Introducing the World Positive Term Sheet

I fully support Obvious Ventures’ introduction of the World Positive Term Sheet and the idea that venture capital term sheets should include details on the core non-financial values of the company.  I’m less certain, though, about the suggestion that the values section of the term sheet should not have legal significance.  If these values are important – perhaps equally or more so than financial return – then why not reflect them in some way in the investment documentation and/or the company’s governance documents?

Without legally binding terms, the company and investors may not be held accountable to the values expressed in the term sheet.  Requiring measurement and reporting on impact is an easy place to start.  No investor would agree to invest in a company without a legal requirement for regular reporting on financial performance.  If an investor is equally concerned about performance with respect to social and environmental indicators, then why rely on a handshake understanding with respect to tracking and reporting on non-financial performance instead of a legally binding provision?

If you would like to learn more about how to incorporate legally binding commitments with respect to social and environmental matters, check out the impact terms project.  It includes sample term sheet language for a variety of legally binding non-financial commitments, including measurement and reporting on impact, transitioning to a benefit corporation or certified B Corp, and special voting rights to ensure social and environmental values are upheld.

Term Sheets 101: What are “conventional” terms?

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:

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: