We send people that link all the time to help them understand option pools. The main point of that post is to make it clear to founders that when an investor is saying they'll invest $X to get 20%, the dilution is more than 20% because of the impact of the pool.
I think if the pool is not part of the premoney, investors just adjust the valuation to compensate.
Just focus on the final output. Take the term sheet and work with your lawyer to model out how much you own after the round is closed. Is that a good deal or not? If you don't like it, there are multiple ways to increase your post-closing ownership. Moving the option pool into the post-money is one of the hardest ways to accomplish that because you are trying to move the investor up on both valuation and convention.
The last 2 rounds I was involved in moved the option pool into the post-money. In one case, the initial price was initally discussed and negotiated with the expectation of a post-money option pool. In the other, there was a term sheet with a post-money option pool so we asked the other term sheets to be rewritten using a post-money option pool (they changed their prices accordingly).
I'll note that in every case where someone has asked for X pre-money, they have asked for less than X in the post-money. That's why I consider that term to be dirty - it's purely a means of obscuring the real valuation, and has nothing to do with employee ownership.
One thing I do in all my term sheets that might be a useful addition is to include a summary cap table showing the founders how much they own and our fund owns post-funding. That pre-empts any confusion over the impact of an option pool increase on each party.
I was under the impression that more and more founders (and even investors) are speaking out against the idea of legal fees paid by the founders. Is that only at the seed stage and acceptable at Series A?
To me it is totally unreasonable. We had a series A investor that required that. Their attorneys poked around and argued about every little thing and charged us $1200 an hour. They even had a $50k cap in the documents which they asked the VC to raise once they saw they were going to be able to exceed. The VC of course agreed because it wasn't his money and then proceeded to pressure us to accept it. We had already wasted so much time with these guys and racked up our own legal bills. So we were pretty much at their mercy.
If my company is going to pay your legal fees, then they work for me, not you and I will reserve the right to fire them and find someone really cheap instead.
If my company is going to pay your legal fees, then they work for me, not you [sic] and I will reserve the right to fire them
This the most logical comment on this thread. I can't believe people accept paying a VC's legal bills during a negotiation. VC's are in the business of doing deals, and have their own legal retainers to work on those deals - not to mention a fan favorite movie "My Cousin Vinny" teaches every American that giving $1 to a lawyer creates client-attorney privilege.
It's amazing that without being sued (and then losing on appeal in court), people are willing to pay out of pocket for a lawyer to actively work against them in what could be one of the most important deals of a founder's life.
> not to mention a fan favorite movie "My Cousin Vinny" teaches every American that giving $1 to a lawyer creates client-attorney privilege.
Yes, but in this case, you aren't paying the lawyers, you're paying the bills that the lawyer is charging their clients, the VC. Essentially, it's a reimbursement where you are paying for the VC's A/C privilege.
The term sheet we posted is just meant to show what a pretty good term sheet looks like from a good investor. The investor having its legal fees reimbursed by the company is something that shows up all the time. Sure, you can negotiate that if you want. You can negotiate other things too, or choose not to. The way this usually plays out though is that unless you have the kind of leverage that lets you basically write your own term sheet, you have to prioritize, and most people prioritize getting what they want on valuation, control, clean terms, etc. before making sure to shift $30K in legal fees back to the investor.
Good question. The anti-dilution right is an adjustment to the investor's shares that occurs when the company does a down-round. The "broad-based" qualifier is a reference to the most company-friendly version of this because it requires the adjustment to take into account the scale of down-round in terms of dilution. For instance, if you closed a round at $20M post and then sold one share afterwards at $10M post, the adjustment would be negligible. There are other variations of anti-dilution adjustments that would ignore such considerations.
The anti-dilution adjustment is generally not something that applies to ordinary course dilution (like employee option grants).
Question: how did you think about giving pro-rata & information rights in this term sheet? It looks to me that the Other Rights & Matters section grants it to _all_ investors. Is that typical in your experience?
Major investors concept (investor has to have invested at least $X) is often added in the definitives. Longer term sheets just state a threshold dollar amount; shorter ones (like this one) just skip that definition and just add it in the definitives.
I'm no fan of long term sheets, but IMO, this term sheet doesn't just punt that term to definitives; it gives me the expectation that all investors will receive "major investor" rights without dollar or ownership thresholds. Specifically, I feel that way because the "major investor" rights (ROFR, co-sale, pro-rata, info) are are in-line with anti-dilution and registration rights, which are typically afforded (in varying degrees) to smaller investors. Were I an existing investor or angel, the definitives adding a threshold would feel like a retrade of the term sheet.
Especially if the intent is to help unfamiliar founders & angels understand what's a "clean" or fair deal, I'd put in a vote that a v2 of this term sheet would clarify the applicability of rights to smaller investors, maybe with some "batteries included" guidance on that point.
Some minor wordsmithing that reflects lawyer and investor /founder preferences happens a fair amount.
The veto on company sales breaks founder friendly occasionally (you need a decent amount of leverage). Some examples:
1. It doesn’t exist
2. It only applies to sales that return less than X multiple of investor’s capital invested
3. It only applies to sales where the founders are getting retention packages (from acquirer) that substantially exceed their recent compensation
The veto on financings is present almost always. A founder would need rare leverage to get rid of it.
On both of these vetoes though there are additional constraints on abusive usage by investors — reputation being the most obvious one.
The post refers to the actual resulting contract (100+ pages) that the lawyers generate as a result of these terms.
Are there any examples of these for the curious to read? I know it’s out of scope for the post topic but as someone who hasn’t read a term sheet before and is curious, I am also curious about reading a full series A sale contract.
It is typical that the term sheet results in ~5 different contracts: the Stock Purchase Agreement (through which the company actually sells stock), the Investor Rights Agreement, the Voting Agreement, the First Refusal and Co-Sale Agreement, and changes to the company's Certificate of Incorporation.
There are also sometimes opinions of counsel and other "ancillary" documents which are just as important but not typically negotiated as they're very standard.
It is mind-bogglingly routine that a company pays $30k to "expand" from the term sheet to definitive contracts, and then the VC firm spends an additional $15-30k++ (reimbursed by the company) to review that expansion to make sure the other firm did it right.
Why Delaware? I'm like, I grok it's a fan favorite and all for various reasons, but for those who aren't savvy about it, why Delaware? (And ideally: why not Delaware? Given that the gist of the criticism about it is that it hugely favors the investors over the founders and the employees.)
To follow on to eric's comment, there are two major aspects of the law:
- what is written as law
- how courts rule
The most important aspect is "how courts rule". This is because law is open to interpretation by those ruling on it.
The main upside of using judges instead of juries is that precedent is real. In a jury trial, you are relying on a random group of people to choose the outcome. In a trial ruled by a judge, you can reasonably expect that judge to rule in a similar fashion as they have on similar cases or based on precedent of previous cases.
Having a more predictable outcome that eliminates the "wild card" aspect of juries allows your representation to give you better legal advice as they can study how the courts have ruled in the past and give advice that will likely put you on the correct side of the law.
