This document summarizes key terms in negotiating a Series A term sheet between investors and founders. It discusses control terms such as board composition, investor protective provisions, information rights, and vesting of founders' equity. It also covers economic terms like valuation, liquidation preference, anti-dilution, and registration rights. The main takeaways are that board control determines decision making power, obtaining director approval is simpler than investor consent, and limits should be placed on investors' ability to force a sale of the company.

1. Negotiating Series A Term Sheets
Benjamin M. Hron
Bhron@mccarter.com
617.449.6584
@HronEsq

2. What is a Term Sheet
♦ Control Terms v. Economic Terms
♦ Standard Agreements
– Stock Purchase Agreement
– Charter
– Investor Rights Agreement
– Voting Agreement
– Right of First Refusal and Co-Sale Agreement
♦ Term Sheet to Closing

3. Part I: Control Terms
♦ Voting Rights and Board Seats
♦ Investor Protective Provisions
♦ Information Rights
♦ Vesting of Founders’ Equity
♦ Right of First Refusal and Co-Sale
♦ Drag-Along

4. Voting Rights and Board Seats
The Series A Preferred shall vote together with the Common Stock on an
as-converted basis, except:
1. [so long as [#####] shares of Series A Preferred are outstanding, the
Series A Preferred as a class shall be entitled to elect [1 or 2] members
of the Board, and
2. as required by law.
At the initial Closing, the Board shall consist of [5] members
1. one representative designated by [investor],
2. one representative designated by the remaining Investors,
3. one representative designated by the Founders,
4. the Chief Executive Officer of the Company, and
5. one person not employed by the Company and mutually acceptable to
[the Founders and Investors][the other directors].

5. Voting Rights and Board Seats
♦ On most matters Series A votes with Common
♦ Typically 5 Directors (3 for smaller financings)
– 2 Investor Directors
– 1 Founder Director
– CEO
– 1 Independent Director
♦ Avoiding a “Captured” Board
– Veto over election of CEO and Independent
– Veto over approval of major corporate actions
– Employment contract for founder/CEO

6. Investor Protective Provisions
Matters Requiring Approval of Series A Stockholders
[So long as [####] shares of Series A Preferred are outstanding,] the Company will not,
without the written consent of the holders of at least [50-67]% of the Series A Preferred:
1. liquidate, dissolve or wind-up the affairs of the Company, or effect any merger or
consolidation or any other Deemed Liquidation Event;
2. amend, alter, or repeal any provision of the Certificate of Incorporation or Bylaws [in a
manner adverse to the Series A Preferred];
3. create or authorize the creation of or issue any other security convertible into or
exercisable for any equity security, having rights, preferences or privileges senior to or
on parity with the Series A Preferred, or increase the authorized number of shares of
Series A Preferred;
4. purchase or redeem or pay any dividend on any capital stock prior to the Series A
Preferred;
5. create or authorize the creation of any debt security [if the Company’s aggregate
indebtedness would exceed $[____][other than equipment leases or bank lines of
credit]; or
6. increase or decrease the size of the Board of Directors.

7. Investor Protective Provisions
Matters Requiring Approval of Series A Director(s)
The Company will not, without Board approval, which approval must include the affirmative
vote of the Series A Director(s):
1. make any loan or advance to, or own any stock or other securities of, any entity
unless it is wholly owned by the Company;
2. make any loan or advance to any person, except advances and similar expenditures
in the ordinary course of business or under the terms of a employee stock or option
plan approved by the Board of Directors;
3. guarantee, any indebtedness except for trade accounts of the Company or any
subsidiary arising in the ordinary course of business;
4. make any investment inconsistent with any investment policy approved by the Board;
5. incur any aggregate indebtedness in excess of $[_____] that is not already included in
a Board-approved budget, other than trade credit incurred in the ordinary course of
business;

8. Investor Protective Provisions
Matters Requiring Approval of Series A Director(s) (cont.)
6. enter into or be a party to any transaction with any director, officer or employee of the
Company or any “associate” (as defined in Rule 12b-2 promulgated under the
Exchange Act) of any such person [except transactions resulting in payments to or by
the Company in an amount less than $[$$$$] per year];
7. hire, fire, or change the compensation of the executive officers, including approving any
option grants;
8. change the principal business of the Company, enter new lines of business, or exit the
current line of business;
9. sell, assign, license, pledge or encumber material technology or intellectual property,
other than licenses granted in the ordinary course of business; or
10. enter into any corporate strategic relationship involving the payment contribution or
assignment by the Company or to the Company of assets greater than [$$$$$$$].

9. Investor Protective Provisions
♦ Investor Approvals:
– Significant corporate events (ex. sale)
– Actions that could adversely impact Series A
– More $$ More Protections
♦ Series A Director Approvals
– Lending/Borrowing
– Insider transactions
– Hiring/Firing Key Employees
♦ Key Issues
– Stockholder v. Series A Director approval
– % of stockholders required to approve

10. Information Rights
Any [Major] Investor [(who is not a competitor)] will be granted access to
Company facilities and personnel during normal business hours and with
reasonable advance notification. The Company will deliver to such
Major Investor:
1. annual, quarterly, [and monthly] financial statements, and other
information as determined by the Board;
2. thirty days prior to the end of each fiscal year, a comprehensive
operating budget forecasting the Company’s revenues, expenses,
and cash position on a month-to-month basis for the upcoming fiscal
year; and
3. promptly following the end of each quarter an up-to-date
capitalization table.
A “Major Investor” means any Investor who purchases at least $[______]
of Series A Preferred.

11. Information Rights
♦ Right to receive periodic reports
♦ Management Rights Letters
♦ Key Issues
– Which investors have rights to information
– Frequency (quarterly or monthly)
– Consequences for failure
– Confidentiality
♦ Nobody ever complies with information rights!

12. Vesting of Founders’ Equity
All Founders to own stock outright subject to Company right to buyback
at cost. Buyback right for [__]% for first [12 months] after Closing;
thereafter, right lapses in equal [monthly] increments over following [__]
months.

13. Vesting of Founders’ Equity
♦ Right to repurchase shares if Founder leaves
♦ Term: 3-4 years; 25% after 1 yr, then monthly
♦ Key Issues
– Credit for time served?
– Repurchase of vested shares in some situations?
– Acceleration on:
Change of Control (single/double trigger)
Termination without Cause
Leaving for Good Reason

14. Right of First Refusal and Co-Sale
ROFR: Company [first and Investors second] will have a right of first
refusal with respect to any shares of capital stock of the Company
proposed to be transferred by Founders [and future employees holding
greater than [1]% of Company Common Stock (assuming conversion of
Preferred Stock and whether then held or subject to the exercise of
options)][, with a right of oversubscription for Investors of shares
unsubscribed by the other Investors].
Co-Sale: Before any person may sell Common Stock, he will give the
Investors an opportunity to participate in such sale on a basis
proportionate to the amount of securities held by the seller and those
held by the participating Investors.

15. Right of First Refusal and Co-Sale
♦ ROFR:
– Right to buy shares offered for sale by others
– Usually company has first right; investors second
– Investors may have over-subscription right
– May be “all or none”
– May be applied to investors as well
♦ Co-Sale (aka Tag Along):
– Right to sell alongside (subject to ROFR)
– May be applied to investors as well

16. Drag-Along
Holders of Preferred Stock and the Founders [and all future holders of
greater than [1]% of Common Stock (assuming conversion of Preferred
Stock and whether then held or subject to the exercise of options)] shall
be required to enter into an agreement with the Investors that provides
that such stockholders will vote their shares in favor of a Deemed
Liquidation Event or transaction in which 50% or more of the voting
power of the Company is transferred and which is approved by [the
Board of Directors] [and the holders of [50-67]% of the outstanding
shares of Preferred Stock, on an as-converted basis], so long as the
liability of each stockholder in such transaction is several (and not joint)
and does not exceed the stockholder's pro rata portion of any claim and
the consideration to be paid to the stockholders in such transaction will
be allocated as if the consideration were the proceeds to be distributed
to the Company's stockholders in a liquidation under the Company's
then-current Certificate of Incorporation.

17. Drag-Along
♦ Compels subject stockholders approve a sale
♦ Facilitates exit where interests differ
♦ Key Issues
– Threshold for exercising
– Is consent of common or founders required?
– Is Board approval required?

18. Control Terms: Key Takeaways
♦ Board composition and director election
determines who controls the company
♦ Obtaining approval of actions from directors is
simpler than obtaining consent from investors
♦ Limit investor right to “drag” other stockholders
♦ If founders’ equity is subject to vesting, get credit
for time served

19. Part II: Economic Terms
♦ Valuation and the Option Pool Shuffle
♦ Dividends
♦ Liquidation Preference
♦ Anti-dilution
♦ Pre-emptive Rights and Pay-to-Play
♦ Redemption Rights
♦ Registration Rights

20. Valuation and the Option Pool Shuffle
The Original Purchase Price is based upon a fully-diluted pre-money
valuation of $[_____] and a fully-diluted post-money valuation of
$[______] (including an employee pool representing [15-20]% of the
fully-diluted post-money capitalization).

21. Valuation and the Option Pool Shuffle
♦ Valuation
– Just one of several the economic terms
– Need to consider terms as a package
– Model outcome in various exit scenarios
♦ Option Pool Shuffle
– Option pool is typically 15-20% of post-FDC
– If included in pre-money FDC
reduces the effective valuation
“phantom” increase to the post-money valuation
shifts dilution to existing stockholders

22. Dividends
Alternative 1: Dividends will be paid on the Series A Preferred on an
as-converted basis when, as, and if paid on the Common Stock
Alternative 2: The Series A Preferred will carry an annual [__]%
cumulative dividend [payable upon a liquidation or redemption]. For any
other dividends or distributions, the Series A Preferred will participate
with the Common Stock on an as-converted basis.
Alternative 3: Non-cumulative dividends will be paid on the Series A
Preferred in an amount equal to $[_____] per share of Series A
Preferred when and if declared by the Board.

23. Dividends
♦ Range from 5-10%
♦ Typically convert when Series A converts
♦ Key Issues
– Try to eliminate/delay accruing dividends
– Fight cumulative dividends
– Strongly resist compounding dividends
♦ Value of dividends can add up
– Most important in middle-of-the-road exit

24. Liquidation Preferences
In the event of any liquidation, dissolution or winding up of the Company,
the proceeds shall be paid as follows:
Non-participating Preferred Stock: First pay [one] times the Original
Purchase Price [plus accrued dividends] [plus declared and unpaid
dividends] on each share of Series A Preferred. The balance of any
proceeds shall be distributed pro rata to holders of Common Stock.]

25. Liquidation Preferences
In the event of any liquidation, dissolution or winding up of the Company,
the proceeds shall be paid as follows:
Full participating Preferred Stock: First pay [one] times the Original
Purchase Price [plus accrued dividends] [plus declared and unpaid
dividends] on each share of Series A Preferred. Thereafter, the Series A
Preferred participates with the Common Stock pro rata on an as-converted
basis.
Cap on Preferred Stock participation rights: First pay [one] times the
Original Purchase Price [plus accrued dividends] [plus declared and
unpaid dividends] on each share of Series A Preferred. Thereafter,
Series A Preferred participates with Common Stock pro rata on an as-converted
basis until the holders of Series A Preferred receive an
aggregate of [_____] times the Original Purchase Price (including the
amount paid pursuant to the preceding sentence).

26. Liquidation Preferences
Deemed Liquidation Event:
A merger or consolidation (other than one in which stockholders of the
Company own a majority by voting power of the outstanding shares of
the surviving or acquiring corporation) and a sale, lease, transfer,
exclusive license or other disposition of all or substantially all of the
assets of the Company will be treated as a liquidation event, thereby
triggering payment of the liquidation preferences described above
[unless the holders of [___]% of the Series A Preferred elect otherwise].
[The Investors' entitlement to their liquidation preference shall not be
abrogated or diminished in the event part of the consideration is subject
to escrow in connection with a Deemed Liquidation Event.]

27. Liquidation Preferences
♦ Most important economic term after valuation
♦ 3 Types
– Non-participating – Founder favorable
– Full Participating – Very Investor favorable
– Capped Participating – Investor favorable
♦ Investors get 1-3x (plus dividends) before others
♦ Participating preferred also shares with Common
♦ Applies to any exit, not just liquidation (ex. sale)

28. Anti-dilution
In the event that the Company issues additional securities at a purchase
price less than the current Series A Preferred conversion price, such
conversion price shall be adjusted in accordance with the following
formula:
Weighted Average:
CP2 = CP1 * (A+B) / (A+C)
CP2 = Series A Conversion Price after new issue
CP1 = Series A Conversion Price prior to new issue
A = Shares deemed outstanding prior to new issue
B = Consideration received for new issue divided by CP1
C = Shares issued in the subject transaction

29. Anti-dilution
In the event that the Company issues additional securities at a purchase
price less than the current Series A Preferred conversion price, such
conversion price shall be adjusted in accordance with the following
formula:
Full-ratchet: The conversion price will be reduced to the price at which
the new shares are issued.

30. Anti-dilution
♦ Conversion Ratio = Conversion Price / Sale Price
♦ Adjusts conversion price for “down” rounds
♦ Weighted Average:
– Proportionate to size and price of down round
– May be “broad” or “narrow”
♦ Full Ratchet:
– Adjusts conv. price to equal price in down round
– Red Flag: investor is aggressive on terms
♦ Exceptions for certain share issuances

31. Pre-emptive Rights and Pay-to-Play
Pre-emptive Rights: All [Major] Investors shall have a pro rata right to
participate in subsequent issuances of equity securities of the Company
(with standard exceptions). In addition, should any [Major] Investor
choose not to purchase its full pro rata share, the remaining [Major]
Investors shall have the right to purchase the remaining pro rata shares.
Pay-to-Play: [Unless the holders of [50-67]% of the Series A elect
otherwise,] on any subsequent [down] round all [Major] Investors are
required to purchase their pro rata share of the securities set aside by
the Board for purchase by the [Major] Investors. All shares of Series A
Preferred of any [Major] Investor failing to do so will automatically [lose
anti-dilution rights] [lose right to participate in future rounds] [convert to
Common Stock and lose the right to a Board seat, if applicable].

32. Pre-emptive Rights and Pay-to-Play
♦ Types of Pre-emptive Rights
– Right to maintain %
– Right to purchase a multiple of %
– Right to purchase (collectively) 100%
♦ Over-Allotment Right
♦ Limitations
– Major Investors
– Pay-to-Play
– Use or Lose (Pay-to-Play Lite)

33. Redemption Rights
The Series A Preferred shall be redeemable from funds legally available
for distribution at the option of holders of at least [50-67]% of the Series
A Preferred commencing any time after [the fifth anniversary of the initial
Closing Date] at a price equal to the Original Purchase Price [plus all
accrued but unpaid dividends]. Redemption shall occur in three equal
annual portions. Upon a redemption request from the holders of the
required percentage of the Series A Preferred, all Series A Preferred
shares shall be redeemed [(except for any Series A holders who
affirmatively opt-out)].

34. Redemption Rights
♦ Right to force redemption after ~5 years
♦ Creates an “exit” option, but rarely (never?) used
♦ May create leverage to force other exits
♦ Key Issues
– Optional v. Mandatory
– Time before right matures
– Length of time allowed for payout
– Consequences of failing to redeem

35. Registration Rights
Demand Registration: Upon earliest of (i) [three-five] years after the
Closing; or (ii) [six] months following an initial public offering (“IPO”),
persons holding [__]% of the Registrable Securities may request [1 or 2]
(consummated) registrations by the Company of their shares.
S-3 Registration: The holders of [10-30]% of the Registrable Securities
will have the right to require the Company to register on Form S-3, if
available for use by the Company.
Piggy-back Registration: The holders of Registrable Securities will be
entitled to “piggyback” registration rights, subject to the right of the
Company and its underwriters to reduce the number of shares proposed
to be registered to a minimum of [20-30]% and to complete reduction on
an IPO at the underwriter’s discretion. In all events, the shares to be
registered by holders of Registrable Securities will be reduced only after
all other stockholders’ shares are reduced.

36. Registration Rights
♦ Demand: Usually limited to 1 or 2
♦ S-3: Usually limited to 1 or 2 per year
♦ Piggy-back
♦ Issues
– Threshold % to exercise Demand rights
– Earliest date Demand rights may be exercised
– # of Demand rights and frequency of S-3 rights
– Minimum IPO price for Demand rights
♦ Founders may be able to get subordinate S-3
and Piggyback rights

37. Economic Terms: Key Takeaways
♦ Dividends and liquidation preferences can have
significant impact on economics
♦ Option pool should be sufficient for near future
♦ Understand if option pool is in pre-money
♦ Full ratchet anti-dilution is very investor favorable
♦ Pay-to-Play helps mitigate anti-dilution in down-round
financing
♦ Pre-emptive Rights should not prevent the
company from raising more money
♦ Don’t sweat Registration Rights

38. Other Terms
♦ Tranches and Milestones
♦ Conditions to Closing
♦ Reps Warranties
♦ Payment of Investor Expenses
– Should be contingent on closing
– Cap (typically $35K-$50K)

39. McCarter English LLP
Questions?
Benjamin M. Hron
bhron@mccarter.com
617.449.6584
@HronEsq