In essence, a term sheet is a legal document that outlines the transfer of capital from investors for equity in a company. This process happens seamlessly every single day on your favorite stock exchange. Gen Zers like myself are used to being able to log onto Robinhood and buy $10 worth of Amazon stock. With VC, however, the process isn’t quite so seamless, and the “terms” of the exchange aren’t quite so cut-and-dry.

The term sheet boils down to two important factors: economics and control. Say it with me. What matters in a term sheet is economics and control. It’s easy to get bogged down in the details, trying to negotiate every last word, but almost always these efforts are in vain. Below, I attempt to cover the key elements of a venture deal. This is meant as a brief introduction.

Economics

    • Valuation – How much it is agreed upon the company is worth.
      • This, along with how much is invested, determines the share price.
    • Option Pool – How many shares are set aside to give early employees.
      • A sneaky way to increase valuation. As shares are given to new employees, existing investors (aka, you) will have their shares diluted. Like inflation.
  • Liquidation Preferences – Who gets their money first when the company is sold.
    • Most impactful when things go south. Can be the difference between a VC losing everything and getting their initial investment back.

Control

  • Board of Directors  – VC firms will often get a seat on the board, which is the most powerful part of the management structure. Give too many board seats to your VCs, and you can get ousted from the company. Mark Zuckerberg owns roughly 20% of Facebook, but he has every final say because he controls the board.
  • Drag-Along Agreement – Basically, why you don’t vote on decisions made by Amazon even though you have stock. A drag-along agreement makes one type of shareholder (common) automatically vote the same as the majority of another (preferred). This ensures no people with less skin in the game can hold a company from selling if it is in the best interest of the preferred shareholders (often, VC firms).

Author: JJ Foster