Congratulations! Here are a few next steps:
Set up time w/ Ravi, David, Ash, Luis, or a Fundraising Expert on the Vault
Accelerate offers from other funds if you have not already done so.
Hopefully you ran your fundraising process in an orchestrated way. That is, you coordinated your investors to all issue term sheets around the same time. If you did, we will look through the term sheets, and then prioritize which investors we like the most, and which terms we like the most. We will then go to the investor we like the most and counter-offer / edit their term sheet with the terms we like (or offer our own term sheet).
If you have not coordinated to receive term sheets at the same time, your term sheet may have a tight deadline date (e.g. 3 days - 1 week). If that’s the case, you need to accelerate all the conversations you are having with other funds, and decelerate the process with the current fund (unless they are your top choice w/ top terms).
To accelerate the others, please notify the other funds you are in discussions with that you received a pre-emptive term sheet and need to get back to the other investor. If they are interested, can they accelerate their process. Do NOT reveal the name of the fund you received a term sheet from to the other investors. And signal interest in the fund you want to move quickly so they know you are interested in them as well.
With the fund that gave you the term sheet, you can buy time a few ways:
Ask for references on them. Ask them to send you 4 names of CEOs they have worked with -- ideally 2 that worked out, and 2 that didn’t for you to call as part of your diligence. Then coordinate scheduling so these calls take a while to happen. That should buy you an additional 1 or 2 weeks.
Tell them that you have other funds that have expressed interest and you want to be fair to them and so you are driving a process. You can also blame your advisory board for not being able to get back to them quickly on the term sheet. “Our advisory board has asked us to treat all investors that have expressed interest fairly. And so we need to carry the process out with others. In parallel, we’d like to complete our diligence with you. And we should be able to get back to you in 3 weeks.”
Blame a customer firedrill. Say that you are deeply flattered but working on a customer firedrill at the moment and will return to fundraising in 2 weeks.
Blame a co-founder crisis. Say your co-founder is out of town on a family emergency and you won’t be able to address this w/ them for 1-2 weeks (until they are back).
Review the term sheet
Here are the items to review in the term sheet in order of importance:
Raise Amount and Valuation
First, look at the overall round size, and the commitment the lead investor is making. Is the lead investor’s commitment conditional upon closing more capital? Ideally, the lead investor’s commitment should be fixed regardless of how much additional capital you bring in. For example, if the lead is putting in $2m against a round of $5m, are they requiring $5m of total proceeds for their $2m to be valid? Or is there $2m guaranteed and is the total round size (up to $5m) at your discretion? Ideally, it’s the later (e.g. Round Size is at least $2m, and UP TO $5m)
Then look at the valuation, and understand how much dilution your taking and if it feels reasonable. For a Series A round, Most institutional funds will want 20-40% of a company. Getting it closer to 20% is better of course. For a seed raise, it can be less (e.g. 10 o 15%).
Employee Pool
The Employee Pool typically comes out of the Pre-Money. That is, YOU (the founders) pay for the employee pool, not the investors. Said another way, every percent of the employee pool is the equivalent of an extra percent of dilution as if it were an investor. Now, after you are funded -- if you exhaust the employee pool -- the board can always issue more shares. And when it does, the dilution will come from everyone -- including the investors. So you are always better off with a smaller employee pool. And if dilution is an issue, it is easier to negotiate down the employee pool than the investor’s ownership percentage.
Board Structure
The Board decides who the CEO is. Look at how it’s structured. Do you still have control? If not, is there an independent seat that dictates who has control? If there is an independent seat, you might want to get the investors consent of the independent board member in the term sheet (and make the independent designee someone who has your back). Or restructure the board to make sure you have control.
Vesting
Have they put the founder shares on a vesting schedule? Is it fair? Ideally, you don’t want to be put on a vesting schedule or you want half or a good portion of your shares to already be vested.
Co-Sale Rights
Co-sale rights require you to notify / ask for consent from the board / investors before you can sell your founder shares. Basically, co-sale rights say that if you are selling your shares, the investors have the first right to buy your shares, and if they decide not to, they can sell their shares alongside yours to the outside investor in proportion to relative ownership. Sophisticated co-founders will carve out a portion of their shares to be immune from co-sale rights -- e.g 10 or 20% of their shares. This way, you can sell you shares in the next round and take some money off the table.
Less Important Terms
Liquidation Preferences
Liquidation Preferences specify that an investor gets paid out first. It’s intended to protect investors from a scam. If I invest $5m into your company for 25%, and the next day you sell the company for cash (e.g. $5m), you would get $3.75m and the investor $1.25m. To prevent that, liquidation preferences exist. It says that the invest gets to recoup their money first before others are paid back. If it’s a 1x preference, that means they recoup 1x their money. If it’s 2x, they get paid twice their money (e.g $10m in the example above) before others get paid.
The other term you might see is “participating”. Participaing is a euphemism for double-dipping. 1x participating means that the investor gets 1x their investment back first, and then for the remaining proceeds the investor also “participates” as an equity investor and gets the percent of the remaining proceeds based on the ownership they own.
1x non-participating is the best. In tighter markets, you will see 1x participating.
Pro-rata Rights
A pro-rata right is the investor’s right to participate in future rounds to minimize their dilution. If an investor invests $5m for 25%, a pro rata right means they get to do 25% of a future round. That is, if you raise $12m in your next round, they get to do $3m of it. Pro rata rights are standard. Just make sure there aren’t “super pro rata rights” -- e.g. I get to do 2x my pro rata.
Change-of-Control Accelerated Vesting
If you get acquired, what happens to your unvested shares? This is specified in change of control vesting. Single-trigger acceleration means upon acquisition all your unvested shares accelerate and are vested. Double-trigger means you need to be acquired AND fired to have your shares vested. The reality is that whatever is put in in the term sheet can be renegotiated / changed with the acquirer at the point of acquisition.
Other Terms
If there are any other weird terms it’s generally a red flag. Review it past your counsel to make sure there aren’t any strange terms.