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A founder-friendly term sheet (samaltman.com)
366 points by sama 1634 days ago | hide | past | web | favorite | 89 comments



Very simple. Very clean. Kudos for having the right spirit of honesty and transparency. VCs have lately taken to bearing their own attorneys' fees on occasion but I have rarely seen a significant VC deal in which the option pool is not brought in as a back-door way of lowering valuation for the founders. Removing that bit of legerdemain from the valuation equation is really quite stunning.

Of course, the question is whether this will catch on and stick, even during bad times. When markets are sunny for investors, it is not too hard to bend for the founder concerns. When things are tight, though, the pattern has always been one of merciless slaughter of the founder interest, as evidenced by any down round within memory. So too, in bad times such as the dot-bust period, atrocities like participating preferred and multiple-x liquidation preferences frequently reared their heads and would, I think do so again in any new time of debacle. While individual investors such as Mr. Altman may refrain from this sort of thing, I wonder whether such moderation would ever become the norm. I would tend to doubt it.

I also think that even this particular term sheet, though undoubtedly fair to founders in its overall sweep, would need to be adapted to avoid unfairness as it is applied to various cases. If a founder has built large value by the time of Series A, it is very non-standard to require that founder to put the entirety of his stake at risk of forfeiture all over again as a condition to getting funded. That, I assume, would be an obvious point of negotiation and one on which any investor would very likely yield when pressed.

These are mere quibbles, though. It is really the spirit of the thing that counts and not the legalese as such. Just as the best contract in the world will not really protect you if you happen to be dealing with a scoundrel, so too the flimsiest of contracts will likely not cause you too much trouble if you are dealing with someone of honesty and integrity. This term sheet reflects the right values that an investor should bring to a deal and, if you get that as a founder, you are 99% of the way there as long as your business interests can match. In the end, that is what counts most of all.


> the pattern has always been one of merciless slaughter of the founder interest, as evidenced by any down round within memory.

It would be interesting to see the stats for investor payoff when that dilution is included. The few cases I know: Anytime the founders were singled out for big dilution the result was sizeable loss for investors (and everyone else, because the companies eventually got sold for parts.)


The no option pool part is great. Taking the option pool out of the pre money creates horrible incentives: founders are incentivized to tell investors they only need a tiny option pool and then once they've exhausted it come back to the board later to ask for a larger pool (that will now dilute everyone).

Founders and Investors should be incentivized to work together for the benefit of the company, not work against each other to the benefit of themselves.

tl:dr; Sam is right, and I hope this becomes standard practice.


I'm an employee with options, and I'm trying to understand how all of this works. Can you please tell me if I have this correct:

1. During initial funding ("pre money") talks the founder is incentivized to ask for a small option pool because she doesn't want to divert a lot of her stock into the option pool

2. After the option pool has been exhausted through new hires the founder then asks the board for a larger pool, which is now created from the combined stock of the founders and the investors - thus the founder is diluted less than if the expanded pool had been created at the start.


That's it!

Keep in mind that not all founders are this savvy when it comes to deal terms, and most investors will push founders to issue a larger option pool than needed. The investor will say something like "we want to be sure we have enough options available to recruit the best employees" or "we don't want to have to issue more options later because it would be a distraction". Both of these arguments have a kernel of truth in them, but they're not very good. You can always issue more options later and it's quite simple. What they're actually saying is, "I don't want you to come back and dilute me later when you could dilute yourself now instead". How thoughtful!

In a perfect world, this would have no effect on you. In the real world, it sometimes causes people to create option pools that are too big/small, since it's a confusing topic and it can be really hard to predict exactly what you need in advance! How people then act in those situations differs massively, but only affects things on the margin (e.g. perhaps the founder will issue a slightly more generous equity package to a new employee because "I have this whole option pool to spend").

tl:dr; this should have very little effect on you as an employee, but if your company's option pool came out of the pre, then the founders probably wasted valuable time and energy figuring this out with an investor who shouldn't have asked to structure it this way in the first place. Unfortunately, like many terms in financing (see the rest of Sam's post), this is too often the case. Fortunately, it will have little impact on the company or your experience, so don't worry about it :)


My company is fairly open about our financial state and investment situation so I'm trying to learn as much as I can while I have the opportunity. Understanding things like this helps me to ask the right questions, so I appreciate you and earbitscom taking the time to respond.


That is correct. If they make the pool pre-money, only the people who had stock pre-money get diluted. If they do it post-money, or even do part of it post-money, the investors share in the dilution.


All founders equity shall be subject to a repurchase right which also reflects a standard 4 year vesting schedule.

If we were taking outside money tomorrow, this would be a point of contention. I understand the idea behind a vesting schedule for founders (the investors don't want you to walk away two days after they invest), and I might grudgingly agree to something like that. But no way would I ever agree to make 100% of my founder equity subject to vesting or repurchase. The bottom line is, I've spend 2+ years working on this company, and without the work I (and the other co-founders) have put in, there is no company, no valuation, no nothing. I'm not going to put all of that equity at risk just to make an investor feel good. If we're all supposed to "be in this together" and have aligned interests, they would have to accept that we've already earned the right to a significant portion of the company.


If the founders have been working on the company for awhile I'll usually agree to a shorter vesting schedule. That said, one of my favorite things in the world is when a founder proposes 6-year vesting for a company they've already been working on for awhile to set the right standard for everyone else.


I didn't realize anybody did 6 year vesting! It's weird, though... I get what you're saying about setting the standard and keeping things consistent, but founders are a bit of a special case, in that - in at least some cases - they've already put in a big chunk of their time.

I guess what would make sense, to my mind, would be a standard N year vesting (where N is 3, 4, 6, whatever) but give the founders credit for "time served" so to speak.

In any case, thanks for sharing this, and for promoting the "founder friendly" approach. It seems right to me, since you want the founders to be taken care of, so they remain motivated to work as hard as they can on building the best possible company. I feel like it's short-sighted of investors to try to squeeze the founders too hard. Worst case, you wind up with founders who have no real incentive to bust their ass building the company!


One way to hit the sweet spot is to figure out how much the founders have put in in 'sweat', their time at market rate and have that chunk of the stock be free from any vesting clauses.


I agree that a chunk free from vesting makes sense, but translating sweat to dollars is contentious. For a couple reasons I can think of:

1) Why should the investor retroactively pay your made-up salary for the privilege of investing? Valuation has something to do with the assets or future assets of the company; a salary is a liability.

2) How much is that sweat equity really worth if the company turns into the next salesforce/facebook/etc? Many millions upon millions. Any typical estimate ("let's call my salary $100k over the last 2 years....") is going to fall so short that it's useless.


For #1: investing in the company I founded is definitely a privilege. The investor obviously thinks that my company would provide a better return than investing elsewhere. High rates of return are not easy to find, hence it's a privilege to invest in the company I founded, in the vision I am creating.

Disclaimer: I am not actually founding a company, nor have I in the past, nor am I likely to build a company that requires VC investment, but this is what my attitude would be if I were.


> The investor obviously thinks that my company would provide a better return than investing elsewhere.

And you obviously think taking the VC's money is more valuable than taking a bank loan/cash advance/going with another VC. Both sides have something to gain. Only thing is, if you're looking for VC money you need the money. The VC doesn't need to invest in you.


Wouldn't you need a valuation to achieve that? Most seed rounds are convertible debt.


AngelList does 6 year vesting with its own employees. I convinced a startup I work with to do 6 year vesting, including my adviser shares (though I had some vest upfront for all the work I put in).

More startups should do this, including with adviser shares.


In the (hopefully) unlikely case one founder has to be fired by the others, this keeps incentives properly aligned.

Few things are as demoralizing as needing to fire a co-founder in the first place, but if they keep the same equity stake as the founders who remain it's worlds worse.


Sure, and that's why I can see putting a portion of the founder equity under a clause like this. But if the founder has, for example, 2 or 3 years already served building the company when the investment occurs, they have already earned some portion of their equity and it should be considered vested immediately.


Resetting vesting is a negotiated point, but when the team starts, it should be under 100% 4 year vested terms.


Though not unheard of, I found this the least founder-friendly part too. It'd be more founder-friendly to do 50% vesting over 4 years. This is especially true if the founder has already put in 1-2 years work, which would be a good and common practice before raising an A round.


On the other hand, we had no vesting schedule, so very founder friendly, but one of our founders left after 3 months by mutual decision. We spent the next 3 years trying to get him out of the company and ended up having to spend a decent amount of cash to buy him out altogether (not to mention the legal fees we had to pay to do so.) It can definitely go both ways.


FWIW, the way its usually handled when the founders have spent a lot of time previously on it is in one of two ways: a) agree to some vesting up front, and the remaining to vest over standard 4/1 terms b) agree to some acceleration (ie, you are given 1 year of acceleration, so its a 3 year rather than 4 year sched) or c) a combination of both. In the end, its a negotiated solution.


I would never join (as a founder) a team that did not have 100% vesting. People quit, unpredictably. Vesting protects founders.


I would never join (as a founder) a team that did not have 100% vesting. People quit, unpredictably. Vesting protects founders.

I'm fine with the basic idea of vesting, and you're right, it does protect the founders (from each other) to some extent. What I have an issue with, is a scenario where you work, as a founder for, say, 3 years, and then take outside investment money, and the investor demands 100% of your founder equity be subject to vesting and/or a "zero price" buyback clause. I would never, ever take that deal. A lot of things can happen, and there is value which has already been created by the 3 years that was put in.. as a founder, I'd expect to retain some percentage of my equity based on that. The exact details would, of course, have to be negotiated.


A lot of things can happen, and there is value which has already been created by the 3 years that was put in..

Indeed. I'm surprised to see so many people here think that a 100% lock-in is reasonable. That effectively sets a zero value on the work done to date, while at the same time presuming that a company is established enough to be worth serious investment, which is paradoxical.

I don't see how this really protects founders to a useful degree either, at least not for very long. While some degree of vesting creates an incentive for everyone to stay on board and do their best to make the project a success for everyone, it doesn't need 100% of the money involved to do that. Even if it did, there wouldn't be 100% lock-in after presumably no more than a year, and then you're back to having a significant chunk of equity that isn't locked in anyway. So again, the argument that a 100% initial lock-in and 4 year vesting period are both necessary seems to contradict the idea that you start releasing a significant fraction of the locked equity after only one year.


100% 4 year vesting is a day-1 requirement, but how much of vesting resets on a new round is obviously a negotiated point.


Where's the cliff in your setup?


One clause that's gone uncommented:

    Transfer Restrictions:
    Bylaws and option plan documents shall include limitations on
    certain transfers, including on secondary markets, to
    competitors, or that may trigger public reporting obligations.
In order for investors, founders, and employees to cash out on their stock holdings, companies need to have an exit. An exit can be an acquisition by an already-public company, or an IPO (taking the company public).

In the first Dot Com bubble, companies would IPO before reaching profitability and sometimes even before reaching significant revenue. For a number of reasons (scrutiny from Wall Street, public reporting obligations, Sarbanes-Oxley), companies that intend to go public increasingly choose to delay their IPOs.

In 2004, Google went public with 2003 revenues of $960m and profits of $105m. In 2012, Facebook went public with 2011 revenues of $3700m and profits of $1000m.

One way shareholders managed their longer time-until-IPO horizons is by selling their stock on the secondary market. Many startups (SecondMarket, SharesPost, etc) were set up to help shareholders of successful companies like Facebook and Twitter sell their private company stock to qualified investors.

The transfer restriction quoted above means shareholders can't transfer (sell) their stock until IPO or unless they have the consent of the board.

Investors tend to have long-term horizons and may not care about getting locked up in an investment until IPO. In any case, investors are well represented on boards. Founders have leverage with the board and can negotiate partial cash-outs (selling some of their common stock to investors), but in any case own their shares outright and can hold on to them until IPO.

Employees with incentive stock options, however, can get screwed. Options are not stock and (even after having vested!) will expire if the employee quits or gets fired. If the company is doing well, the Fair Market Value (FMV) of the stock may be much higher than the employee's exercise price, which means exercising the options will incur a large Alternative Minimum Tax (AMT) penalty. This means an employee might have very valuable, vested stock options but no way to keep them upon leaving the company because exercising can put them in a tricky cash flow situation where the IRS expects them to pay taxes on unrealized (and unrealizable, because of transfer restrictions) capital gains.

This term sheet is generally founder-friendly, but the transfer restriction is certainly not employee-friendly.


This is intentional. I believe that secondary markets are usually bad, and always distracting. I'm not opposed to pre-exit liquidity, but a secondary market that the company does not oversee causes huge issues. Most companies now prevent this.

Your point about ISOs expiring is reasonable--I think a lot of companies are using RSUs partly for this reason.


I understand it's intentional. What your original post made me realize is that transfer restrictions have become standard terms. More people should understand what that means.

Secondary markets have issues, but so do secondary offerings overseen by the company. There can be pretty big principal-agent problems, both around price and around timing.

I'm less familiar with the traps and pitfalls of RSUs, but in general they seem fairer than ISOs. I hope they're used more widely.


It benefits no one to have employees sitting around vesting because they can't pay their taxes to leave, hence RSUs have become more popular.

I'm more interested in the emergence of derivatives markets against RSUs. It's started already, and I wonder if companies are going to attempt to put that cat back in the bag, or just ignore it as it largely doesn't affect them.


Could you expand on be "huge issues" caused by secondary sales? I'm having trouble thinking of any. The most common criticism I've heard is that secondary sales can make it difficult for the company to maintain a fiction about their common share price, but that amounts to a tax dodge anyway. Love to hear some concrete thoughts on the matter.


A good example would be 409A valuations[1], which set the price at which options can be granted. Sale of employee stock on a secondary market can dramatically raise the price at which the company has to grant future options, making it harder to hire, and hurting future employees.

While this might be ok in open markets with real competition, it's possible (and in fact common) for common stock in trending companies to be overvalued on secondary markets.

[1] http://en.wikipedia.org/wiki/Internal_Revenue_Code_section_4...


I can't speak for Sam, but two other issues in addition to tax and valuation are explicitly mentioned in the term sheet:

(1) Public reporting: Once the market for secondary sales gets to a certain point, the company is essentially public. As such, it has to register with the SEC and publicly disclose a whole bunch of information it'd rather not. This used to be triggered by having over 500 shareholders, although I believe the number has recently changed.

(2) Competitors: Stockholders have certain statutory information rights. Although you can limit those rights contractually, as a general matter, you don't want your competitors owning shares.


But RSUs are taxed at grant, aren't they?

While there's no tax surprise later on, a company like Facebook can't offer a new employee "an RSU now worth $400K" vesting over 4 years, without triggering over $100K in taxes that second.

Or am I misunderstanding how RSUs are taxed?


I don't understand how employees can get screwed with ISOs from a tax liability stand point. ISOs are not taxable until a capital gain is realized i.e. exercise and sale. Are you referring to non-qualified stock options?


"There is a catch with Incentive Stock Options, however: you do have to report that bargain element as taxable compensation for Alternative Minimum Tax (AMT) purposes in the year you exercise the options (unless you sell the stock in the same year). We'll explain more about the AMT later."

http://turbotax.intuit.com/tax-tools/tax-tips/Investments-an...


What is the level of acceptance for (a) post-money option pools and (b) investors paying their legal fees amongst firms versus enlightened angels? I know Spark Capital publicly adopted (b).

If I asked for these terms from a firm today, would I get laughed out of the door? (Not that that should stop one from asking).


Great. We agree to these terms. Thanks, Sam. Welcome to Team Earbits.


Three pages in total, and all in fairly plain english. The simplicity of this term sheet speaks volumes of the confidence the investor has in their investments. I wonder if there is a correlation between the complexity of an early stage investor's term sheet and their over all success?


On the "pay investors legal fee's", I was recently very shocked of how many things investors want their Portfolio companies to pay for them.

For instance, if investor is required to travel for Board Meetings they will require company to pay for it. Also some investors will make companies do regular financial audits with a firm of their choosing and force the company to again pay for it.

My biggest questions is, were does the 2% annual fee that investors charge their LP's go? I know some firms have on-site staff to help their companies with recruiting, PR etc, but most don't.


It is customary for companies to pay the travel expenses of all of their board members. That's not out of the ordinary.


Neither is paying their legal fees out of the ordinary. Doesn't necessarily make it right. I don't think there's any good reason a company should pay board members travel expenses.


Board member travel expenses makes sense because you are extracting value of their interactions (assuming they are working as they are supposed to), since they are part of your board.

Legal fees for investor related actions don't benefit the company at all unless they happen before the checks are signed.


This is an odd kind of adversarial stance to take with your Board. Not all of your board members are necessarily VC's either. You might have a solid advisor on your board.


Not to mention that your most solid advisor could be one of your VC's too ;)


If everyone is up-front about the legal fees, what does it matter?

The legal fees are paid after receiving the investment. If you negotiate for a pre-money valuation, and the terms require you to pay the legal fees, you simply take it out of the valuation.

The VCs can offer slightly more money and have the company pay the legal fees, or offer slightly less and the VC can pay the legal fees. There is no difference between these two things.


"The legal fees are paid after receiving the investment"

May be the case, but unless you can negotiate a deal with your law firm that the fees are contingent on closing, if the deal falls apart you've still got the legal fees to pay, and no investment cash to pay them with.


That's only true for your own legal fees. If the deal falls apart, you don't have to pay the VC's legal fees.


Massive salaries of GPs and associates.


That's pretty good stuff.

I'd suggest adding an acceleration clause removing the repurchase right upon founder termination by the company if that hasn't been dealt with elsewhere. Four years is a long time.


> Four years is a long time.

Perhaps that's exactly why it's there. If you can't commit for four years, should you really be founding that specific company? Maybe a different idea, or a different team that you are willing to commit 4+ years to would be a better choice.


>No option pool. Taking the option pool out of the pre-money valuation (ie, diluting only founders and not investors for future hires) is just a way to artificially manipulate valuation. New hires benefit everyone and should dilute everyone.

This is my favorite part. For example if you have an early exits and don't use the pool the founder still is diluted for shares never optioned.


A side benefit of removing the pool is simplifying the math. A common way for investors and lawyers to model the fixed option pool is to use an Excel spreadsheet with circular references, which results in unstable numbers and all sorts of confusion later.

Or to frame it more generally, complexity increases transaction costs.


It's more complicated than that. Complexity is almost always more risky for the founders than the investors because of information asymmetry. Because the investors do a lot of deals, they understand all of the implications and side effects of each term. The founders, even with good advisers and attorneys will likely have trouble understanding the implications of complex terms. This is a classic wall street scam where the bank presents complex terms in the guise of sophisticated banking but it's really just a sneaky way to screw the customer. It's always good to reduce the complexity in agreements because valuing options is very difficult without experience.


If you don't understand the complexities of an option pool (either pre or post money) you are dumb and have no business starting a company.


don't need to do that all - its actually basically a very simple model without the circular reference.


> A common way for investors and lawyers to model the > fixed option pool is to use an Excel spreadsheet with > circular references

Huh? That makes no sense.


Here's how the model often works (not saying it's a good idea, but pretty common): Pool increase => total number of shares => price per share (because the valuation is fixed) => number of shares investor is getting => pool increase necessary to maintain a fixed percentage.


None of that should result in circular references on a spreadsheet.

Incidentally, this SS makes it clear that you are negotiating over essentially 3 numbers (as price per share doesn't matter) in a first investment. And those #s don't change with whether the option pool is created pre or post investment, that just changes how you talk about them a bit.

EDIT: See, like this https://docs.google.com/spreadsheet/ccc?key=0AjHAG0M-0vxXdGt...


I don't quite understand your spreadsheet. Founder shares are usually purchased well before the investment, but here you're calculating them as a function of the total number of shares. Because the number of founder shares is already established, price per share absolutely matters.

EDIT: That is, price per share isn't an independent variable (it can be calculated as a function of the other variables) -- but it can't be arbitrarily set.


There are two scenarios:

1) The founders haven't been working especially long on the company and haven't incorporated (maybe they have an LLC, but not a C Corp). In this case it actually is pretty common for the # of founder shares to be set at the time of investment. Founders pay far less (really just a token amount like $.01) than investors. In this case the price per share is independent (and kind of meaningless. Do you want 3.5M shares worth $1 each, or 35M shares worth $.10 each. Though there are psychological norms people tend to stick to).

2) The founders have been working on the company for a while and incorporated well before taking investment. This is the scenario you describe. I added a 2nd sheet ("scenario 2") to cover this case.

As you can see it also contains no circular references.

As you said price per share is no longer arbitrary here as it's fixed by the # of founder shares created pre-funding. Sometimes you might do a split (or reverse split) here to adjust the price per share to the same psychological norms as above.


OK, what does this mean exactly - "All founders equityshall be subject to a repurchase right"? Sorry if this is supposed to be obvious, but this is the first term-sheet I've encountered.


This doesn't address your particular question, but I like to recommend Eric Koester's guides to term sheet newbies:

http://www.avvo.com/attorneys/20007-dc-eric-koester-1214516/...

There are several pages of articles & you might have to read and re-read a few times. It's dense, but clear.


It functions the same way as options vesting for employees.

Founders usually purchase all their shares up front, so this term says that the company can buy a percentage back if they leave before 4 years.


I've seen that used as a club against people.

A: "I want to sell to a third party."

Company: "We have a repurchase right."

A: "Well, I'm selling for $10 a share."

Company: "We don't think that's the right price."

A: "What do you think is the right price?"

Company: "We would need to hire an auditor to determine that, and you would have to pay for him."


A repurchase right is a right of first refusal at a given price, if you can get a better price then you should normally be free to do so.

Auditors for independent valuation should only come in to play when there is no price, for instance, when a block of shares is offered to existing shareholders or the company and they can't agree on a valuation.

Drag along / tag along clauses definitely can complicate this.


A repurchase right can mean different things - you'd need to go to the specific language to really determine what it means.

In the case of Sam Altman's founder-friendly term sheet, what you're describing is covered by the 'ROFR/Co-Sale Agreement' section.

The repurchase right here refers to what happens if a founder leaves before their four-year vesting schedule is up - the company has the right to repurchase their unvested stock, almost certainly (although his term sheet doesn't specify) at the original near-zero issue price.

Since founders typically own 100% of their stock for tax purposes (hold it for a year, only have to pay long-term instead of short-term capital gains), the only way companies can subject founders to a vesting schedule is to have the option of buying the unvested portion back.


It all depends on who causes the leave, if the founder causes the leave I have no problem with such a repurchase right, but if the company causes the founder to leave (and this does happen) then the company should lose their repurchase right. Subtle stuff this.


Sure, absolutely.

The standard mechanism for this is accelerated vesting - I think Nivi wrote the definitive bit on it, here:

http://venturehacks.com/articles/acceleration-termination


If i correctly understood the stock options seminar i recently had to go through, it means two things:

1) if you want to sell your stock to someone else before IPO, the company has to approve the sale. If they don't like who you're selling to (which could just be because they don't want voting shares belonging to outside people), they can choose to buy it back instead. If they don't like your price (too low or too high), then you and the company have to negotiate a 'fair' price.

2) The company has the option, but is not required, to buy back any unvested shares that you have already exercised if you leave.


Sam,

Thank you very much for sharing this. Two questions:

1) Without an option pool, how do you prevent founders from issuing more options to themselves?

2) On the other side, do the Participation rights include the right to purchase into the option pool when it is created? i.e. is creating the option pool a "offering of new securities".


I'm not Sam, but I have some insight;

1) The Board has to approve all new shares, so founders would have to go to a vote in order to give themselves a new chunk.

2) There won't be an option pool created. The participation clause is in relation to new rounds of funding. As new money comes on board, new shares will be added and the pro-rata participation means that Sam will be able to invest alongside the new round to maintain his percentage of ownership.


1) work with founders you trust? or, when there is a board, it'd have to be board-approved. 2) options pools are carved out of this.


Love this. Would consider myself super lucky to have someone as founder-friendly as Sam as an investor.


The liquidation preference reads like a 1x participating preferred statement: "We have the RIGHT to get back our capital AND then everything is split pro rata."

Shouldn't liquidation preference clauses read more like: "We have the OPTION to get back our capital OR ELSE everything is split pro rata."?

Also... can you explain the dividend clause? I understand the preference (preferred dividends get paid first), but what is the significance of 8% (8% of what)?


The liquidation is pro-rata for the common shareholders. So once Preferred gets paid, the common splits the remaining pro-rata. With the actual docs (Shareholders rights agreement that goes with the purchase, it would be clear).

8% of the amount invested. This is a standard term to allow investors to get paid if the company is in business a long time is cash flow positive, but not likely to have a liquidation event. VC funds typically have a 10 year life and need are way to return money to their LPs.


No, after the liquidation preference, everything is split among common holders.


To be clear for those who aren't following the salient detail here - the preferred stock does not convert to common if the liquidation preference is exercised. The investor gets up to their money back (1x preference), and no more.

If they choose to participate pro-rated they convert to common first, and participate equally with everyone, without the preference.

The investor would chose to convert to common when the sale price is greater than the post-money valuation of the deal. On this basis their pro-rated participation will be greater than the amount invested.

If the sale price is less than the post-money valuation of the deal, they would be sensible to keep their preferred stock, and exercise their 1x preference, meaning they get their original amount back 100 cents on the dollar. The remaining is then split between the common shareholders proportionally (in effect without the dilution from the investor that exercised their preference).

Mark Suster (@msuster) from GRP put together a good spreadsheet [1] that shows the preference effect on sale, including preferred non-participating stock and preferred-participating (PP) stock (essentially double dipping into sale proceeds).

Brad Feld (@bfeld) from Foundry Group has a good write up of the different types of participation on his blog [2].

[1]: http://www.docstoc.com/docs/47831420/Venture-Capital-Valuati... [2]: http://www.feld.com/wp/archives/2005/01/term-sheet-liquidati...


> There is a 1x liquidation preference, but I’m willing to forgo even that and buy common shares (and sometimes do, although it has implications on the strike price for employee options so most founders don’t want it).

+1 for that - common shares mean non-founding employees have to pay through the nose if they want to exercise early.


Does anyone have a .docx-version I can customize (as my company was not Incorporated in Delaware... I tried brute, without success: https://dl.dropboxusercontent.com/u/20673425/misc/founder-fr...


I found this site: http://www.pdfonline.com/pdf-to-word-converter/, which got it the pdf into rtf format. Then I used Word to open the rtf and saved it to a docx (without any conversion/formatting issues alert)...

Then, for yall, I uploaded the docx in my public dropbox folder: https://dl.dropboxusercontent.com/u/20673425/sharing_dont_de...


This is truly excellent, I've had some such nasty stuff come up in term sheets and it just creates animosity straight away between founders and investors.

If I ever get the chance to invest back into another startup one day I wouldn't think twice to use a straight forward term sheet like this.


I understand its founder-friendly term sheet.But Is this fair enough term sheet for both founder and inverstor?.


> Option pool

I see the point that this is just a price negotiation. However, I don't understand why the form of presentation is so important to people. If you get a standard term sheet that says $2M investment at a $6M pre-money valuation and a 15% pool, it takes about 2 minutes to do the math to see this would be the same as a term sheet that said $2M on a $4.8M pre-money valuation, with the 15% pool coming in and diluting all parties after. The discussion on this thread seems to lean toward the idea that the latter term sheet is more founder friendly. I wouldn't see the latter term sheet as more founder-friendly, I would see them as equal.

Why do VCs continue to write term sheets the standard way? After all, if they thought entrepreneurs would really prefer the latter term sheet, it would obviously be in their interest to write it that way, and VCs are not dumb. I think they think that entrepreneurs prefer it the standard way, they like a cosmetically higher pre-money number, and I suspect they are generally right. I don't think on this matter they expect they are fooling the naive entrepreneur: this is pretty basic, and I doubt many would want to go into business with someone who couldn't grok this.

Now, diluting after but keeping the $6M pre-money... now that's founder friendly! Who doesn't like higher valuations! I suspect this is what a lot of people mean by founder friendly.

> Lawyers

As a founder I disliked this clause, I didn't understand why I had to pay the VCs legal bills. The major bummer on this is that VCs have less incentive to really grind down the amount if the company is paying, I agree with that.

But I have seen a lot of entrepreneurs grind on this particular term, and I think it's nuts to make this a point of principle.

VC's annual W-2 compensation is the management fee minus expenses. In the traditional customary structure of company pays, the deal expense comes out of the invested capital and doesn't impact annual compensation.

When you grind your VC on this point, you are saying this: listen you jerk, I am going to make you pay this out of your personal paycheck this year. And I'm going to make you go back to your partners and explain why, rather than customary deal terms, his partners have to eat their share of this bill personally.

Now, maybe it ought to be that way, I don't know -- I'm more with the other commenters that say what's the difference, just ask them to add $25K to the round size and scale up the pre-money accordingly and call it a day.

But running a business deciding what battles to fight or not.

As a founder, you can work valiantly to ensure that $25K of your $5M round comes directly out of the pocket of the guy who is going to be your partner in building the business for the next 5 years, instead of the family offices and endowments that are his investors, where it is customarily paid, but I think there are other points of negotiation you'd get more leverage out of pushing. Ask the VC to gross up the round size by the attorney's fees and use whatever leverage you have on more important points.

Incidentally, "company pays" can be a reasonable structure for angel investors as well as VCs: Say you have a $1M round with all angels, and for some reason your deal can't use one of the free open source docs out there. If there is a need for a lawyer (let's say you are raising from US investors but it's not an American company and they might reasonably want to understand any risks associated with this): if your lead investor is putting in $200K and then 16 other individuals are each putting in $50K, it's not reasonable for the lead to be out of pocket on the cost personally, and splitting the bill 17 ways makes no sense either, it would be much more sensible for the company to pay, and if need be the round be made slightly bigger. The same principle could apply to institutional rounds with multiple investors involved.


Hang on, if that's the rationale for it, aren't VCs essentially defrauding their own investors by forcing portfolio companies to pay what is really the VC's expense out of the money that's just been invested in them?


How is it fraud if it's a negotiated and agreed-upon term? IMHO, it's really just called 'being a dick'.


Fraud against the VC's own investors – they are spending money on lawyers for a deal, which is logically an expense of the deal, but accounting for it as a productive investment, for which they receive commission.


A three page term sheet? Wow.




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