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 <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>

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

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>

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

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>

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>

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>

Common Stock Payout Management’s Share
VC’s Share

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>

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

At high valuation, payout %
approaches ownership %

Liquidation Preference Multipliers

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>

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>

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>

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>

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>

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>

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>