VC Terms are like Prenups - It's all about Control and Economics

Have you heard this famous quote "You pick the valuation I set the terms"? That is because in venture capital, the terms under which a deal is done are sometimes more important than the headline valuation or amount raised. So today, I will be starting a new series about VC terms, what to look out for and how to navigate the murky waters. The goal of today's episode is to help us see the end goal of every term sheet. It is all about control and economics! First of all, introduction.

A venture capital (VC) term sheet is a document that outlines the terms and conditions of an investment in a startup or other early-stage company. It serves as a framework for negotiation between the company and the VC firm and typically includes both control terms and economic terms.

Control terms are provisions in the term sheet that relate to the governance and management of the company. These terms outline the rights and responsibilities of the VC firm with respect to the company's operations and decision-making processes.

Economic terms are provisions in the term sheet that relate to the financial terms of the investment. These terms outline the details of the investment, such as the amount of money being invested, the valuation of the company, and the terms of the preferred stock that the VC firm will receive.

Here are some examples of control and economic terms that might be included in a VC term sheet:

Control terms:

1. Board seats: This term specifies the total number of board seats available and how these seats are allocated among founders, existing investors, and new investors. Most times, an odd number is mostly favoured mainly to avoid the possibility of tie votes. In some cases, there might be provisions for independent board members. The size of the board is also mostly a function of the size of the company or the number of interests that needs to be represented. There are statutory board members and also board observers - I will explain this better in another article.
2. Information rights: This term defines the information the VC firm is entitled to receive from the company and at what frequency.
3. Reserved Matters: Reserved matters are certain decisions or actions that require the approval of the board of directors or a specified group of shareholders before they can be implemented. These matters are typically considered to be of significant importance to the company and are therefore reserved for the board or specified shareholders to decide. Reserved matters may include decisions related to changes in the company's business strategy, major investments or acquisitions, and changes to the company's capital structure. They may also include matters related to the company's governance, such as the appointment of new board members or the amendment of the company's bylaws.
4. Drag-along rights: This term gives the VC firm the right to require the company's other shareholders to agree to a sale of the company. Essentially saying that the lead investor can force other shareholders to sell their shares under certain circumstances
5. Tag-along rights: This term gives minority shareholders the right to join in the sale of the company if a majority shareholder decides to sell their shares.

Economic terms:

1. Investment amount: This term specifies the total amount of money that the VC firm will invest in the company.
2. Valuation: This term specifies the pre-money valuation of the company, which is the value of the company before the VC firm's investment. The pre-money valuation plus the investment amount equals the post-money valuation. This also forms the dilution effect on all shareholders.
3. Preferred stock: This term specifies the terms of the preferred stock that the VC firm will receive as part of the investment. Preferred stock typically has priority over common stock with respect to dividends and liquidation.
4. Dividends: This term specifies the conditions under which the company will pay dividends to its shareholders, including the VC firm's preferred stock.
5. Liquidation preference: This term specifies the order in which shareholders will receive their share of the company's assets in case of a sale or liquidation. There is a lot to unpack here. I'll reserve that for another publication

In the next publication, I will select some of these terms and dig deeper into them.