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

What you’ll learn What is Venture Capital When it’s appropriate What are Term Sheets A few things to watch out for VC’s are not the enemy

What is Venture Capital

When it’s appropriate

What are Term Sheets

A few things to watch out for

VC’s are not the enemy

How VC’s work Investor Investor Investor VC fund Investor Startup Startup Startup

When VC is appropriate Good for Big Opportunities Need lots of cash to take advantage of Must have “exit” within a few years Way for VC to get their money back, e.g. Acquisition IPO

Good for Big Opportunities

Need lots of cash to take advantage of

Must have “exit” within a few years

Way for VC to get their money back, e.g.

Acquisition

IPO

VC is not for… Slow-growth companies Lifestyle businesses Zombies!!! Image by Dubb http://www.subdivisionmodeling.com/forums/showthread.php?t=1133

Slow-growth companies

Lifestyle businesses

What is a Term Sheet Negotiated before actual contract Lays out the important terms Short and readable At least, compared to legal contract

Negotiated before actual contract

Lays out the important terms

Short and readable

At least, compared to legal contract

What’s in the Term Sheet Numbers Amount of money to invest Number of shares Valuation Liquidation Preference Dividends Other terms Who’s involved Board of Directors What happens in future rounds Etc.

Numbers

Amount of money to invest

Number of shares

Valuation

Liquidation Preference

Dividends

Other terms

Who’s involved

Board of Directors

What happens in future rounds

Etc.

Valuation How much is company worth? Determines share price & ownership % Somewhat arbitrary for startups Post-money = Pre-money + Investment $8m = $6m + $2m Value = Share Price * Number of shares

How much is company worth?

Determines share price & ownership %

Somewhat arbitrary for startups

Post-money = Pre-money + Investment

$8m = $6m + $2m

Value = Share Price * Number of shares

Common Stock Payout Management’s Share VC’s Share

Liquidation Preference When there’s a Liquidation event, Acquisition Sold off for parts :( VC’s get Preference . Investors get all their money back before anybody else gets anything Sometimes 2x or 3x their money

When there’s a Liquidation event,

Acquisition

Sold off for parts :(

VC’s get Preference .

Investors get all their money back before anybody else gets anything

Sometimes 2x or 3x their money

Liquidation Preference: At low valuation, VC’s take all

At high valuation, payout % approaches ownership %

Liquidation Preference Multipliers

Is this Fair? Us entrepreneurs are getting screwed! They’re taking advantage of us with all these terms! Why can’t they just be regular shareholders?

Us entrepreneurs are getting screwed!

They’re taking advantage of us with all these terms!

Why can’t they just be regular shareholders?

Preferred Shares are necessary If investors held common stock, they would have no control Preferred stock is necessary to avoid mischief

If investors held common stock, they would have no control

Preferred stock is necessary to avoid mischief

Dividend Mischief Monday : VC’s invest $2m for 25% common equity share Check deposited into bank. Tuesday : I call shareholder meeting to vote on dividend. 75% vote Yes 25% vote HELL NO!!! WTFOMGBBQ!!! Motion passes Wednesday : Dividends dispersed. VC’s get $500k dividend check I’m off to Thailand with my $1.5m dividend Perfectly legal

Monday : VC’s invest $2m for 25% common equity share

Check deposited into bank.

Tuesday : I call shareholder meeting to vote on dividend.

75% vote Yes

25% vote HELL NO!!! WTFOMGBBQ!!!

Motion passes

Wednesday : Dividends dispersed.

VC’s get $500k dividend check

I’m off to Thailand with my $1.5m dividend

Perfectly legal

VC’s are not Evil They are protecting their investments Without VC your idea is not a company Don’t like the terms? You can walk away Try to find a better deal

They are protecting their investments

Without VC your idea is not a company

Don’t like the terms?

You can walk away

Try to find a better deal

Cumulative Dividend Increases LP payout value over time Minimum investment return increases E.g. 8% per year Motivates Management to Exit Aligns incentives with VC

Increases LP payout value over time

Minimum investment return increases

E.g. 8% per year

Motivates Management to Exit

Aligns incentives with VC

Final Tips Talk to people who’ve been through it Get the waterfall chart Shows payout at different valuations Understand motivation behind terms Think collaboratively, not adversarially

Talk to people who’ve been through it

Get the waterfall chart

Shows payout at different valuations

Understand motivation behind terms

Think collaboratively, not adversarially

Thanks! Professor Lance Young Slides, Spreadsheets & more at http://www.EmbracingChaos.com/business

Professor Lance Young

Slides, Spreadsheets & more at

http://www.EmbracingChaos.com/business