What is a “conventional” term sheet?
Throughout the Impact Terms website, we describe innovative deal terms in contrast to terms found in “conventional” term sheets—mostly, in reference to early stage equity investment deal terms. Without a firm grounding of these basic terms, much of the content on this site will be out of context.
Are you prepared for the content on this site?
It’s important to have a strong foundation in early stage financing and term sheets in order to benefit from the innovative deal terms found on the Impact Terms Project.
For example, do you know the terms “liquidation preference” and “participation?” A term sheet might read:
Liquidation Preference: In the event of any liquidation or winding up of the Company, the holders of the Series A Preferred shall be entitled to receive in preference to the holders of the Common Stock a per share amount equal to [x] the Original Purchase Price plus any declared but unpaid dividends (the Liquidation Preference).
Participation: After the payment of the Liquidation Preference to the holders of the Series A Preferred, the remaining assets shall be distributed ratably to the holders of the Common Stock and the Series A Preferred on a common equivalent basis.
What does this mean? Simply that, if the company is sold, investors will receive all the money invested multiplied by [X] before anyone else is repaid, and then that they will be repaid alongside other shareholders based on their ownership. For example, with 2X liquidity preference and full participation, if an investor puts in $2 million for 33% ownership, and the company sells for $10 million, they get $4 million in liquidity preference and $2 million from participation.
As a rule of thumb, if you didn’t know both these concepts—or others, like the difference between pre- and post-money valuation, the difference between capped and automatic conversion in a convertible note, or other frequent deal terms like vesting, anti-dilution provisions, or drag-along provisions—it would be worth learning more about conventional term sheets before studying innovations for impact and liquidity.
An overview of common terms
When reading term sheets, it can be useful to divide terms into three categories:
- Economic: Economic terms have an impact on the financial return created for investors and entrepreneurs in the deal. These include the price, any liquidation preference, share participation, or other mechanisms used to provide returns to investors.
- Control: Control terms include board representation, right of first refusal in subsequent investments, or anything else that affects control over the company’s key employees or major decisions.
- Other: Other terms include constraints or requirements for the current or future financing rounds, as well as all of the impact and liquidity innovations described on this website.
A great introduction to term sheets is the book, Venture Deals, by venture capitalists Brad Feld and Mendelson. Or, you can read Feld’s blog, which describes the terms below in detail:
- Economic terms:
- Control terms and concepts:
- Other terms:
Some sample term sheets
Today, in 2015, most startup investments take the form of a small subset of the possible deal structures. Some of the most common are described in blogs and sample financing documents: