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How To Read A Term Sheet

Venture Capital

If you’ve never seen a term sheet or before — or have for that matter — it can have a dizzying effect. There’s a lot of complex language and terms you’ve likely never seen before. To help ensure best practices and simplicity in your current and future rounds, use National Venture Capital Association’s sample term sheet or one that’s been modeled after it. Moreover, understanding the terms in the agreement, as well as having a very good lawyer, will help you get through it.

Here’s a quick, skimmable glossary of terms to understand. The glossary is built so you can follow along — each term is listed in the order it appears in the sample NVCA term sheet.

Investors: Those who are investing money into the business.

Amount Raised: Total amount raised to date.

Price Per Share: Price of each share.

Pre-Money Valuation: Value of the company before investment.

Capitalization: Company’s shares multiplied by share price.

Dividends: Distribution of company’s profits or reserves to its shareholders based on a percentage rate of the purchase price when declared by a predetermined group like the Board of Directors (typically not declared in early-stage companies until liquidation event).

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Liquidation preference: The order of funds returned to a particular class of stock ahead of other classes of stock in the event of a liquidation event, such as the sale of the business.

Voting rights: The grouping of stockholders, typically preferred stock as one group and common stock as another group, when it comes to a vote on core items as defined in the term sheet.

Protective Provisions: Veto rights that investors have on certain actions by the business.

Anti-Dilution Provisions: Protects an investor from dilution resulting from later issues of stock at a lower price than what the investor originally paid.

Mandatory Conversion: Conversion of preferred equity into common stock based on a public offering and/or consent of preferred stockholders.

Pay to Play: Requires preferred-stock holders to buy the firm’s new stock issues or else lose certain benefits like anti-dilution protection.

Redemption Rights: A feature of preferred stock that allows investors to require the company to repurchase their shares after a specified period of time.

Representations and Warranties: Provides guarantees and assurances about the state of the business between the company and investors.

Conditions to closing: Tasks that must be fulfilled before the deal agreement is closed.

Registration Rights: A restricted stock investor’s right to require a business to list the shares publicly so that the investor can sell them.

Demand Registration: Entitle an investor to force a company to register shares of common stock so the investor can sell them to the public.

Piggyback Registration: Allows a business’s shares to be sold in conjunction with a new public offering.

Lock-up: Restricting the sale or transfer of shares post-transaction.

Right to Participate Pro Rata in Future Rounds: An investor’s right to continue to participate in future rounds so they can maintain their percentage ownership.

Matters Requiring Investor Director Approval: Identifies critical business decisions that would require consent from the investor representative on the Board of Directors.

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Non-Competition and Non-Solicitation Agreements: Neither party is allowed to enter into or start a similar business.

Non-Disclosure and Developments Agreement: Agreement to not pass along confidential information to an external party about the business or its products or services.

Employee Stock Options: A security which gives the employee the right to purchase company stock at a set price for a fixed period of time.

Key Person Insurance: Life insurance on the key management team member(s), such as the CEO, that are critical to driving the value and success of the business.

Right of First Refusal/Right of Co-Sale (Take-Me-Along): Defines the right of an investor to buy or sell shares in the future prior to an offer going out to another party.

Board of Directors: Body of elected or appointed members who jointly oversee duties that are outlined in the company’s charter.

Drag Along: A right that enables a subset of shareholders to force all other shareholders to agree to the sale of the company.

Founders’ Stock: Shares of common stock that are issued to founders at the formation of a new business.

No Shop/Confidentiality: Requires business not to solicit any offer of an investment in the company by a party other than the venture capital investor for a certain period.

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