What is an Equity Term Sheet?
An equity term sheet is a non-binding agreement that outlines the basic terms and conditions under which an investor will make an equity investment in a startup. It serves as the foundation for more detailed legal agreements and is crucial for setting expectations between founders and investors.
✅ Main Points Covered in a Term Sheet
▶️ Valuation: This defines the pre-money valuation (the value of the company before the investment) and the post-money valuation (the value after the investment).
▶️ Investment Amount: The amount of money the investor is putting in.
▶️ Equity Stake: The percentage of the company the investor will own after the investment.
▶️ Type of Shares: The type of equity being issued, such as common stock or preferred stock, and their respective rights.
▶️ Board Composition: Details on how the board of directors will be structured post-investment, including who will have the right to appoint members.
▶️ Liquidation Preference: Specifies the order in which investors get paid in case of an exit or liquidation, often giving them priority over other shareholders.
▶️ Anti-Dilution Protection: Clauses that protect investors from dilution in future financing rounds, typically by adjusting their ownership percentage if new shares are issued at a lower valuation.
▶️ Voting Rights: The rights that investors will have in decision-making processes, including veto rights on key decisions.
▶️ Vesting of Founder Shares: The terms under which founders’ equity will vest over time, ensuring they remain committed to the company.
▶️Exit Provisions: Details on how and when investors can exit their investment, such as through an IPO or acquisition.
✅ What Startup Founders Need to Know
▶️ Non-Binding Nature: The term sheet is generally non-binding except for certain clauses like confidentiality and exclusivity. However, it sets the stage for final negotiations, so it should be taken seriously.
▶️ Understand Valuation and Dilution: Founders must clearly understand how the proposed valuation affects their ownership and control of the company.
▶️ Board Control: Be cautious about giving up too much control over the board, as this can affect decision-making power.
▶️ Liquidation Preferences: Ensure you understand how liquidation preferences work, as they can significantly impact the returns for founders and other shareholders in an exit scenario.
▶️ Vesting Schedules: Founders should negotiate vesting schedules that reflect their commitment and contribution to the company while protecting themselves from premature dilution.
✅ Seed Round vs. Series Round Term Sheets
✅ Seed Round:
▶️ Typically simpler and more founder-friendly.
▶️ May include fewer investor rights and simpler terms like convertible notes or SAFEs (Simple Agreements for Future Equity).
▶️ Valuation is often lower, with fewer structured protections for investors.
✅ Series Round:
▶️ More complex, with detailed investor rights, protections, and governance structures.
▶️ Involves larger sums of money, higher valuations, and stricter terms.
▶️ More negotiation over board seats, liquidation preferences, and anti-dilution clauses.
✅ Acceptable vs. Unacceptable Points
✅ Acceptable Points:
▶️ Reasonable Valuation: Aligns with market standards and company potential.
▶️ Standard Liquidation Preferences: Typically 1x liquidation preference without participation.
▶️ Balanced Anti-Dilution: Weighted-average anti-dilution protection is standard.
✅ Unacceptable Points:
▶️ Excessive Liquidation Preferences: Multiple liquidation preferences (e.g., 2x or more) can be detrimental to founders.
▶️ Full Ratchet Anti-Dilution: This can heavily dilute founders in future rounds.
▶️ Excessive Board Control: Investors demanding too many board seats or veto rights can stifle the founder’s ability to lead.
✅ Conclusion
Founders should approach a term sheet with a clear understanding of its implications on their company’s future. Negotiating terms that protect their interests while also attracting investor support is key to long-term success. Understanding the difference between seed and series term sheets, and what is acceptable versus what is not, can help founders navigate this critical stage in their startup journey.
