Demystifying A Term Sheet

December 24, 2015


As a Founder, understanding an Investor’s Term Sheet can be a bit difficult. You will ususally have your team of lawyers or your investor relations consultant help you to understand it. Just in case you want a head start, here are the ten most common terms to help you demystify a term sheet.

  1. Anti-Dilution: In the event that a company issues equity at a lower valuation then in previous rounds, anti-dilution protects the investor.
  2. Drag Along Rights: Provisions where investors can drag along stockholders and the company’s founders to consent to a sale of the business. Minority shareholders are able to negotiate a preferential or a minimum price or even a minimum profit. Majority shareholders must sell their shares on the same terms and conditions even if they don’t agree with the sale of the company.
  3. Equity Vesting: This is usually a specific period of time, like 3-5 years. Certain conditions have to be met before the investor is completely vested in the company.
  4. Liquidation Preference: This specifies in which order and how much an investor is paid during liquidation. Participating Liquidation Preference means that the preference holder receives a predetermined return, but is not entitled to any extra that could be distributed to the shareholders. Non-Participating Liquidation Preference means that after an investor receives his predetermined returns than he can still have a slice of the surplus pie with the other equity shareholders.
  5. Pre-Emptive Rights: This requires the company to first offer any newly issued shares to existing shareholders on a pro rata basis. This is used often in financing rounds so investors can protect their percentage equity stake.
  6. Put/Call Option: These two clauses are usually used in the case of death or bankruptcy. A put option entitles a shareholder to require the other shareholders to purchase the shares of minority shareholders. The exercise of the put option can be made subject to a particular event or pre specified time period. In Call option the shareholder is obligated to sell his interest to one or more other shareholders or the company.
  7. Right of First Refusal/Offer: This requires shareholders that want to sell their shares to an outsider or a third party to give the first right of refusal to the other investors.
  8. Shotgun Clause: Typically called a Buy Sell Agreement that lays out how shareholders can exit a company or resolve issues that may come up.
  9. Tag Along Rights: This co-sale protects minority shareholders by giving them the right to have their shares bought using the same terms as the majority shareholders.
  10. Veto Rights: One of the easy terms to understand simply means that shareholders can veto certain matters. Typically, this is used for hiring and firing of employees plus the financial and strategic planning of the company.

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