Venture Capital Term Sheets

or

How you can make millions of dollars and keep none of it for yourself

Leo Parker DiracUW Business School MBA CandidateSupporter of the Robot Revolution

What you’ll learn

• What is Venture Capital When it’s appropriate

• What are Term Sheets A few things to watch out for

• VC’s are not the enemy

How VC’s work

Investor

Investor

Investor

VCfund

Investor

Startup

Startup

Startup

When VC is appropriate

• Good for Big Opportunities Need lots of cash to take advantage of

• Must have “exit” within a few years Way for VC to get their money back, e.g. Acquisition IPO

VC is not for…

• Slow-growth companies• Lifestyle businesses

Image by Dubb http://www.subdivisionmodeling.com/forums/showthread.php?t=1133

Zombies!!!

What is a Term Sheet

• Negotiated before actual contract• Lays out the important terms• Short and readable

At least, compared to legal contract

What’s in the Term Sheet

• Numbers Amount of money to invest Number of shares Valuation Liquidation Preference Dividends

• Other terms Who’s involved Board of Directors What happens in future rounds Etc.

Valuation

• How much is company worth? Determines share price & ownership % Somewhat arbitrary for startups

• Post-money = Pre-money + Investment $8m = $6m + $2m

• Value = Share Price * Number of shares

Common Stock Payout

0

10

20

30

40

50

60

70

80

0 20 40 60 80 100

Company Value ($m)

Payou

t ($

m)

Management’s Share

VC’s Share

Liquidation Preference

When there’s a Liquidation event, Acquisition Sold off for parts :(

VC’s get Preference. Investors get all their money back

before anybody else gets anything Sometimes 2x or 3x their money

Liquidation Preference:At low valuation, VC’s take all

At high valuation, payout % approaches ownership %

Liquidation Preference Multipliers

Is this Fair?

• Us entrepreneurs are getting screwed!

• They’re taking advantage of us with all these terms!

• Why can’t they just be regular shareholders?

Preferred Shares are necessary

• If investors held common stock, they would have no control

• Preferred stock is necessary to avoid mischief

Dividend Mischief

• Monday: VC’s invest $2m for 25% common equity share Check deposited into bank.

• Tuesday: I call shareholder meeting to vote on dividend. 75% vote Yes 25% vote HELL NO!!! WTFOMGBBQ!!! Motion passes

• Wednesday: Dividends dispersed. VC’s get $500k dividend check I’m off to Thailand with my $1.5m dividend

• Perfectly legal

VC’s are not Evil

• They are protecting their investments

• Without VC your idea is not a company

• Don’t like the terms? You can walk away Try to find a better deal

Cumulative Dividend

• Increases LP payout value over time Minimum investment return increases E.g. 8% per year

• Motivates Management to Exit Aligns incentives with VC

Final Tips

• Talk to people who’ve been through it

• Get the waterfall chart Shows payout at different valuations

• Understand motivation behind terms Think collaboratively, not adversarially

Thanks!

• Professor Lance Young

• Slides, Spreadsheets & more athttp://www.EmbracingChaos.com/business