Top 10 Term Sheet Hacks

Venture Hacks

Aug 28 2008venturehacks.com

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What is Venture Hacks? It!s just Game Theory applied to raising Venture Capital.

Looking a few moves ahead. Realizing the consequences of Series A decisions, and

knowing how it!ll affect future series, the management of the company, and the exit.

Apologize in advance to the VCs. :-)

Institutional Knowledge

“It’s Standard”

Read a blog post

“If Slide is worth $550M...”

Why cover it?

- VCs know a lot more than you do - Average partner invests in 2-3 deals, many trade

away. A VC firm puts out 30-50 termsheets per year, negotiates a dozen.

- The first round is the most important - most dilutive, template for later. Experience is

the worst teacher - exam comes before the lesson.

• Two + termsheets

• Independent

• Credible investors

• Create a market for your shares!

Leverage

Otherwise, you have no leverage!

I!ll touch on how to raise, briefly - we do cover some of this on the blog too.

“Raising venture capital is the art of younger men seducing older men”

- Anonymous

Or women, as the case might be.

The Timeless Art

• Social Proof - “We’re meeting Sequoia next week”

• Authority - “Marc Andreesen is an angel”

• Scarcity - “Only room for one investor in this round”

• Desirability...

Again, not meant to be a “how do I raise money”.

Five Quick Tips

• Great team (check the mirror)

• Pick a big market (now!)

• Even angels don’t fund niche plays

• Do something hard

• Have a plan for distribution

• Stay close to the money

Keynesian beauty contest.

Your 50-page business plan doesn’t matter

• One-liner; executive summary

• 10 slides

• Financials; micro-economics

The Pitch

The Approach

Get introduced...

...to the Partner...

...from someone they respect...

...at roughly the same time.

Timing is important - exploding termsheets notwithstanding, deals have a way of

going stale.

Synonyms for “NO”

“Come back when you have more progress”

“We need to see a CEO”

“NO”

“Maybe” “Later”

“It’s not you, it’s me”

“We’ll follow a credible lead”

Yes means a termsheet!

“Value Add?”

Smart money

• Wisdom, not Intelligence and Energy

Money

Dumb Money

• Most likely to trumpet value add

Unbundle control, advice, and money - advisors are a bargain!

Let!s assume you get the termsheet... now for the real hacks.

1. The Board of Directors

Valuation is temporary

Control is forever

Classic mistake entrepreneurs make is to fixate on valuation. Control matters much

more, and most control derives from the board.

You can!t divorce your investors. You can!t recover control!

“Trust, but Verify”

- Ronald Reagan

“The line between good and evil is permeable and almost anyone can be induced to cross it

when pressured by situational forces.”

Philip Zimbardo,

Stanford Prison Experiment

Intentions don!t matter!

Contracts are made for worst-case scenarios.

Partners come and go. Funds come and go.

Rules of Thumb

• Make the Board Composition Proportional to ownership

• Independents usually aren’t

• Create a new seat for a new CEO

• Control is a one way street, from Common to Preferred

2. Valuation

Learn to signal gracefully

Purely supply and demand

Ignore outliers

Money has karma too!

It!s an art, not a science, even though people try and calculate or justify it.

Investors in Ning and Slide aren!t saying those companies are worth hundreds of

millions - rather that Marc and Max are.

Down rounds kill you. High valuations seal the exits.

3. The Option Pool ShuffleConvert apples-to-apples

Take the post-money option shares out of the pre-money

$6M pre-money$4M raised

25% post-money pool=

$3.5M pre-money

This one IS simple.

Convert by taking the post-money option pool percentage out of your pre-money.

4. Vesting is Testing

With board control, it’s a founder issue

4 years, some credit, single trigger, double trigger

Subtleties - do you vest just by being on the board? Definition of triggers. Cliff ?

Sweetener to bring on a CEO?

Without board control, it!s very important.

5. Liquidation and Anti-Dilution

• “Standard” is 1x, Broad-Based Weighted Average

• Designed to protect investors from quick flips and overpriced rounds

• Can change the terms dramatically!

• Great potential for mischief in private-private transactions

6. Protective Provisions

AKA The Fine Print

Protect minority shareholders

Hack 1: Sale ok above a certain price

Hack 2: Fundraising ok above a certain price

7. Expiration and Non-Disclosure

“We made a commitment to the other investors to give them time to do their diligence”

Either the termsheet is binding or it’s not...

...but it’s very bad form to shop

8. Counsel

Get your own advocate

There are “entrepreneur friendly” ones available

Draft the docs

Cap the fees

We can recommend you entrepreneur-friendly counsel.

9. The New, New Thing

• RoFR - Spend now, pay later

• Super Pro-Rata - Huge option value, negative incentives

• One-sided confidentiality

• One-sided binding termsheet (pending diligence!) - placeholder

• Stock repurchase at FMV

In general, pro-rata is all you want. Otherwise, signaling.

10. Don’t Forget...

83(b)

Right to transfer / diversify

Founder Preferred

In Parting

• Line up your options

• Keep control

• Friendly investors don’t deliver hostile termsheets!

• Raising money is the easy part. Returning it...

• founders@venturehacks.com