Just Say No: VC Terms that can really hurt (Part 2) by Fred Destin

  • Source link: https://venturehacks.com/terms-that-hurt-2
  • TL;DR: When signing a term sheet, try to avoid clauses that limit the exercise period for options to too short of a window, give the VC multiple liquidation preferences, apply cumulative dividends, are overly complex, and of course never sign a term sheet that you don’t fully understand.
  • How helpful?: 4/5 
  • Topic Tags: term sheet, exercise period, multiple liquidation preferences, cumulative dividends
  • Relevant questions addressed:
  • What are some term sheet clauses that entrepreneurs should avoid?
  • Summary bullet points
  • Limited exercise period for options when an employee leaves the company
    • Many stock option plans limit the window in which employees can exercise their options after leaving the company to 3 months.
    • It’s better to try to get a longer window so that you can share in the wealth when the company has reached a greater maturity.
  • Multiple liquidation preferences (2X, 3X, etc)
    • Usually this is a clause included in order to get the VC to accept a higher valuation. Risky
    • If the company goes public or the liquidation preferences are negotiated away in a subsequent round of financing, you win.
  • Cumulative dividends
    • “Sometimes an 8% dividend is slapped on, and it accrues over time when it isn’t paid. Again, this is not appropriate for most venture deals, but it may be part of an acceptable trade-off.”
  • Complexity
    • When the term sheet gets too complicated, you can end up spending an enormous amount of time disagreeing about how clauses should be applied and less time on focusing on nailing business execution and growth, which is how you actually create value.
  • Signing a term sheet with parts that you don’t understand
    • It’s extremely important to know exactly what you are signing. Don’t be afraid to ask questions and push back on clauses
  • Follow up links