A non binding agreement between owners of a company and
investors for setting the terms under which an investment will be
What is a Term Sheet?
The return on the investment in the liquidation event, such as
selling the company or an initial public offering (IPO)
What allows the investors to exercise control over the business or
to veto certain decisions
The 2 Things That Matter
High Demand = High Price (Valuation)
Current investor will increase the valuation to limit the dilution from
Note: If existing investors want to re-invest, they will argue for a
ﬂat round (equal to previous round) or a down round (Less than
Investment Economics 101
Pre money Valuation
Valuation of company before receiving the investment
Post Money Valuation
Valuation of the company after receiving the investment
(Pre money valuation + Investment = Post money valuation)
Investing $5M at a Pre-Money $20M valuation = 20%
Investing $5M at a Post-Money $20M valuation = 25%
• Stage of the Company
• Competition with other funding sources
• Experience of Founders and Team
• The VC stage of ﬁnancing
• Numbers: Sales, Revenue, Projections, Cash Burn; etc.
The Cap Table is the ledger that shows who owns the company.
When you sell the company, it determines who gets paid what. It
also shows who can vote and how much power they have in the
• Exercise control by electing a board of directors
• In the event of liquidation, common shareholders have the rights
to the assets after preferred shareholders and debt holders.
• Have higher priority to claim assets and earnings than common
• Don’t usually have voting rights
• Seed Financing
• Convertible Notes
• “Series Seed” or “Pre-Series A”
• Series A
• Series B
• Series Z
Note: Sometimes, you’ll ﬁnd Pre-Seed or Pre-Series A. There’s
also bridge rounds
A short term debt that converts into equity at an agreed on
maturity date or in conjunction with future ﬁnancing rounds. The
most important things about a convertible note agreement are:
Since the convertible note holders bore more risk investing earlier
in the company, they get a discount on the share price, which is
usually 10% - 20%.
The valuation cap provides the convertible note holders with a
maximum valuation protection in case the company’s valuation
In the event of liquidation, the Preferred Shareholders can be
entitled to receive 1x, 2x, 3x, or even 10x per share more than the
common shareholders.This is not a common practice these days.
• Full Participation: Pay back the investor, then split the proﬁts
• No Participation: split proﬁts based on ownership percentage
• Capped Participation: Investor gets the highest option between
the agreed cap (e.g. 3x the investment), or full participation.
Liquidity Event: a sale of the company of the majority of the
Notes: Always give Investors No Participation
There are two approaches:
Series C gets its preference ﬁrst, then series B, then A
—In case of low liquidation, the last series investors might get
paid 100% of the liquidation, and everyone else will get nothing
Pari Passu (Blended Preferences)
All series are equivalent in status. So series A, B and C are
proratably until the preferences are returned
(More than one Series)
• Example Scenario: Liquidation at $15 Million
• Stacked: Series B will get $15M, Series A will get nothing
• Pari Passu: Series A gets 20%, and B gets 80%. The
entrepreneur gets nothing since the preference is $25M
(More than one Series)
A $5M $10M $15M
B $20M $30M $50M
Gives the investor the right to invest purchase “x” amount of
shares at a predeﬁned prices for a “y” period of years
Example: a 10-year warrant for 100,000 shares at a $1 per share
gives the investor the option to buy 100,000 at anytime over the
next decade for $1 per share.
Warrants create a lot of complexity. Avoid them, even if you
end up lowering the pre-money valuation.
Pro rata gives the investor the option to invest in the company in
future rounds at the same valuation
Note: Pro rata is a latin word that means ‘in proportion’
Pro rata rights
Investor must keep investing in future ﬁnancing rounds in to avoid
having their preferred stock converted into common stock.
If an investor invests but not to the full extent of his/her pro rata
share, then a percentage of his/her share convert from Preferred
Used to protect investors in case of down rounds (i.e. selling
shares at a lower price than previous round)
• Full Ratchet Antidilution: Means that if the company issued
shares a lower price per share than previous round, the earlier
round is effectively reduced to match price of current round.
Note that you can agree on half ratchet, 2/3 ratchet, etc.
• Weighted Average Anitdilution: The number of shares issued in
the current investment round is used in the re-pricing of the
• New Conversion Price = Old Conversion Price x ((Common Stock
Outstanding + Common Stock Purchasable) / (Common Stock Outstanding
+ Common Stock Actually Purchased
Gives the investors to right to force all shareholders to sell the
company, regardless of how they feel about the sale
Equity (or stock option) reserved to compensate and motivate the
employees working at the company.
10% employee pool is a typical practice
Investors might ask for increasing the pool from 10% to 20%. This
will reduce the pre money valuation by 10% (e.g. from $20M to
Note: having a 10% - 20% employee pool is acceptable. If the
investor insists on increasing the number to 20% try to negotiate it
Note: By increasing the option pool, investors will reduce their
chance of getting diluted
Employee Pool (Option Pool)
A mechanism that ensures the equity is earned over time. This
can be used to make sure founders will not leave the company, or
to motivate employees to join and stay with the company.
For Example, giving an employee 3% equity vested over 3 years,
means that the employee will get 1% equity after completing each
year in the company.