Series A Term Sheet

A short-form term sheet which captures all the main areas needing to be agreed during a fundraise, with annotations to help founders navigate the process.

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This is an example of a comprehensive term sheet. Often VCs will share shortened 1-2 page versions of term sheets which only include the main points (valuation and round structure), in a hope founders sign them and move into a period of exclusivity where the rest of the terms can be negotiated. We have included all the key terms here to be helpful, and we recommend founders cover some of the more challenging topics (e.g. founder vesting) ahead of signing anything. The terms contained within are common for European early-stage deals, which may differ to other geographies.

The lead investor is taking the lion's share and will generally be agreeable to however the founders want to fill out the rest of the funding round.

It is important to understand the distinction between pre-money and post-money, and how employee stock options fit within the calculation.

For clarification. Pre-money valuation + total new capital raised = Post-money valuation.

⭐ Companies need to ensure they have sufficient ESOP to incentivise new and existing employees for this next stage of growth. Investors will push for those shares to be issued prior to their funding round (i.e. part of the pre-money valuation), however the fairest outcome is to split the ESOP half in the pre-money, half in the post-money (so everyone gets diluted). The amount of ESOP will gradually decrease as the company gets larger. Typically 8-10% unallocated for Series A.

Preferred shares meaning they are in a new class which sits above the Common shares. It is an important nuance, as these shares carry special rights (e.g. liquidation preference, voting rights).

Investors need time to finalise their diligence. They typically put forward term sheets knowing there are a few key areas outstanding which they need more information on. Customer calls and founder reference calls are common parts of confirmatory diligence, as is digging deep into the numbers. Some investors may engage external consultants to do diligence work at this point (e.g. accountants or consultants).

⭐ This means in the event of a sale of the business, Investors in this funding round are guaranteed at least 1.0x the money they put into the business, before anyone else gets profits.

Lets take an example. If this example business is sold after the Series A for €100m, then this clause would not be triggered and the lead investor would get 16% x €100m and the remaining €84m to everyone else (simplifying things). If however the company is sold for €10m, the first €8m will go to the lead investor (who is guaranteed at least 1x their investment), and all other shareholders have to split the remaining €2m, despite the fact they own 84% of the company, they only get 20% of the proceeds.

This is commonly termed the 'pref stack' which is the sum of the preferred shares x their liquidation preferences, and in reality is the hurdle exit value which needs to be overcome before common shareholders (often the founders and employees) see any money from an exit.

Investors have the ability to block the payment of dividends. In the event they are paid, they are paid equally across all share classes (pari-passu) as opposed to a hierarchy.

⭐ Pari-passu means any benefits apply equally across all classes of Preference shares. Early investors (seed/Series A) like to insert this terminology. Later stage (Series B+) prefer to remove it, as they want to benefits to accrue based on seniority of share class.

Preference shares can be converted into ordinary shares at the moment of the investors choosing. Conversion also happens automatically upon exit. In rare occasions, it might be more beneficial to hold ordinary shares instead of preference shares. It is also customary to insert a minimum return threshold upon IPO, often a figure (5x in this instance) which should easily be exceeded.

Anti-dilution protects Preferred shareholders from a scenario where the Company issues shares at a price lower than the ones the Investor bought as part of this funding round. In practice this only really kicks in when there is a down-round (the company raises money at a valuation lower than this Series A).

The fairest and most common form of anti-dilution is broad-based weighted average (BBWA), which essentially averages the share price between the funding rounds, weighted based on the capital of the round. The alternative mechanism if a full-ratchet, which results in the conversion price being the lowest available.

It is common for the lead investor to be able to appoint a member to the Board of Directors. They may also ask for an Observer seat, which is a non-voting passive seat, typically so that the VC Fund can have two people oversee their investment.

Board composition varies significantly by company and stage. In the early stages it is typical for the founders to have seats, as well as early stage investors with significant ownership. We advice to keep the overall number of Directors to a minimum (<5), as having too large a board can be inefficient when it comes to making key decisions.

Investors gain the right to influence key business decisions via their voting rights. For matters involving the overarching corporate structure (e.g. the number of shares, the board structure, exit processes etc.), the majority of the investors need to approve.

Investors receive an array of special rights. The most important ones are:

• Pre-emption: The right to buy new shares in future funding rounds, ahead of any new external investor, pro-rata to the investors existing ownership. Also commonly referred to as pro-rata rights. These rights can be very valuable in high growth companies as they guarantee an ability to buy shares in future funding rounds and often include a clause wherein if the investor does not take-up at least 50% of their pro-rata right in a future funding round, they lose it going forward (to prevent an overhang of indefinite pro-rata rights).
• Tag-along: Also known as co-sale rights. If a majority shareholder sells his stake, this clause protects minority shareholders who have the ability to jointly sell their shares as part of the transaction, thereby tagging along.
• Drag-along: The other side to the tag-along. If everyone wants to sell their shares into a transaction, the majority of shareholders have the right to force a minority shareholder into the sale as well. This clause prevents a small minority of shareholders being able to veto any deal which everyone else agrees to.
• ROFR: Investors get the right of first refusal (ROFR) being an agreement where whenever an offer is put forward to the company (for acquisition of shares commonly), the investor can match or better it, and be given preference in negotiations.

⭐ Founder vesting can vary significantly deal to deal. Almost all of the criteria in this clause are up for negotiation. It is most common at the Series A stage to see a 4-year schedule with a 1-year cliff, and fairly standard definitions around Good and Bad Leavers. If the business has been operational for some time, the percentage of shares subject to vesting may decrease (i.e. to 75% or even 50%) if founders can argue they have already built something material over several years which should be recognised by the investors.

The reason for vesting, is to create alignment between investors and founders. Without these clauses, investors risk a situation where founders leave and take a huge chunk of the equity with them, making it very hard for the business to incentivise new management.

Reps & Warranties will be a key element of the long-form documentation and hence not typically covered in detail in the term sheet.

Reps & Warranties are a process whereby the Company and its founders, provide guarantees that the information they provide is factually accurate, and the business is as it has been shown to be to investors. These clauses are inserted mainly to prevent fraudulent activity, where a founder could make bold claims about their business to incentivise investment (e.g. signed customers, a revenue figure, key contracts existing), which may not actually be true. During the legal documentation a list of key statements are typically drawn up, and the Company / Founders need to state they are true to the best of their knowledge, or face financial repercussions.

To consummate the deal, lawyers need to draft long-form documentation which goes into far more detail than just this termsheet.

Part of that cost is typically borne by the Company, as the documentation is only required when a deal is being done and both parties utilise the same set of documents. These fees are subtracted from the final wire transfer, or occasionally professional fees are invoiced directly to the company (with their approval).

While the investors are completing their confirmatory diligence, they need assurances that the Company isn't shopping around for a better deal. This is a lengthy way to say the Company wont do a deal with someone else in the interim, although it is in reality hard to police.

The first rule of fight club...

Governing law is conferred based on where the company issuing the shares is incorporated.