Discuss: What to look out for in a VC term sheet?

The adrenaline rush of receiving a term sheet from an investor after multiple attempts of pitching can be quite a thing. You look at the document and the terms seemed fair, but for many early-stage founders, looking through an often template-style document produced by a lawyer can be overwhelming and sometimes, confusing.

According to VentureBeat, there are four critical things to watch out for in a VC term sheet.

Four things to watch out for in a VC term sheet

Valuation (Price Per Share)

Valuation essentially means the price an investor is willing to pay for shares in your company. Logically speaking, a higher share price is better than a lower share price.

That said, it is not always the case. The lower price of a share can sometimes mean more flexible terms in other areas.

You also need to be aware of the current valuation, and how it will potentially affect your next raise. There’s a possibility of a “down-round” if investors seek to reset the company’s valuation.

Liquidation Preference

Liquidation preferences define the division of proceeds between shareholders (common and preferred) in the event of a sale of the company – regardless of equity ownership.

There are two provisions to take note. Multiple liquidation preference and “participation” versus “non-participation”.

Multiple liquidation preference allows for the shareholder to get a multiple of their capital back (two times, three times, etc) prior to any other investors participating in sale proceeds. In other words, the lower the liquidation preference, the better it is for the founder(s).

“Participation” is when the investor participates in all proceeds, after the liquidation preference, based on their ownership percentage. “Non-participation” results in investors either a) getting their liquidation preference or b) option to convert their preferred shares to common shares and participating pro-rata with all other investors.

Founder Vesting

Vesting monthly over four years is a common way to establish a vesting schedule for founders stock. Vesting starts when the company is formed in a way that the founders stock is normally given by portion. For example, 50 percent of your stock is vested at the time of the financing, and the balances “vest” monthly over a two, three, or four-year period.

Let’s discuss