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A Standard and Clean Series A Term Sheet (ycombinator.com)
623 points by akharris 86 days ago | hide | past | web | favorite | 168 comments

As a Series A investor who invests in startups outside of the Valley, it's hugely useful to have something like this (independent of us) that we can point to as to what's normal, especially for founders who don't necessarily have the network to help them.

Founder's (and lawyers) who've never seen a term sheet before will often argue against standard terms (which no mainstream VC would move on) and on the flip-side, bad VCs will often try and put onerous terms into term sheets which can hurt the startup in future fundraising rounds or liquidity events.

While there's been a huge increase in transparency at the pre-seed/seed/SAFE fundraising stage, Series A and beyond is still very opaque.

Great to see YC extending their work on transparency into the Series A stage!

How do we balance against an orthodoxy setting in? As a startup employee, it was unusual and impossible to ask for ISO options until recently. It's changing now. Why shouldn't there be terms in the agreement that felt perfectly reasonable a few years ago but seems unfair to the founder now?

A standard form should be a guidance. It shouldn't become an unquestionable text.

Yes and they aren’t unquestionable.

YC released the SAFE and then a few years later, after working with thousands of founders, thought it was too confusing to have a feel for ownership and conversion with pre-money valuation caps, so they moved to a post-money SAFE.

The SAFE itself has a few variations and you’re welcome to add/remove things as they make sense. With more complicated legal documents, like a Series A raise, of course people should adapt.

Open standards are a starting point.

What are some of the fixed in stone parts of a series A that most vc will not move off of?

I wouldn't talk in absolutes because having a ton of negotiating leverage can make everything fair game. But in an run of the mill deal, it's pretty tough to make a VC give up anything that's not in brackets.

Ya. If you are blowing up and VCs are knocking down the door to throw money at you, you can write your own ticket. Look at Zuckerberg who was able to do many rounds of funding while maintaining total board voting control.

> will often argue against standard terms

What's that like? Are you competing with other investors? Or do founders agree to forgo funding because they don't like anything on offer?

Generally from what I've seen in the market founders will typically either come around to accepting the terms or will raise money from non-VC source (corporates, PE funds, etc).

Glad you agree.

Looking forward to seeing some (more) term sheets from you!

Former founder here. I wish I had had this when I was raising my series A. I lost control of the board at my series A when the VC said that a 2-2-1 structure would be better for everyone. 13 months later, I was fired from the company I had started. The risks are real.

Had I known what a standard, clean series A term sheet looked like, I could have just pointed to this term sheet on ycombinator.com and said - "Make it like that."

I've found the Y Combinator resources to be some of the most valuable resources out there for startup founders. Do yourself a favor and familiarize yourself with what is available. It could help you not get fired from your startup.

What's a 2-2-1 structure and how did it result in you getting fired?

Edit: just saw it's in the article

> The way in which founders most often lose control at the Series A is with a 2-2-1 board structure, i.e. 2 founders, 2 investors and an independent board member. The loss of board control is most significant because it means the founders can be fired from their own company.

At least you made to series A. I know guys who didn't make it through a seed round without loss of control.

Could you link to some of these resources , their start up school doesn't really include documents such as this.

Yeah, thanks guys!

Can someone please help me understand what common re-vesting schedules are for founders? Like, if I raise seed money, surely I'll have to agree to a reasonable 4-year vesting schedule. But then if I raise a series A, B, and C, do I have to agree to new vesting schedules at each raise? Will I then not fully vest until 4 years after my series C? Do I lose all my vested shares at each raise? On the one hand re-vesting seems unfair to me, but on the other hand if I were to give someone 20 million dollars I wouldn't want them to quit the next day.

Also, sometimes you hear about founders being fired by their board. In this case, are they getting fully vested or are they just leaving with the equity they had vested at that point in time?

Re-vesting schedules are all over the map.

Some amount of re-vesting is often required at Series A, but it largely has to do with how vested the founders already are. If for example they've been working on the company for only a year, the existing vesting schedule will probably be left alone. On the other hand, if they've been working on the company for multiple years and are close to fully vested at Series A, it's almost guaranteed that the Series A investor will ask the founder to re-vest some amount of shares (for the reason you describe).

Re-vesting generally does not show up again after the Series A.

If you get fired before you fully vest, whether you leave with the equity you have or all your equity is something you can negotiate as part of the vesting terms.

Thanks Jason

Jason and I are happy to answer any questions people have about this document: why we included the terms we did, how to think about using, etc.

My reading is that this includes a pre-money option pool (aka the "option pool shuffle": http://venturehacks.com/articles/option-pool-shuffle), which while standard feels dirty.

Any thoughts on this?

We send people that link all the time to help them understand option pools. The main point of that post is to make it clear to founders that when an investor is saying they'll invest $X to get 20%, the dilution is more than 20% because of the impact of the pool.

I think if the pool is not part of the premoney, investors just adjust the valuation to compensate.

Just focus on the final output. Take the term sheet and work with your lawyer to model out how much you own after the round is closed. Is that a good deal or not? If you don't like it, there are multiple ways to increase your post-closing ownership. Moving the option pool into the post-money is one of the hardest ways to accomplish that because you are trying to move the investor up on both valuation and convention.

The last 2 rounds I was involved in moved the option pool into the post-money. In one case, the initial price was initally discussed and negotiated with the expectation of a post-money option pool. In the other, there was a term sheet with a post-money option pool so we asked the other term sheets to be rewritten using a post-money option pool (they changed their prices accordingly).

I'll note that in every case where someone has asked for X pre-money, they have asked for less than X in the post-money. That's why I consider that term to be dirty - it's purely a means of obscuring the real valuation, and has nothing to do with employee ownership.

One thing I do in all my term sheets that might be a useful addition is to include a summary cap table showing the founders how much they own and our fund owns post-funding. That pre-empts any confusion over the impact of an option pool increase on each party.

I was under the impression that more and more founders (and even investors) are speaking out against the idea of legal fees paid by the founders. Is that only at the seed stage and acceptable at Series A?

To me it is totally unreasonable. We had a series A investor that required that. Their attorneys poked around and argued about every little thing and charged us $1200 an hour. They even had a $50k cap in the documents which they asked the VC to raise once they saw they were going to be able to exceed. The VC of course agreed because it wasn't his money and then proceeded to pressure us to accept it. We had already wasted so much time with these guys and racked up our own legal bills. So we were pretty much at their mercy.

If my company is going to pay your legal fees, then they work for me, not you and I will reserve the right to fire them and find someone really cheap instead.

If my company is going to pay your legal fees, then they work for me, not you [sic] and I will reserve the right to fire them

This the most logical comment on this thread. I can't believe people accept paying a VC's legal bills during a negotiation. VC's are in the business of doing deals, and have their own legal retainers to work on those deals - not to mention a fan favorite movie "My Cousin Vinny" teaches every American that giving $1 to a lawyer creates client-attorney privilege.

It's amazing that without being sued (and then losing on appeal in court), people are willing to pay out of pocket for a lawyer to actively work against them in what could be one of the most important deals of a founder's life.

> not to mention a fan favorite movie "My Cousin Vinny" teaches every American that giving $1 to a lawyer creates client-attorney privilege.

Yes, but in this case, you aren't paying the lawyers, you're paying the bills that the lawyer is charging their clients, the VC. Essentially, it's a reimbursement where you are paying for the VC's A/C privilege.

The term sheet we posted is just meant to show what a pretty good term sheet looks like from a good investor. The investor having its legal fees reimbursed by the company is something that shows up all the time. Sure, you can negotiate that if you want. You can negotiate other things too, or choose not to. The way this usually plays out though is that unless you have the kind of leverage that lets you basically write your own term sheet, you have to prioritize, and most people prioritize getting what they want on valuation, control, clean terms, etc. before making sure to shift $30K in legal fees back to the investor.

What are 'standard, broad based weighted average anti-dilution rights' in this context?

Surely early investors will be diluted, so what are these peculiar rights referring to?

Good question. The anti-dilution right is an adjustment to the investor's shares that occurs when the company does a down-round. The "broad-based" qualifier is a reference to the most company-friendly version of this because it requires the adjustment to take into account the scale of down-round in terms of dilution. For instance, if you closed a round at $20M post and then sold one share afterwards at $10M post, the adjustment would be negligible. There are other variations of anti-dilution adjustments that would ignore such considerations.

The anti-dilution adjustment is generally not something that applies to ordinary course dilution (like employee option grants).

Question: how did you think about giving pro-rata & information rights in this term sheet? It looks to me that the Other Rights & Matters section grants it to _all_ investors. Is that typical in your experience?

Major investors concept (investor has to have invested at least $X) is often added in the definitives. Longer term sheets just state a threshold dollar amount; shorter ones (like this one) just skip that definition and just add it in the definitives.

I'm no fan of long term sheets, but IMO, this term sheet doesn't just punt that term to definitives; it gives me the expectation that all investors will receive "major investor" rights without dollar or ownership thresholds. Specifically, I feel that way because the "major investor" rights (ROFR, co-sale, pro-rata, info) are are in-line with anti-dilution and registration rights, which are typically afforded (in varying degrees) to smaller investors. Were I an existing investor or angel, the definitives adding a threshold would feel like a retrade of the term sheet.

Especially if the intent is to help unfamiliar founders & angels understand what's a "clean" or fair deal, I'd put in a vote that a v2 of this term sheet would clarify the applicability of rights to smaller investors, maybe with some "batteries included" guidance on that point.

How commonly do you see each of the voting/veto rights you listed negotiated? What are some others that may be listed that you'd deem inappropriate?

Some minor wordsmithing that reflects lawyer and investor /founder preferences happens a fair amount.

The veto on company sales breaks founder friendly occasionally (you need a decent amount of leverage). Some examples:

1. It doesn’t exist 2. It only applies to sales that return less than X multiple of investor’s capital invested 3. It only applies to sales where the founders are getting retention packages (from acquirer) that substantially exceed their recent compensation

The veto on financings is present almost always. A founder would need rare leverage to get rid of it.

On both of these vetoes though there are additional constraints on abusive usage by investors — reputation being the most obvious one.

The post refers to the actual resulting contract (100+ pages) that the lawyers generate as a result of these terms.

Are there any examples of these for the curious to read? I know it’s out of scope for the post topic but as someone who hasn’t read a term sheet before and is curious, I am also curious about reading a full series A sale contract.

Take a look at the Model Legal documents from the NVCA: https://nvca.org/resources/model-legal-documents/ (free to download, requires giving up email)

It is typical that the term sheet results in ~5 different contracts: the Stock Purchase Agreement (through which the company actually sells stock), the Investor Rights Agreement, the Voting Agreement, the First Refusal and Co-Sale Agreement, and changes to the company's Certificate of Incorporation.

There are also sometimes opinions of counsel and other "ancillary" documents which are just as important but not typically negotiated as they're very standard.

It is mind-bogglingly routine that a company pays $30k to "expand" from the term sheet to definitive contracts, and then the VC firm spends an additional $15-30k++ (reimbursed by the company) to review that expansion to make sure the other firm did it right.

Why Delaware? I'm like, I grok it's a fan favorite and all for various reasons, but for those who aren't savvy about it, why Delaware? (And ideally: why not Delaware? Given that the gist of the criticism about it is that it hugely favors the investors over the founders and the employees.)

Delaware Court of Chancery is like a standards body for anything else: it's a set of well known, public rules.

Every major law firm has extensive experience in it.

Every major investor's law firm has extensive experience in it.

It doesn't use juries, it uses judges. Cases can move very quickly. The Chancery is well-funded, and the judges have deep experience in corporate law.

To follow on to eric's comment, there are two major aspects of the law:

- what is written as law

- how courts rule

The most important aspect is "how courts rule". This is because law is open to interpretation by those ruling on it.

The main upside of using judges instead of juries is that precedent is real. In a jury trial, you are relying on a random group of people to choose the outcome. In a trial ruled by a judge, you can reasonably expect that judge to rule in a similar fashion as they have on similar cases or based on precedent of previous cases.

Having a more predictable outcome that eliminates the "wild card" aspect of juries allows your representation to give you better legal advice as they can study how the courts have ruled in the past and give advice that will likely put you on the correct side of the law.

Delaware Court of Chancery, tons of precedent in corporate case law

Do the terms (and fundability) remain same/similar for Delaware PBCs as well?

This term sheet template is very investor friendly primarily because of the lack of detail.

The Company has very little leverage after a term sheet is signed especially given a standard no-shop provision. You want to reduce the number of items that need to be negotiated later in the process as much as possible.

This not only reduces the likelihood of having to agree to a less than favorable term that was not addressed in the term sheet, but also reduces legal costs (which the Company is paying).

The post does make note of this:

> Some great investors still send longer term sheets, but this has more to do with their preference for going a bit deeper into the details at this stage, rather than deferring this until the definitive documents. The definitive documents are derived from the term sheet and are the much longer (100+ pages) binding contracts that everyone signs and closes on. It’s common to negotiate a few additional points at this stage, though deviation from anything explicitly addressed in the term sheet is definitely re-trading. Also, in a few places, this term sheet refers to certain terms as being “standard.” That may seem vague and circular, but term sheets frequently do describe certain terms that way. What that really means is that there’s an accepted practice of what appears in the docs for these terms among the lawyers who specialize in startups and venture deals, so make sure your lawyer (and the investor’s lawyer) fit that description.

Theoretically this would appear to be true.

In practice, the firms that give 1-pagers don't really try to pull a bait and switch like that. They offer the 1-pager so they can close quickly, not so they can get quickly into the no shop to drive onerous terms. Could a firm consciously adopt that strategy? Sure, but it wouldn't last very long because people talk to each other.

Also, even the 1-pager goes into detail on liquidation preference, veto rights, board composition, drag-along and founder vesting. These are the items that get negotiated a lot or are otherwise really important to know before signing up.

As mentioned elsewhere, this exercise was descriptive, not prescriptive. Some of the founder friendliest investors use term sheets that look similar to this. Some of the unfriendliest investors still send 10 page term sheets.

Agreed. A founder should assume any ambiguity in a term sheet will be resolved in the investors favor (since you're very unlikely to walk away from a deal after signed). I preferred more comprehensive term sheets so that we could pin everything down while the investor was still in "courting mode".

Something we did in our later financings was to (very politely) provide an interested investor with a fairly comprehensive (~7 pages) template term sheet that had blanks for the major economic terms, but otherwise fully specified all the details of the proposed deal. This kept things from drifting off "founder friendly" after signing and had the added bonus of making offers easier to compare.

>especially given a standard no-shop provision.

Why is the no-shop provision standard, especially given that this document says it's the only binding term? What's going on here? I'd like to understand it a bit more.

Pet peeve of mine: You should never take a raw screenshot of a Word doc, with its red and blue underlines, cursor, etc. Convert it to a PDF first or find a way to turn off the highlighting+cursor.

Better yet, embed the PDF in an inline iframe so text can be copied, highlighted, etc.

A downloadable version of the doc is linked directly above the image. That does the job nicely, since it allows you to immediately edit.

newer browsers can actually just embed PDFs natively[0] in an iFrame, but there are more fault-tolerant ways to do it that provide a better ux.

Cool note, Google Drive provides an embed code for PDFs[1] which I've found to be useful.

Filestack also provides a great API for viewing PDFs in apps/browsers[2] that I use all the time.

0- https://pdfobject.com/static/

1- https://alicekeeler.com/2016/06/05/google-drive-embed-pdf/

2- https://www.filestack.com/docs/concepts/transform/#document-...

Curious to know what the "typical" ranges are for some of the bracketed sections:

* What are typical / optimal post-money option pool sizes?

* What are typical / optimal founder vesting schedules?

* What are the usual ratios of lead investor / follow-on investor amounts?

It seems that the majority of the Preferred can vote to change the # of directors - wouldn't that offset the initial founder-friendly board setup or am I missing how that vote is used?

Ranges we see:

Option pools: 10-15% Vesting: If there are new rules here, they are around re- vesting and highly dependent on how long the company has been around. *Ratios: A bit harder to say, but the lead is usually taking a significant majority of the round.

Do "A Standard And Clean Employee Equity Offer" next!


I concur. Do you concur?

This is so valuable, just to have a reference point to ask, "so I've seen other sheets with X, what's the case for your preference?"

I have neither raised or invested, but do a lot of negotiations and having an external reference for framing discussion creates a lot of value. Seed is still in front of me, but these templates remove a lot of friction.

I was going to not-comment because it was just good news, but in case there was doubt, this is great.

Is this term sheet descriptive or prescriptive? Are you telling us what standard straight-forward terms are right now, or what they should be right now (and would be, in a slightly better world)?

descriptive, but note the comment about the brackets.

The only surprising bit for me was the dividends. Most terms sheets I've seen don't require the 6% dividend. Seems weird.

I was surprised by the % being included as I figured that would be decided by the board at the time a divindend is approved. I have no idea why a % which would be defined before knowing the details of the companies financial situation.

I wonder if this is more of a protection against the board deciding on a dividend when it is in the best interest in the near term for the company to keep money in the bank. So defining 6% might mean "this company has so much cash that they can return a 6% dividend without harming the long-term potential". Perhaps if you aren't able to return 6%, you aren't ready to return a dividend at all?

The dividend provision just says that the common won't get a dividend unless the preferred has already received their 6% (per year). It doesn't mean that you couldn't issue the preferred a smaller dividend--that would just count toward the 6% but still wouldn't allow the common to get a dividend until the remainder is paid out to the preferred.

It's relatively rare for venture backed startups to issue ordinary course dividends anyway (for the reason you stated, funding development/growth is typically seen as a better use of company cash to try to get to a big exit or IPO, etc.).

Yes, this.

Am also confused by this (and hoping this comment would get some love!)

Noncumulative preferreds aren’t required in the same way as cumulative preferreds.

This is extremely useful. Most importantly, I am glad that they included examples of what is non-standard. These are the real curveballs that are difficult for first-timers to gauge. whether they are "normal" to have on a term sheet or whether they're getting squeezed without really knowing.

Over 1x participating preferred I've seen a few times. A TOTAL nontransparent scam in my view.

Could someone here talk more about the "no shop" clause, which seems 100% geared toward giving a buyer better than a competitive price. But, the document says it is the only term that is legally binding!

How is "nothing in this document is legally binding and the buyer doesn't have to buy, EXCEPT for the term that the seller may not talk to any other buyers in any way." What kind of sense does that make? Would you "accept" an offer to sell your car that says it isn't binding in any way except that you may not talk to anyone else about selling your car to them, for the next 30 days?

Also since it says it is "legally binding" what are the remedies? What is the history of such a term?

Why would founders agree to it and actually follow it?

One potential modification would be to add some language to the No Shop clause to allow the lead investor to approve any other conversations about the round. This can be helpful when the Series A round is larger, as the diligence by separate investors can proceed in parallel.

This may seem like a slightly out-of-place question, but is there any equivalent term sheet for seed funding ?

Our safe docs are pretty good for this: https://www.ycombinator.com/documents/#safe.

iirc the SAFE doesn’t cover vesting, information rights and control rights (I guess this is because typically companies that YC invests in are set up with something like Stripe Atlas or similar?)

In many European hubs the typical term sheets for seed financing are provided by Angels or seed stage VCs and typically aren’t as founder friendly as in the US.

Having more information/a recommended seed term sheet from YCombinator that explicitly covers the above (or references Stripe Atlas) would help.

Really appreciate all the documents and context that you are publishing. The impact is vast and goes way beyond the Valley and the immediate YC network.

AFAICT, the norm with SAFEs is that they're very hands off in terms of company operations, at least in SV.

ty for the clarification ericd

Thank you.

* What should someone do if they get push back from an investor when asked to this term sheet?

* If this term sheet is used, can we avoid the legal costs of a Series A?

It’s meant to provide transparency on what good and clean terms are. It won’t generate negotiating leverage for you if you don’t have any, though on the margins it might help you persuade someone that a term is “market.”

Most of the legal costs don’t arise from the term sheet. They come from legal diligence and drafting the definitive docs.

Probably raise from elsewhere. We got a term sheet that included all the bad things mentioned about control in there. They wanted a 2-2-1 board + a whole bunch of protective provisions about requiring their approval for almost anything. Overall wasn't a pleasant experience and we would have saved months of our time had we not bothered working with them.

We got very lucky that things didn't work out with them

The legal fees come from the definitive agreement not the term sheet.

Now switch the preferred shares to common shares and eliminate all liquidation preferences and you'd have something closer to a fair term sheet template.

No young start-up should ever agree to preferred shares or any liquidity preferences. This is the next great battle for founders to win over venture investors. To push that risk back onto the investors where it should be instead of allowing the investors to unduly offload even more of their risk onto the founders and early employees.

Liquidity preferences should have never become common with start-ups, they should be quite rare. There is no more important territory for founders to be focused on taking back from venture capitalists than that. Liquidity preferences are a routine source of screwing over the founders and early employees. YC could do something tremendous for founders by fighting on their behalf to put that shifted risk back where it should be: with the investor; the founders and employees already shoulder enough risk as it is.

Downvotes are because

1) This is a standard series A term sheet

2) This is a 1x non-participating liquidation preference.

Plenty of folks sign term sheets with MUCH WORSE preferences. Participating 1.5x etc.

This preference simply says, investor gets their money back if invested on a preferred basis during Series A.

That's where the real problems often come, participating preferred at 1x+. This is not one of those term sheets.

3) Fair is what is available in the market that is not misleading. A 1x nonparticipating preference is much more logical than many other approaches, so is easier to understand. And yes, if you take 20M from a Series A funder and sell for $22M, you are basically going to get $0.

There's no such thing as "standard". "This is a standard contract" is something lawyers say to get you to agree to things you may not have otherwise agreed to.

I'm not saying this flippantly. I've negotiated many contracts over the decades and I've heard "this is standard" dozens of times, but it's always negotiable.

Note, I'm not saying the agreement presented is fair or not. That's situational. Just that "it's standard" is irrelevant.

Which is why "standard" isn't an especially useful term; the better term is "market" --- what similar deals, negotiated repeatedly by people with similar leverage, have settled out to. These terms seem somewhat better for founders than market (but YCA might have unusually strong startups).

If you've negotiated many term sheets for Series A with not even a 1x nonparticipating liquidation preference - impressive.

That said, also illogical, why are these investors doing a preferred investment vs common if they don't have a preference?

The only people I've run into who can negotiate nonsense contracts are folks playing with other folks money (family etc). I will say I stay far away from those types of folks. Often crazy, and often have enough money to pursue their flights of fancy, including ungrounded legal theories, a good long distance.

Preferred investment can generate a yield and/or can take priority over some but not all other equity. I’m not saying it’s a good deal...just trying to answer your question.

Not sure why the downvotes. The reality is preferences are what poisons employee equity grants and is what ends up surprising people when startups end in any way other than spectacular success.

It’s unrealistic to do away with the common/preferred split, but protecting founders and perhaps some key employees as well as banning any kind of participating preferences or ratchets is a good place to start.

1x preference I think has meaning and it's reasonable.

Basically, the VC's are 'getting their money back first' - after all, they put the money in.

So if they put $1M in and the company sells for $1M ... should they only get $200K back? Or their $1M? Is the question.

Arguments can be made either way, but a 1x preference I think is something quite fundamentally different from multiples of preference.

Participating preferences are bogus - obviously, as are > 1x in most cases.

This term sheet is nonparticipating 1x. Despite the first comment in this chain, this is actually a very reasonable approach, and preferred stockholder is always going to have a preference - or there would be no point in being preferred.

I agree, I don't expect any shift against preferred shares (although I'll always advocate that direction). I do think ground can be reclaimed on the liquidity preferences. That particular area in VC today is so frequently egregious I don't think it would be very difficult to rapidly improve it.

Yeah excessive preferences do exactly this. But it's not the preference mechanism as much as what the preference does in relation to business value. Assuming liquidation preferences are 1x, what it means is that the company needs to build value that is well in excess of the amount that's been raised. The reason people end up surprised is that the amount raised is not always transparent, nor is the value of the business.

How does a VC deal without at least a 1x liquidation preference work? The founders have taken $X from investors and control the board. What prevents them from selling the company and pocketing their share of $X? In what way is a 1X liquidation preference unfair?

Well, selling the company for the post-money valuation will give the investors their $X back. The thing that the liquidation preference works is preventing certain types of control fraud.

For example, if the founders take $1M in funding on a $2M post-money valuation, then end up losing $1M to excessive payroll costs to insiders and sell the remnants of the company for the pre-money valuation, the investors are out half their money without a liquidation preference. In short, the liquidation preference means that any losses come out of founder equity first, rather than the new cash infused in the business. This is important because the founders control the company and can choose to take courses of action that impoverish the company at their personal benefit.

Right, that's an example of the scenario I was referring to and why I pointed out that in the scenario we're talking about the founders retain control of the board.

The broader point is that investors should eat the same dog food as the founders and early employees, including when it comes to common shares and no liquidity preferences. The fairness point you asked about includes removing preferred shares, you're splitting it as though I was only talking narrowly about an issue of a 1x preference. I fundamentally disagree with start-up investors receiving preferred shares as a norm.

I think YC should take the lead in trying to strip liquidity preferences from the industry. They should become non-standard in most term sheets. Ideally they advocate up the chain further by leveraging their considerable influence to water down or eliminate liquidity preference whenever possible. YC has been a founder-friendly venture firm from the beginning, I believe one of the best pro-founder fights for them to pick is to work toward ending the standardization of liquidity preferences. It's currently backwards, liquidity preferences should be rare.

I can't tell what you're saying here. You say I'm focusing too narrowly on the 1x preference, but then go on to say you disagree with preferences at all. I asked: how does a VC deal with no contractual investor protection work? You could be giving up $X in exchange for contractual rights to only $X/5 in a sale that occurred the next day. That's not a moral problem, it's a math problem, right?

Query whether this needle can't be threaded by allowing the board to waive liquidation preferences, so long as the investor board member(s) approve. I agree with you that a certain level of investor protection is needed to prevent fraud (obviously there's the threat of a lawsuit for breach of fiduciary duty, but there are many reasons why that would not be a reasonable substitute for a liquidation preference).

The question I have is when the founders have acted in good faith and the company goes downhill, should the founders bear all the downside risk there?

I can see someone saying yes - if the company goes south, everyone should get the money they invested as shareholders back. But that's a different argument.

An additional question I'd ask - is some method of waiving liquidation preferences by the board (again, including the investor board member) a good idea from the perspective of aligning incentives?

Let's say the company has seen a downturn where there are two options at play: a sale at a value that would give the founders nothing, after the liquidation preference is exercised OR a risky (but legally defensible) Hail Mary business plan to bring the company back from the brink.

If the founders get nothing out of the sale, aren't they incentivized to choose the Hail Mary option? (Obviously there are other opportunity costs for the founders.) If the liquidation preference could be waived by the board, then that would give the founders an incentive to approve an "efficient" sale.

Note: I am suggesting the idea of the board approving the waiver, as opposed to the preferred shareholders, so that the waiver applied across the board to all preferred shareholders. And the investor board member would have to vote in the best interests of the company when voting in the role as a board member, as opposed to in their own self interest, which they do as a preferred shareholder.

All that being said, I don't think liquidation preferences are the place to focus on making "standard" term sheets more company friendly. I could write a lot about that...

This term sheet is a fair distillation of fairly standard terms. I think what adventured is looking for is something that moves the Overton Window as to what's "standard." I don't think YC was purporting to play that role here.

With organizations like the NVCA playing such a pivotal role in the terms of VC financings, I think it is critically important that thought be given on the founder side towards advocating more founder-friendly "standards."

Liquidity preferences are also critical in allowing companies to grant employee stock options at valuations substantially below what the Series A investors pay. If liquidity preference disappear, the IRS will likely take a much closer look at low strike prices on options.

probably true

I'm a founder and have never been an investor. I feel there are many things that could be improved, but I don't feel that moving investors to preferred is one of them.

My sense is that investors take a risk and that preferred protects them from a lot of downside of that risk. If they didn't have that protection, they'd need to do way way more work to protect against the risk, making it harder for startups to get/close their funding rounds.

Also, since investors price the risk in, you'd end up having to give investors more upside in the success case, which is a thing I'd personally prefer not to do.

What do you think are the upsides of investors having common stock only?

I think you already answered that question in your post. There would be incrementally more proceeds for the founders and employees in an exit that is flat or below the postmoney valuation of the Series A round. But as you also noted, this stuff doesn't exist in isolation - pull one lever and it results in other changes. In this case, that outcome would probably change how the investors think about the risk-reward and may depress the valuation itself, especially if it's relatively high.

> There would be incrementally more proceeds for the founders and employees in an exit that is flat or below the postmoney valuation of the Series A round

Right, I understand the outcome, but why do we want to do that.? What problem is solved by this? I'm trying to extract the benefits so that we can weigh them against the downsides.

I think it just comes down to risk preferences. If you optimize for a higher valuation and give the investor downside protection for that, then you own more of the business and therefore more of the upside. If you choose to better optimize for the downside by taking away investor downside protection, you may end up with a lower valuation, lower ownership of the company and lower upside.

Ya... Preference means higher valuations means more cash. So employees can get less diluted (upside), higher salary (downside), and bigger team (derisking=both). Removing will lose those.

Removing preference may seem like it more strongly aligns existing team during critical events... But that'd get priced in to the above, say by 80% based on today's preferred vs common. Ouch!

Todays push to 1x participating vs higher in older days is great. I do agree about misalignment during some critical events..

I'm not sure why you framed this as an us-vs-them fight.

Hypothetically, each investor has some internal valuation for your startup, and is willing to take <x> risk. Giving those investors preferred shares reduces that risk, which means you can theoretically get more money while giving up less of the company. Obviously you trade that for the downsides of having preferred shareholders, but that's a choice for the founders.

The venture capitalists in implementing liquidity preferences as a commonality defined it as an us-vs-them fight. It's an aggressive risk shift onto people - the founders and employees - that are far more vulnerable in the start-up building process than the very wealthy capital class that makes up most of the VC world and its institutional money.

Overwhelmingly the VCs are not your pals. They are there to make money, you should deal with them accordingly. In the best case scenario they're business partners, that's it. They don't feel bad about liquidity preferences and how that benefits them. Founders should never feel bad about fighting for the best terms they can get, the VCs will do exactly the same thing when they can - it's a core part of their job.

I would take the premise a step further actually. Potential early employees should always avoid joining start-ups that have liquidity preferences that could meaningfully negatively impact their own outcome (the worse the potential impact, the greater the aversion should be). When the liquidity preference hatchet comes down, the non-founder employees typically get smashed particularly hard.

Another great way to kill off liquidity preferences, is to create a competitive incentive related to employees and starve liquidity preference start-ups of talent. Start-ups should begin touting the lack of onerous liquidity preferences as a notable recruiting point re compensation packages.

> The venture capitalists in implementing liquidity preferences as a commonality defined it as an us-vs-them fight.

... You'd have to support that argument, because it is not evident.

This is a mutual agreement between two informed parties. You don't have to take those terms, and you are free to offer them more common stock as a risk substitute. I also don't understand why you invoked class warfare here, which really undermines any credibility to your argument.

> This is a mutual agreement between two informed parties.

YC has put so much effort into founder education over the years precisely because that frequently has tended to not be the case. Quite the opposite.

I'm not sure what you're defining as informed here (mutually responsible for understanding what is being signed, sure), however I would point to knowledgeable as the more important term. The problem continues to frequently be that founders and early employees are nowhere near as mutually knowledgeable as their counterpoints in the VC world, who are elite professionals at these deals and do them for a living.

There's a great statement above by @mnemotronic that summarizes the routine imbalance between the two sides: "I'm a software guy. Most of that sheet is a foreign language to me."

I can sympathize, I've been dealing with VCs since the late 1990s and the terms/legal side is still an immense chore.

> I also don't understand why you invoked class warfare here, which really undermines any credibility to your argument.

No it doesn't, because it's not invoking class warfare, it's making a point about the typically dramatic financial condition and personal risk imbalance between the two sides (the personal damage absorbed if things go south). Founders and early employees can easily see their lives ruined if a venture fails, it's a not uncommon outcome, HN sees such stories posted regularly.

Upvoting the parent. The comment is worthwhile and merits discussion. Should not have been downvoted.

The comment that this is a way of reducing investor risk and may yield a higher valuation is well-taken. But founders should not agree to it, because their risk is far, far, far higher than that of the investors.

A founder gets one shot, or maybe two or three shots, in their lifetime. An investor gets many shots across a diversified portfolio. A founder puts their career and their financial future across in this one basket. They put their sanity and their personal happiness in this basket. An investor puts nothing but a small portion of their, or more frequently other people's, wealth in this basket.

Making it less likely that a founder will get a payoff is just stupid. A founder should do everything they can to reduce their risk, even at the cost of a lower valuation.

And remove/edit the vesting schedule. A vesting schedule of this sort may be reasonable for YC, but is unreasonable in some other cases. Many founds have already invested their life savings (and more) and years of work without pay. They should not lose their existing shares.

If it's essentially a growth round labelled as an A you can normally negotiate the vesting schedule, but if you're at a standard Series A point, then it's unlikely you'll be able to change it unless you're a super hot deal.

It'll likely take 7+ years from a Series A to an exit, if a founder leaves straight after funding and keeps all their equity, that's hugely demoralizing to the rest of the founders. They'll have to do the work to generate the value of the business over the next decade and end up with exactly the same rewards as the founder who left. It's the kind of thing that kills businesses.

From an investor perspective, an investor is unlikely to want to invest if the founders aren't committing to stick with the business.

I realized the above might not have been clear: you can potentially negotiate the length of vesting period, but not the existence of vesting period.

You can make arguments like this in negotiations and sometimes they can work. It just depends. As I mentioned elsewhere, this was meant to be more descriptive than prescriptive. Founder vesting/re-vesting is often a negotiation point in a Series A term sheet and the outcomes are varied and fact-dependent enough that it's tough to say that there's a standard here.

The vesting schedule line has 2 sections, 1 for founders (which is bracketed, i.e., needs negotiation) and 1 for other employees.

The rank and file get a standard 4-year, monthly vest, 1 year cliff. The founders presumably get something very different. Existing employees are an unknown.

Existing employee vesting is generally left alone unless they have something crazy.

I didn't see a vesting schedule indicated for founders, only for regular employees. The spot for the founder vesting schedule was blank brackets indicating a negotiation with no default.

(I just read the inline version, not the downloadable Word version.)

Bad preferences happen when Founders are overoptimistic or focused on optics (like a postmoney of $1.00B). Even the standard 1x/nonparticipating reflects a mismatch in optimism. Few founders would accept the valuations that would come with an all-common investment, so it's rarely discussed.

Yes employees suffer along with the founders when bad preferences are chosen. But that's still the founders fault, not the investor.

You're arguing against something I didn't make a point of. I never said it was the investor's fault that the founder signs a bad term sheet. Investors will generally pursue the best terms they can get, founders should do the same.

My obvious point is that founders and employees should conspire whenever possible - acting in their shared interest - to eliminate investor-favorable liquidity preferences as a common part of start-up term sheets.

If the startup isn't going to agree to preferred shares, they're not going to get funded. If the startup is wildly successful, the preference won't matter anyway.

I love this line:

    Company: [_______], A Delaware Corporation.
Because no one is gonna incorp anywhere else. Despite 90% of SV companies starting in California.

It doesn't matter where the company raising an A started, it is usually incorporated in Delaware. If the company incorporated elsewhere, it will almost always reincorporate in Delaware prior to raising an institutional round.

This isn't true for certain international jurisdictions, but within the US, it is a near certainty.

Right, I just thought it was a funny quirk of our legal system.

Network effects don't just exist in tech.

Delaware has the most developed corporate law and support services for corporate transactions (you can file charters, mergers, etc. within an hour there; good luck doing that in most other states, including CA). Every company that incorporates in Delaware adds further value to every other company that's in Delaware. Each marginal company adds to the Delaware legal corpus and support structure because (1) it ensures Delaware has the greatest variety and largest supply of potentially significant corporate legal cases, which means it has the greatest variety and largest supply of actually adjudicated cases and thus developed and stable law, and (2) it pays Delaware annual fees for those support services. This in turn attracts more companies to incorporate there because of that ever expanding corpus/infrastructure. And so on and so forth.

This is really helpful, thanks a lot! Just wondering, is the template released as Creative Commons or anything similar? I'd like to use it in some teaching material but only if it's intended use.

I know this article focuses on founders, but I'd love to see something done in the industry for employees (especially early employees!) as well.

One of the former companies I worked at never allowed early exercise and issued standard ISO with 90 day expiration upon leaving, which is unfortunately essentially the analogue of "standard and clean" when it comes to employee compensation. By the time I was ready to leave (4+ years, I was very early) all my equity was vested, and buying it required spending ~250k (USD!) between cost of exercising and AMT taxes, all while the company shares were illiquid as ever. The company had no interest in helping me, despite me asking for an extension to the option expiration, they were too bitter that I was leaving and creating significant "damage" to the business.

It was incredibly painful and I felt very cheated and stupid for agreeing to those terms in the first place (actually faced some deep depression and anger against the world for a few months because of this, and thought about going to therapy), but what did I do in the end? I paid out the money. Yes, I wrote a check to my employer for 60k, and another check to the IRS for 190k, depleting my non-emergency savings (and this is from a very frugal person, who never even spent more than 8k on a car, car being my biggest expense ever). There were funds who would lend me the money, but wanted 50%+ of the proceeds, and if the company goes under you're still on the hook for a taxable event when the loan is forgiven.

Luckily AMT for ISO exercise can be slowly (very slowly) recouped in future tax years (and the new tax law made it a bit easier by increasing the deduction and the phaseout limits), but I still had to waste so much of my after tax money just to leave with what I matured over the years. And that money is now sitting in the government pockets for years, producing me no interest and losing value with inflation until I recoup all of it.

Fortunately, a year after I bought those shares one of the investors contacted me and bought some of my equity, so I was able to recoup all what I originally put in (and then some). But it's simply insane, and I am still in the hole for all that AMT that I will recoup in ~10 years, no less.

Other coworkers who left and didn't have the money to come up with the exercise and tax liability, simply lost them, justifying to themselves "well, they're probably not going to be worth anything anyway" (which could be totally true even after paying thousands to exercise them!).

It's a plain insult to startup employees. I wish all startup employees would rebel against this and refused to accept any startup offer unless there was early exercise paid by the company upon joining, or option expiration window of 10+ years.

I, for one, know that will never __ever__ join another startup again for this reason.

I'm very sorry that happened to you. 90 day exercise windows remain a huge issue in the industry, and one we've been fighting to fix for years now.

Fortunately, the fix is very simple: companies should just offer 10 year exercise windows. That prevents this scenario from happening to employees. We've written about this a bunch of times: https://dangelo.quora.com/10-Year-Exercise-Periods-Make-Sens... https://blog.samaltman.com/employee-equity https://triplebyte.com/blog/fixing-the-inequity-of-startup-e...

We hope that 10 year exercise windows will become the industry standard so that no one needs to worry about this anymore. Unfortunately, that hasn't happened yet. In the meantime, you can see a list of companies that have committed to them here: https://github.com/holman/extended-exercise-windows.

This sucks. Sorry to hear they did that to you and I’m glad you made out ahead of the game.

A company I worked with had the opposite approach — they not only allowed for early exercise, they allowed for immediate exercise of all unvested shares with an 83(b) election (and converted the vesting schedule into a clawback schedule). AND they offered a bonus for the amount of the exercise price.

So in effect, if you had $100k in stock vesting over 4 years, the company would bonus you $100k, you’d then exercise, file an 83(b) election, and you owned Common with a clawback provision.

You of course were liable for the income tax on the $100k, the company was liable for the employer portion of same, and when/if the shares were sold you’d be liable for capital gains accordingly, but overall this seemed like an eminently fair offer to employees and cost the company only the employer portion of the income tax on the bonus.

Everyone loved it and employees felt respected and treated fairly. Why don’t more companies do this?

What a great step in the right direction!

The $40k+ you could owe in taxes is still a problem. Perhaps the company could give you an open-ended loan of the $100k (that you paid back if you returned the stock, or after a good exit).

Agreed, but: I think that might cross the line into what a loan actually is vs. what income actually is (or at least the IRS might have something to say about it).

I know the $40k in taxes sucks, but if you step back and think about it, it's actually quite "fair" (ignoring fundamental arguments about whether taxes are fair heh ;).

You are receiving $100k in stock options/stock. That will grow over time. I think it's fair to be taxed on that stock as income (since it is income! you're being given an asset) and then, later, be taxed on the gain of of that asset (if there is a gain). If you leave the company, they'll have the option to buy back any clawed-back stock, so you could even end up ahead (let's say you vest 50% then leave, so company pays you $50k for the unvested/clawed-back stock -- then you're actually ahead of the game by $10k net of taxes).

Well, this was just very refreshing to hear, and I'm happy it is the complete opposite of my personal experience when dealing with startups.

Don't trust founders who don't let their employees early exercise.

On the other hand, my options are underwater due to a down round. Some incentive, right?

it is, of course, complete BS that this is the norm.

however, be aware that you can negotiate for early exercise or 10 year expiration prior to joining. even if the startup has never done anything like that prior, they will make it happen if they really want to hire you.

I have a deep network of friends in Silicon Valley who jump from startup to startup, and I tried to educate them when it comes to this topic, telling them to absolutely make sure the equity conditions were reasonable. None of them has ever managed to change those on an offer, it always comes back as "It's the standard contract!", and they are in general strong performers.

In my experience, unless you are really an insanely high quality and senior hire, for a standard software engineer they're not going to do anything like that, since they have other candidates at the door who won't mention the equity pieces, you can't fight the system too easily.

I've personally been in an interview feedback loop, back when I was at a startup, where one of the founders (who was an interviewer) said: "This guy is technically really good, but asked too much about the details of the equity compensation, I think he might not be focused enough on our mission, let's pass".

perhaps im extrapolating too much based on my own two data points. im just a normal senior eng, but have been able to get my last two offers modified (once with early exercise, once with 10 year expiration).

The alternative to making sure the equity conditions are reasonable is to value them at $0 when deciding whether the compensation package is good enough to get you to join.

But how does that solve the problem I had, exactly? If you later find out that your equity is on paper worth a lot of money, and you want to pursue other opportunities, do you just leave the potential money behind because of an assumption you made several years before which turned out to be statistically much more unlikely than the current expected outcome?

When your startup is at series E and your options on paper are valued 7 figures and all the investment rounds were raised with clean terms (see linked post), I find it debatable to still hold on to the assumption that they should be valued at $0, like they were at Seed/Series A when you joined, and so be willing to walk away from them rather than dealing with painful vesting/exercising conditions that were initially set in your contact, no?

When you play the lottery, you expect $0 back, but you also expect that in the rare case you win you won't have to pay taxes on your win years before being able to get the prize, otherwise you just wouldn't play at all.

thank you for raising this point.

I agree it would be beneficial if the "Standard and Clean Series A Term Sheet" was employee-friendly as well.

We're closing our seed round this week - this is such a good reference, especially because I have a technical background.

Is anybody able to shed some light on the key differences between a seed term sheet and this Series A term sheet?

Does anyone have a link to a great intro on VC for dummies? I keep seeing these kind of posts but not the big picture in blog form. Maybe a thousand words or two, not too detailed.

Very useful, thanks! Is access to financial statements implied? what about requiring audited financials? or is that not common/expense at that stage?

Those are diligence items that aren't typically defined in a term sheet. You'll deal with that directly with the investor, potentially as a condition to close as worked out in the full docs.

Annual and quarterly unaudited is normally implied. Sometimes monthly too. Most good Series A investors understand that audited financials don't make sense this early and their lawyers will draft something like the audit requirement can be waived by the investor in any year, or that audits won't be required until 2-3 years out.

are there any good book with lots of examples of term sheet/valuation math for startups?

Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, Brad Feld.

great, i’ll get the book. thanks!

Founders should invest time and effort to ask for more board seats. The YC doc is a good start but if you follow this to the letter you may lose control in your B or C when the B and C investor also want board seats. Also it’s important to keep in mind that there is no “standard.” Everything is always negotiable.

Can someone please explain each clause in layman’s terms. Thanks.

Trying to learn the lingo of VC.

For real estate, your state’s realtor organization will have standard purchase forms available with a quick google search. With these, a title insurance company, and home inspector, you can easily do a private party real estate deal where everybody has reasonable insurance.

I'm a software guy. Most of that sheet is a foreign language to me.

Are you starting a (venture-scale) company? Learning this language is critical.

Are you working for a startup? Becoming more familiar with this language is helpful - you can figure out whether the founders/executives know what they're doing or not.

Are you working for a large company? Learning this language will not provide much benefit for you IMO.

If the answer to either of the first two questions is yes, where would I go to learn the jargon? (I do know about google, I'm just hoping there's a good resource that has everything so I don't need to search individual terms).

This book is pretty good and reasonably up to date: https://www.amazon.com/Entrepreneurs-Guide-Business-Law-4th/...

We used an older edition as a textbook in a Venture Capital seminar back when I was in law school.

Thank you!

Venture Deals by Jason Mendelson and Brad Feld is a good overview. If you want to get more technical, the NVCA publishes a list of their own "standard" documents, which go into depth on some of the standard and non-standard provisions and what they mean, but it's not quite as user friendly.

Thanks, I'll take a look.

Is there any similar resource and guidance for seed/angel, thanks

I thought the original SAFE was on casetext.com. Too bad this wasn't loaded there as well.

How enforceable is that "No Shop" clause that is said to be binding in the document?

I'm going to answer this question a little differently, because enforceability can also depend on facts and circumstances. Think of the binding / non-binding distinction as more of a social commitment signal. The No Shop means that once the company and investor both sign, they're pledging to work together to figure out this deal along these high level terms for the next 30 days. They've made a commitment to each other. Venture is a relatively small community and going back on your word gets around. Social consequences can be just as bad as legal ones.

Well yes... It is a promise.

Your reply suggests that it's not binding ('legally' binding, obviously).

It can be legally binding.

Ok... So how would you enforce it? It does not seem to form a contract.

I realise that this is mostly US law and that my limited knowledge relates to British law. So with that in mind, my understanding is that a simple promise is basically not legally enforceable.

It can be enforced with a lawsuit like this, when an investor doesn't care as much about their reputation with founders: https://www.bloomberg.com/news/articles/2018-04-25/crypto-bi...

I'm sorry but that does not answer my question at all.

It's quite obvious that a legal dispute may be settled in court. We do not know the details of the case you quoted so it's difficult to comment.

I'm asking specifically about the template that is posted here because it looks like a simple promise and, as mentioned, these have no value in many jurisdictions. I suppose I'm asking how it works in Delaware, basically.

I suspect that the first reply I got is actually it...

> In many jurisdictions of the United States, promissory estoppel is an alternative to consideration as a basis for enforcing a promise. It is also sometimes called detrimental reliance.

Wiki: https://en.wikipedia.org/wiki/Estoppel#Promissory_estoppel_2

PDF: https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?refe...

Yes I know estoppel.

But in this case?

Question: do investors usually vest at the same rate as founders, or at all?

E.g. if they put in 1M for 25%, do they legally receive the 25% of shares right away?

What's typical here? In terms of investor vesting relative to the founders.

Investors don't vest and (to a first approximation) can't be fired. (They can constructively "quit", by refusing to answer your emails, but they keep all their equity and you keep all their money.)

The question of whether they "legally receive the shares right away" can be a bit more nuanced, particularly in e.g. a transaction for a SAFE or convertible note.

Founders vest, VCs dont.

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