5-minute primer on VC Term Sheets

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

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

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

What is a Term Sheet
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.

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

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

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?

Preferred Shares are necessary
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

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

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

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

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

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5-minute primer on VC Term Sheets

by Leo Dirac on Aug 12, 2007

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5-minute primer on VC Term Sheets — Presentation Transcript