Andrej Kiska is a partner at Credo Ventures
.If you have not read first part on flip-term equity, I highly recommend doing it before moving on. For a general introduction to term sheets and compromise between high valuation and a complex investment structure, please refer to the introduction publish the guide.
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Digging in the remaining set of entrepreneurs terms can usually find in a term sheet equity round, the first position does not cover . They are for the most complex issues, which are often misunderstood and can lead to serious disputes.
The terms
liquidation preference clause very important that is sometimes overlooked by entrepreneurs. It is one of the key terms used to protect the downside of an investor.
Generally, you will find one of two variations of the definition of the liquidation preference in a term sheet: participation or non-participation or their combination (ie -plafonné participants, although this is rare in my experience).
The best way to explain the liquidation preference is using an example. Let's say that an investor has invested € 1 million for 10 percent stake in the company. If the investor has a preference for non-participating liquidation, it has the right to choose during a liquidation event (ie outlet, or any type of transaction involving a buyout of existing shareholders, not just a bankruptcy sale) if they would like to receive a preferred return specified in the clause or liquidation preference of 10 percent of output prices.
Usually, the preferred return is equal to the amount invested (in our example EUR 1,000,000), but can be a multiple of this amount (ie 2x liquidation preference corresponds in our example to 2,000,000 EUR).
Let's say an investor in our example is 1x (also called "simple") liquidation preference, ie € 1,000,000. When the company is sold, it may choose whether to receive one million euros or 10 percent of output prices.
Using simple math, it makes sense to choose EUR 1,000,000 if the exit price is less than € 10 million, and choose 10 percent of the company if the price output is above EUR 10 MM.
Similarly, if the investor has the 2x liquidation preference (and therefore its preferred return is 2,000,000 EUR), the exit price at which it becomes interesting to the 10 percent of the company instead of the preferred return is EUR 20 MM.
Things get a bit more complicated with the involvement liquidation preference. In this scenario, the investor exit first gets his favorite back then the rest of the output of the product is distributed pro rata to all shareholders.
Take the example above: the investor has provided EUR 1 MM 10 percent of the company with participation 1x liquidation preference. If the business is sold for 10 million euros, the investor first gets 1 EUR MM, and then also 10 percent of the remaining EUR 9 MM for a total of EUR 1.9 MM.
In general, we tend to stick with a simple preference-out 1x liquidation, which is the most welcome alternative for companies. liquidation preference Entrepreneur Friendly's also important to attract future investors or output partners, who do not want to see a disproportionate amount of the purchase price up to investors as opposed to contractors.
However, if the contractor has unreasonable expectations of evaluation, we tend to include stricter liquidation preference (2-3x non-participants). Personally, we feel it is too entrepreneur-hostile. If we can not reach an agreement on acceptable evaluation, we prefer to walk away from a deal rather than understanding the difficult conditions that can cause fighting between founders and investors and deter future investors to invest.
Drag along rights this law allows an investor (or, if a startup has several investors, by agreement between all existing investors) to drag the remaining shareholders (including founders) to sell their shares if the investor decides to its sale.
Generally, this right can only be exercised after a certain period of time; the norm is between 1-3 years after the transaction. Sometimes running a slide down right must be approved by the Board of Directors startup.
Many entrepreneurs worry that right and it's easy to see why. At first glance, it appears that the investor can decide the fate of the company without consulting the founders. That the founders must realize is that no buyer will buy a company if they do not want to sell, because the founders and their team are an essential part of what the acquirer buys.
This is why a brake can be operated in practice if also approved by the founders. We at Credo has never exercised along right front brake, but still want to have it in the term sheet. It is for the unlikely event that some shareholders (usually a non-essential, as one of the first employees angry shot that has a stake in the company and wants to damage it) will try to block a transaction.
acquisition of the founder of another law that deals with founding quarrels. Essentially, when founders take an outside investment, they will not own any outright equity. Instead, it will be acquired over time. If you are not sure what vesting, please read post by Fred Wilson .
describe the mechanics in an example. Our typical conditions are: the signing, each founding directly holds 30 percent of its stake. The remaining 70 percent of the participation is invested over the next 4 years.
How this look in practice? Let's say one of the founders is believed to possess 50 percent of the company once the investment is made. According to the acquisition of its founder, it will hold 50 percent * 30 percent = 15 percent of the company outright. In two years, it will own 50 percent * 30 percent * 50 percent (1-30 percent) * (24/48 months) = 32.5 percent. In four years, he will own all of 50 percent.
At first glance, this may seem a very entrepreneur-unfriendly clause. However, we mostly use in our seed investments, where the founders are working on their first project together.
There is a simple reason: let's say there are four founders, where each holds a 25 percent stake in the company. There are many cases of real life, where one of the founders gets in an argument with the other and leaves. If the acquisition of no founder, suddenly you have a 25 percent shareholder in your company who not only do not add value to the business, but perhaps angry and a mission to sabotage the rest of the business just to get back at you. The acquisition of the founder and helps to mitigate the consequences of the founders of quarrels.
reports be prepared that an investor will typically want to see a monthly report, or at least a quarter in a very early stage of startup lifecycle .
In general, this includes a statement of monthly income and balance sheet (your accounting firm can produce) along a short qualitative comments of the Director General on the most important news of the month. These materials are also used as support material for a board meeting.
Closing speech
These may seem initially quite controversial. That is why it is very important to sit down with the VC who offered the term sheet, and let it guide you through the logic of each term.
If something seems suspicious to you, just Google each term. If you want a deeper dive on term sheets, I recommend this piece by Alex Wilmerding.
Some people say that the acceptance of an investment of an external investor is like getting married. It is true that you could spend more time with your investor with your wife or husband. If this is the case, the signing of a term sheet is like getting engaged.
How often do you see couples from having a happy relationship in a long discussion? Just keep that in mind when you are negotiating the term sheet. The way you start your relationship with your investor could be very indicative of where it might be heading.
Guide the founder of the first to term sheets :? What is an equity investment