Over the years my partner Jason Mendelson and I have heard from numerous people that they’ve been exposed to our Venture Capital Term Sheet Series as reference material in a college course.  We are delighted by this and whenever we’ve been asked, we’ve always said (and will continue to always say) “with our blessing.”  However, we haven’t kept track of any of this over the year and have a few ideas for things we can do to update the material now that five years have passed.

So – I’m writing with a simple request.  If you’ve used, or encountered, our Term Sheet series in a college (undergraduate or graduate) course or any other teaching / seminar environment, can you leave a comment below with the information (school / program / year / professor) or email me the information?

For those of you concerned about nefarious plots on our part, I assure you that we are delighted this material is out there in the public and are happy to have it freely used and passed around for all eternity.  I promise we won’t send Jack Bauer your way.

Simeon Simeonov, the Founder & CEO of FastIgnite, has put together a nice Stock Option Vesting Calculator.  It works just fine for stock vesting as well. 

Sim is a dynamite entrepreneur who has also done a tour of duty as a VC so he knows the drill well.  In the email he sent me about it he said it was inspired to put it together after reading several of the posts in the Term Sheet Series that Jason Mendelson and I wrote several years ago.

Sim – next up – how about a simple liquidation preference and exit analysis calculator?

Suddenly the blogosphere is talking about the need for a standardized first round term sheet.  The latest iteration of this seems to have blossomed when TheFunded Founder Institute released a “Plain Preferred Term Sheet” (developed with WSGR).  According to the article in TechCrunch, the goal is to (a) protect founders and (b) reduce legal fees.  Kudos for yet another shot at this – between all the blog posts that have been written about this over the past few years, term sheets are no longer a mysterious thing to an entrepreneur.

However, let me suggest that the problem is not “the idea first round term sheet.”  We now have a bunch of these – the YCombinator one, the TechStars one, the NVCA model docs, and several from law firms (WSGR did the YCombinator one, Cooley did the TechStars one.)

I think the focus should be on standardizing the docs and having a handful of fill in the blank terms for a first round financing.  I’ve done my share of financings with a set of bullet points in email (I just proposed one today) and I’ve stated that the only things people should care about in the first round financing is (a) valuation and (b) the amount raised.  That said, there will always be a handful of other things to argue about in a first round investment – most notably vesting dynamics, change of control issues, and option pool size (which is really just valuation).  However, you should be able to do this off of a one page checklist that everyone understands.

But let’s get back to the real issue – standardizing the docs.  I read through the protective provisions in TheFunded Founder Institute (TFFI) term sheet and they are a version that leaves a few things out that are important to me.  I like a tighter version.

First is the TFFI version:

“So long as 25% of the aggregate number of Preferred shares issues in the financing are outstanding, consent of at least 50% of the then-outstanding Preferred will be required to (i) alter the certificate of incorporation if it would adversely alter the rights of the Preferred; (ii) change the authorized number of Preferred Stock; (iii) authorize or issue any senior or pari passu security; (iv) approve a merger, asset sale or other corporate reorganization or acquisition; (v) repurchase Common Stock, other than upon termination of a consultant, director or employee; (vi) declare or pay any dividend or distribution on the Preferred Stock or Common Stock; or (vii) liquidate or dissolve.”

Following is the standard we use in all of our financings:

“For so long as any shares of Series A Preferred remain outstanding, consent of the holders of at least a majority of the Series A Preferred shall be required for any action, whether directly or through any merger, recapitalization or similar event, that (i) alters or changes the rights, preferences or privileges of the Series A Preferred, (ii) increases or decreases the authorized number of shares of Common or Preferred Stock, (iii) creates (by reclassification or otherwise) any new class or series of shares having rights, preferences or privileges senior to or on a parity with the Series A Preferred, (iv) results in the redemption or repurchase of any shares of Common Stock (other than pursuant to equity incentive agreements with service providers giving the Company the right to repurchase shares upon the termination of services), (v) results in any merger, other corporate reorganization, sale of control, or any transaction in which all or substantially all of the assets of the Company are sold, (vi) amends or waives any provision of the Company’s Certificate of Incorporation or Bylaws, (vii) increases or decreases the authorized size of the Company’s Board of Directors, (viii) results in the payment or declaration of any dividend on any shares of Common Preferred Stock,  (ix) issues debt in excess of $100,000, (x) makes any voluntary petition for bankruptcy or assignment for the benefit of creditors, or (xi) enters into any exclusive license, lease, sale, distribution or other disposition of its products or intellectual property.”

Details, but important ones.  The protective provisions in the TFFI term sheet include the word “adversely” in section (i) – this is simply “lawsuit bait” if it ever comes to pass as an issue.  I also want a protective provision to disallow increases in Common Stock.  And – given the board size, I want a protective provision that doesn’t allow the board to be increased without my consent.  Finally, I want a protective provision against making an exclusive deal or license for the assets – this is another way of selling the company out from under the investor.

Now, I guess I’ll negotiate on these, but I can’t imagine why anyone would struggle with any of this.  Except for the lawyers.  Remember – we are still in the term sheet – just wait until the lawyers expand this into the actual financing documents.  I’m sure the WSGR lawyers might have a different point of view, as might my lawyers, or any other lawyer that looks at this.  Or, if the WSGR lawyer is on the other side of the deal (representing the VC) he might have an issue with the TFFI version.

Standardizing the deal documents would solve a huge part of this.  Also, if the lawyers acknowledged that they aren’t adding much value at this level (e.g. it’s a simple negotiation and a straightforward thing to document), you could get to a place where lawyers should be able to do this for a low fixed price (say, $10,000).  However, this has to be done at the legal level, or you don’t really solve the fundamental issue.  Sure – you theoretically can streamline the process by starting with a better “form” that has been “pre-negotiated” (e.g. take it or leave it), but until you standardize the legal stuff behind the deal, you are always going to have lawyers armed with word processors redlining things.

I’m not unhappy about the effort to simplify this – quite the opposite – I’m delighted even more people like TheFunded are getting in the mix.  However, I encourage everyone, especially the lawyers, to recognize the value in standardization of the underlying docs (with the appropriate “fill in the blank negotiated terms”).  I’m not sure how to get this to a standard point, but it’s got to be easier than figuring out if universal healthcare is possible and – if so – solving for it.

Fred Wilson has a nice post up titled The Ideal First Round Term Sheet.  In it he describes the process of closing a financing using a standard set of Series A terms from Gunderson that he agreed to as part of the term sheet.  In this case, the VC (Fred’s firm – Union Square Ventures) isn’t using a law firm.  Fred states:

“I’d like to see this practice become standard in our industry. We need to lower the time and cost of raising capital. We need to eliminate a lot of bad terms that have caused a lot of harm (tranched investments, mutiple liquidation preferences, super pro-ratas, etc, etc). We need to converge on a set of standard Series A terms that everyone uses.”

I couldn’t agree more.  Chris Dixon wrote a post titled Ideal First Round Funding Terms that Fred points to.  I agree with almost everything Chris says, and especially agree with his assertion that you should “only negotiate over 2 things – valuation and amount raised.”

When my partner Jason Mendelson and I wrote our Term Sheet series in 2005, we had a lot of people thank us for demystifying the term sheet.  Some time last year, both TechStars and Y Combinator open sourced their financing documents – TechStars were done in conjunction with Cooley Godward and Y Combinator’s were done in conjunction with Wilson Sonsini.  On top of all of this, the NVCA (National Venture Capital Association) has had a set of model legal documents up on the web for a while (Jason was on the team that put these together).

So – there’s now no shortage of term sheet data (and forms) available.  Now the trick is to get everyone to start using the same stuff.  It seems like first round deals is a great place to start.

Ironically, if you read through all the various sets of documents with a fine tooth comb, you’ll find an interesting phenomenon – they are all slightly different.  So – a next step is to get Gunderson, Cooley, and WSGR to standardize on one set.  If there was truly a set of “first round docs” (for angel rounds, seed rounds, and venture capital rounds – whatever you want to call them) – life would be a lot better for entrepreneurs, VCs, and probably even the law firms since most first round deals are money losers for them even though they generally cost way too much.

We’ve funded a company called Brightleaf that plans to help with the document production part of this problem.  But we also need leadership from VCs and law firms to realize that there really should only be two terms being negotiated in most first round financings – valuation and the amount raised.

Bambi Francisco was at TechStars Investor/Demo Day in Silicon Valley yesterday and did a short interview with me on how TechStars works.

Mom – please listen to at least the first 30 seconds as Bambi calls me a technology luminary!

In 2005, my partner Jason Mendelson and I wrote a long series of posts describing all of the parts of a typical venture capital Term Sheet.  We started on 1/3/05 with a post on Price and finished up on 8/23/05 with a post on Indemnification and Assignment. 

Of all of the stuff I’ve written over the past four years, my stats continue to tell me that stuff we wrote in the Term Sheet series is some of the most popular content on my blog.  As I was writing my post I Blog, I Tweet, But Why I realized that many of you have started reading my blog after 1/1/06 so you might have missed this series.

We’ve seen this series used as the base for a number of college courses, we’ve been thanked by people all over the world for writing it, and we’ve been encouraged to publish a version of it in book form.  Maybe someday we will get around to it, but for now it’s still relevant as an original web based life form. 

For quick reference, following are the key posts:

• Price
• Liquidation Preference
• Board of Directors
• Protective Provisions
• Drag Along
• Anti-Dilution
• Pay-to-Play
• Dividends
• Redemption Rights
• Conversion
• Conditions Precedent to Financing
• Vesting
• Information Rights
• Registration Rights
• Right of First Refusal
• Voting Rights
• Employee Pool
• Restriction on Sales
• Proprietary Information and Inventions Agreement
• Co-Sale Agreement
• Founders Activities
• Initial Public Offering Shares Purchase
• No Shop Agreement (also Unilateral or Serial Monogamy)
• Indemnification
• Assignment

While the 24 references are a bit dated (we might use Lost or Weeds this time around), I hope you will also enjoy (or at least forgive us for including) a little bit of Jack Bauer.

I love a good rant and Dave McClure has a doozy up titled VC’s & Tech Lawyers: Innovate, Automate, Simplify.  Several years ago when Jason and I wrote our Term Sheet series, I often thought to myself (and often out loud) “why is this so complicated?” (ok – there were some adverbs used as modifiers in the sentence as in “why is this so X Y complicated?”)

In addition to a delicious rant, Dave has some good suggestions for all of us.  Anyone doing a seed or light Series A round (< $1m) should read Ted Wang of Fenwick & West’s article Reinventing the Series A for some additional ideas. 

In 2005, Jason Mendelson (my partner and co-author of AsktheVC) wrote what has become an extremely popular series dissecting the “term sheet.”  The feedback we got from it encouraged us to write several more series of blogs and ultimately led to us deciding to start writing AsktheVC to answer random questions from entrepreneurs.

Last Friday I pointed to a post from Dave Naffzinger (Judy’s Book) about Stock Options from an Entrepreneurs Point of View.  I woke up today to two more great entrepreneur posts on term sheets.  The first is from Dick Costolo (FeedBurner) titled Venture Terms – Liquidation Preferences and Participation.  The second was titled Term Sheet Hacks was on a new blog titled Venture Hacks and written by Naval Ravikant (Vast.com) and Nivi (EIR at Atlas Ventures.) 

When I started this blogging thing back in May of 2004, I stated that I was motivated by Fred Wilson’s post on Transparency.  I love that smart entrepreneurs are adding to the body of knowledge out there around the funding process.  I’ve always been befuddled that a financing (both angel and VC) and the “term sheet” are such as mysterious thing.  It has been rewarding to get thousands of emails over the past two years thanking me / Jason for what we’ve written – and it is fun to see some smart entrepreneurs continuing to add to the demystification of the term sheet.

Rick Segal is in the middle of a negotiation and is having some frustration with his co-investor – a “US VC” – around settling on a few terms that he thinks are silly.  I agree with two of them but struggle with the third.

• Expenses: If the deal doesn’t close, the startup pays.  I agree – that’s silly, especially for an early stage company.  I can imagine some later stage / VC buyout type deals where this might apply, but it doesn’t make sense in an early stage deal.  However, the company should always pay (using their newly raised money) when the deal closes.
• Exclusivity Term: 90 day exclusivity is too long.  I agree – if you can’t get the deal done in 45 days from the signing of the term sheet, something is wrong.
• Founder Buy Back: This one isn’t simple – it’s very context specific, personality dependent, and linked to stage, capital structure, roles and responsibilities of the founders, existing and future management team, and a whole bunch of other stuff.  I don’t think there’s a general case here – I think you have to address this deal by deal.

Rick – don’t worry about the “US VCs” – if they are offended by the philosophy of Canadians, just offer to take them to a hockey game.

Every now and then I run into a new VC term in a term sheet that I’ve never seen before. My legs tremble with excitement as I stare at the words to dissect what they mean.  On Friday, a long time friend sent me the following new and exciting term.

Compelled Sale Right: So long as VC (together with its permitted transferees) continues to hold at least 10% of the outstanding common shares (on an as-converted basis), and so long as an IPO has not been completed, then, at any time from and after the seventh anniversary of the transaction, if VC or the Company shall receive a bona fide offer from an unaffiliated third party to purchase 100% of the equity of the Company, VC shall have the right to cause each other stockholder to sell such stockholder’s equity securities on the same terms and conditions applicable to VC.

My first reaction was “what the fuck?”  My second reaction was “eh – this is just a different twist on redemption rights.”  But – then I thought about it some more and thought “you’ve got to be kidding me!”

So – after seven years, if there hasn’t been a liquidity event, a VC that owns at least 10% of the company can force all the other shareholders to sell their shares to an unaffiliated third party.  Read it slowly and think about it.  Basically, this term gives a minority shareholder the right to sell the company after 7 years, with no input from any other shareholders.

Be forewarned – this is not a nice term.

Tim Wolters has written a post on anti-dilution clauses from an entrepreneurs point of view.  Tim promises to write more on other terms like liquidation preferences, reverse vesting, dividends, class voting rights, “and any other terms that have bitten [him] on the ass before.”  Tim is co-founder and CTO of Collective Intellect, a new company that just recently closed a Series A funding.  He was previously the co-founder and CTO of Dante Group, a company I funded that was acquired by webMethods.  Expect straight talk and some good insights from Tim.

For my 40th birthday, I got a couple of cool t-shirts with photos of me substituted for Jack Bauer on 24.  The only thing disconcerting was the image of me holding a handgun.  I was pondering how ripped I looked (on Jack’s torso) when two questions on term sheets came in from someone at Ernst & Young.  Being the excellent delegator that I am (much better than Jack, if you know what I mean), I forwarded the questions on to Jason who promptly answered them.  They are as follows:

1. What would you deem the most hotly contested points of the term sheet? The most hotly negotiated term (after price) is the liquidation preference. In a Series A deal, it is between the company and the investor. While it’s often an intense negotiation, it’s straightforward because there are only two interests to consider (the founders and the Series A investors). In later stage, the negotiations become even more interesting. Take a situation where you have a Series D deal with each Series (A, B, and C) having different prices. By definition each of the different Series investors will have different payouts on their previously purchased stock and the Series D investors will be negotiating with several sets of interested parties (the founders, the Series A investors, the Series B investors that are not in the Series A, and the Series C investors that are not in the Series A / B).  Of course, the notion of participating preferred plays into this negotiation also.

2. In your view, how has the role of legal counsel changed over time during the deal process (in the past 10 years or so)? Legal counsel is relied on more heavily these days to be a business arbiter, rather than a “take no prisoner negotiator” who must win every last deal point. These deals aren’t rocket science and any good lawyer knows that.  As a result, legal counsel (at least good legal counsel) is now much more of a deal maker than hard ass negotiator.

Jason and I hope you enjoyed reading our term sheet series at least as much as we enjoyed writing it.  While we won’t be competing with our friend Jack Bauer for any drama awards (I tried to make it 24 posts, but could only get to 20), we’ve tried to take a balanced and pragmatic approach to explaining the mysterious “VC term sheet.”  Remember – we’re not lawyers (ok – Jason is) and this isn’t legal advice so you should not rely on it for anything, yada yada standard disclaimers follow.  In other words, use at your own risk.

For ease of reference, following are the various sections (linked to their corresponding post) that we covered.

• Price
• Liquidation Preference
• Board of Directors
• Protective Provisions
• Drag Along
• Anti-Dilution
• Pay-to-Play
• Dividends
• Redemption Rights
• Conversion
• Conditions Precedent to Financing
• Vesting
• Information Rights
• Registration Rights
• Right of First Refusal
• Voting Rights
• Employee Pool
• Restriction on Sales
• Proprietary Information and Inventions Agreement
• Co-Sale Agreement
• Founders Activities
• Initial Public Offering Shares Purchase
• No Shop Agreement (also Unilateral or Serial Monogamy)
• Indemnification
• Assignment

If you have any questions, comments, or suggestions for things we missed, email me anytime.  We have had numerous requests for republishing this content – if you are interested, please contact me.  We’re usually happy to oblige – we just want to make sure we know about it.  Until next season …

We’re down to our last two sections on a typical VC term sheet.  Since they are both things that most entrepreneurs simply live with as part of a financing, we decided to combine them into one post.

The first clause is indemnification and usually looks as follows:

“Indemnification:  The bylaws and / or other charter documents of the Company shall limit board member’s liability and exposure to damages to the broadest extent permitted by applicable law.  The Company will indemnify board members and will indemnify each Investor for any claims brought against the Investors by any third party (including any other shareholder of the Company) as a result of this financing.”

Given all the shareholder litigation in recent years, there is almost no chance that a company will get funded without indemnifying its directors.  The first sentence is simply a contractual obligation between the company and its board.  The second sentence – which is occasionally negotiable – indicates the desire for the company to purchase formal liability insurance.  One can usually negotiate away insurance in a Series A deal, but for any follow-on financing, the major practice today is to procure director and officer (D&O) insurance. 

The next clause – assignment – looks as follows:

“Assignment:  Each of the Investors shall be entitled to transfer all or part of its shares of Series A Preferred purchased by it to one or more affiliated partnerships or funds managed by it or any or their respective directors, officers or partners, provided such transferee agrees in writing to be subject to the terms of the Stock Purchase Agreement and related agreements as if it were a purchaser thereunder.”

The assignment provision allows venture funds to transfer between funds and make distributions to their limited partners (their investors).  This is something companies must normally live with and is a term that is rarely availed upon by investors. 

Neither of these terms should be controversial.  The company should be willing to indemnify its directors and will likely need to purchase D&O insurance in order to attract outside board members.  The assignment clause simply gives VC firms flexibility over transfers which they require to be able to run their business and – as long as the VC is willing to require that any transferee agrees to be subject to the various financing agreements – the company should be willing to provide for this (although entrepreneurs should be careful not to let the loophole of “assignment without transfer of the obligation under the agreements” occur.)

Earlier this week I did a brief post on the “no shop agreement” that is a common feature in a term sheet.  I compared signing a no shop to the construct of serial monogamy in a relationship.  I had a couple of comments (one that was intellectual, one that was a little harsher and painted VCs as “duplicitous.”)  I was mulling over my obviously (in hindsight to me) asymmetric view when Tom Evslin very clearly and coherently articulated why my analogy was really unilateral monogamy (e.g. the VC isn’t signing up for serial monogamy – only the entrepreneur is.)

Tom – and the comments I received – are correct (although I don’t agree with the generalization that “VCs are duplicitous.”)  After reading Tom’s post, I thought about my own behavior (at least my perception of my own behavior) vs. the general case and realized I’ve mixed the two up.  I’ve been on the giving and receiving side of unilateral no shops many times and – when on the receiving side – have usually been sensitive to why the other party wouldn’t sign a reciprocal no shop.  In most cases, I simply don’t put a lot of weight behind the no shop due to the ability to bind it with time (30 – 45 days), plus whenever I’m on the receiving end, I’ve done my best to test commitment before signing up to do the deal. 

In addition to Tom’s post, Rick Segal wrote up his thoughts in a post titled “The Handshake Clause” where he makes the point that his firm doesn’t sign a term sheet until they are committed to doing a deal.  His explanation of how he approaches this is useful, but it is important to acknowledge that there is a wide range of behavior among VCs – the group that doesn’t put a term sheet down until they are committed are at one end of the spectrum; the group that puts down a term sheet to try to lock up a deal while they think about whether or not they want to do it is at the other.  I’d like to think that we are at the “good” end of this spectrum (e.g. we won’t issue a term sheet unless we are ready to do a deal.)  Obviously, your mileage will vary with the VCs you are dealing with – hence the value of doing your own due diligence on your potential future partners.

As I mulled this over, I came up with a couple of examples in the past 10 years where the no shop had any meaningful impact on a deal in which I was involved.  I could come up with an edge case for each situation, but this was a small number vs. the number of deals I’ve been involved in.  In addition, when I thought about the situations where I was a VC and was negatively impacted by not having a no shop (e.g. a company we had agreed with on a term sheet went and did something else) or where I was on the receiving end of a no shop and was negatively impacted by it (e.g. an acquirer tied me up but then ultimately didn’t close on the deal), I actually didn’t feel particularly bad about either of the situations since there was both logic associated with the outcome and grace exhibited by the participants.  Following are two examples:

1. We signed a term sheet to invest in company X.  We didn’t include a no shop in the term sheet – I don’t think there was a particular reason why.  We were working to close the investment (I think we were 15 days into a 30–ish day process) and had legal docs going back and forth.  One of the founders called us and said that they had just received an offer to be acquired and they wanted to pursue it.  We told them no problem – we’d still be there to do the deal if it didn’t come together.  We were very open with them about the pros and cons of doing the deal from our perspective and – given the economics – encouraged them to pursue it (it was a great deal for them.)  They ended up closing the deal and – as a token – gave us a small amount of equity in the company for our efforts (totally unexpected and unnecessary, but appreciated.)
2. I was an existing investor in a company that was in the process of closing an outside led round at a significant step up in valuation. The company was under a no shop agreement with the new VC.  Within a week of closing, we received an acquisition overture from one of the strategic investors in the company.  We immediately told the new lead investor about it who graciously agreed to suspend the no shop and wait to see whether we wanted to move forward with the acquisition or the financing.  We negotiated with the acquirer for several weeks, checking regularly with the new potential investor to make sure they were still interested in closing the round if we chose not to pursue the acquisition.  They were incredibly supportive and patient.  The company covered their legal fees up to that point (unprompted – although it was probably in the term sheet that we’d cover them – I can’t recall.)  We ended up moving forward with the acquisition; the new investor was disappointed in the outcome but happy and supportive of what we did.

As I said earlier, these are edge cases – in almost all of my experiences the no shop ended up being irrelevant.  But – as both of these example show – the quality and the character of the people involved made all the difference.  Near the end of his post, Tom makes the point that it’s “good negotiating advice to make sure that every clause which can be mutual is mutual.”  I completely agree.