In his recent post for VentureBeat, former serial entrepreneur Bob Ackerman discusses the investment term sheet and provides some solid guidance for start-ups. Ackerman says term sheets can vary considerably in depth and length, ranging from one or eight pages, and for first-time entrepreneurs the language often seems derived “from an alternate universe populated by lawyers.” Ackerman offers four key things to look for in a term sheet before signing on with an investor:
1. Valuation. Assessing the price an investor is willing to pay for shares in your company is obviously a critical issue, Ackerman says, but getting to an acceptable valuation is anything but obvious. Sometimes you’d actually be better off accepting a lower price in exchange for more flexible terms in other areas, he points out.
2. Liquidation Preference. This defines the division of proceeds between common and preferred shareholders — regardless of equity ownership — if the company were to be sold. Under a multiple liquidation preference arrangement, the lower liquidation preference is better for the entrepreneur, whereas “participating preferred” means the investors participate in all proceeds based on their ownership percentage. In the case of the latter, Ackerman recommends putting a cap on that percentage – for example, once a certain return on capital is achieved for the investors.
3. Founder vesting. Investors often require that founders re-earn their equity over time. This ensures the founders’ continued focus and commitment to the company they are putting money into. Calling this “a legitimate request,” Ackerman also notes that founders should get ahead of the discussion and figure out a viable vesting schedule themselves.
4. Board structure and composition. This is where true control of the company lies. The question of who decides on such issues as budgets, financing and stock grants typically has more impact on control of a company than share ownership alone. In general, Ackerman says, a smaller board is more efficient, and care must be taken when deciding who will represent the investor.
Of course, all provisions of the terms sheet should be studied, ideally with a lawyer present. Overall, when meeting with investors to discuss it, “make sure you come to the table equally prepared.”
Posted February 27th, 2013 under Tech Transfer