VC Speak: Termsheet Language & understanding the possible booby traps in financing rounds.
Well drafted term sheets are one way start-ups have in their long succession of endeavours attained a good valuation. This is the dream for every start-up. As a start-up, when you find an investor, you should first negotiate the broad terms of the investment. This is usually done in person with the investor. We suggest that, it may be useful to develop a deal memo that may assist as a checklist for negotiating the deal. The memo is also useful to keep a record of the broad terms that parties agree to and it will be the basis of creating the term sheet. Since the termsheet will usually be developed by the investor, the memo will enable the entrepreneur to ensure that the investor is complying with the terms that are negotiated.
A term sheet is as an agreement between you and your investor. They are a series of terms that are captioned in a termsheet ranging from the value of your business, how much money you are getting and the stake that translates into the money you will get.
Early start-up investment/bridge financing instruments are usually different from a termsheet since they delve into raising small/seed capital. They are usually kept really simple. However termsheets are detailed because investors want to negotiate for rights that secure their investment. Accordingly, it helps to understand the rights,and the terms vcs use. This signifies your sophistication as an entrepreneur to the VC and assists you avoid a deal you will regret.
KEY TERMS (terms have been simplified as much as possible for the audience, if you are a VC please note that we did not use a technical meaning )
Pre money valuation: Refers to the company's valuation before the investment or;
Pre money valuation = post money valuation – new investment
Post money valuation: A company's valuation after an investment is made.
Post money valuation = Pre money valuation + New Investment
Series: It is a name of an investment round typically given to a company's significant round of venture capital financing. A company can have several series of financing A through Z! Although it is rare to find companies that do rounds to Z. Usually progression of these rounds depends on the age of the company.
Bridge Financing: Is the investment a startup needs to finance a specific milestone or operations such as financing a new project prior to a much bigger round of investment.
Pre-emption rights: Is a right for current shareholders to get the first option to purchase newly authorized shares.
Liquidation Preference: This is the negotiated reward investors get upon a liquidating event. It simply suggests how proceeds of a startup should be shared - be it through an exit sale or a winding up of the company.
Preference/preffered shares: These are shares that get additional rights unlike ordinary/common shares. Preference shares are usually issued to investors and attract preferential rights. Preferential rights include: liquidation preferences and anti-dilution protection.
Anti-Dilution Provisions : the basic idea is that if you have a down round, the investors will get additional stock to preserve their stake in the company.
Conversion to Common : The crux of this term is that the buyer of preferred shares can convert to common if he decides it’s a better move to get paid on a pro rata common/ordinary shares basis.
Board Representation : Investors want to ensure their continued involvement as your company evolves, protect their position, and play a role in the ongoing management of their investment. To this end, it is common for a prospective investor to request a seat on the board of directors.
Employee option Pool: This refers to shares reserved for employees at incorporation or prior to a qualified round of financing. The option pool is usually used as a device to dilute existing shareholders/founders. Founders should therefore be aware of the implications of widening the employee option pool.
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