How To Negotiate A Term Sheet With a VC by Ryan Westwood

TL;DR - Founders should spend time negotiating their term sheets, hire an experienced attorney, and understand the key provisions that apply to preferred stockholders.

Helpfulness - 4

Tags - term sheet, term sheet negotiation, term sheet advice, venture capital, VC

Questions answered:

  • What is a term sheet?
  • Why is a term sheet important?
  • Why should founders hire an experienced lawyer?
  • Why should founders understand provisions that apply to preferred stockholders?

Summary:

  • Founders should make the most of their term sheets.
    • A term sheet is a formal document briefly laying out the initial agreement between a founder and a venture capitalist.
    • Although not legally binding, the term sheet is the chief document used by legal counsel to prepare the final agreement and to resolve any disputes.
  • Founders should hire the right lawyer.
    • Highly experienced lawyers know how to close deals, anticipate pitfalls, and proactively take care for logistic weeks before they are needed (e.g. obtaining wire account information and bank routing numbers).
    • They will ensure the corporate legal aspects of the VC-funded company are set up properly.
  • Founders should know the difference between the terms of preferred and common stockholders.
    • If founders decide that they want to sell some of the shares to a third party, preferred stockholders must be given the right to purchase them first; which can affect business decisions that founders may want to make (e.g. offering stock option to entice a prominent businessman to join the board of directors).
    • Preferred stockholders are often given co-sell rights or “tag-along rights” which allow a minority shareholder to sell stakes in a company if he/she wants to.
    • Preferred stockholders are often given liquidation preferences.
    • Founders should be aware of the control they give to preferred shareholders, especially the investor who has the majority of preferred stock.

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