreadsheets & more at </li></ul><ul><li>http://www.EmbracingChaos.com/business </li></ul>
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