What’s in a Term Sheet for a Priced Equity Round?
Term Sheet clauses fall into two main categories: Economics (who gets what) and control (who gets to decide what).
Economics
Valuation
- Pre-money valuation: The company’s value before the new investment.
- Post-money valuation: Pre-money valuation plus the investment amount = total value after the deal
→ Why it matters: This determines how much of the company you give away for the investment you receive in cash.
Investment Amount
- The size of the check your investor is writing, at what price per share of stock, sometimes in tranches tied to milestones
Equity and Ownership
- Details how much ownership (equity take) the investor gets, based on the fully diluted cap table (i.e., all outstanding and issued shares are included)
- Investors typically receive preferred shares, which carry special rights and protections
- Preferred stock may carry dividends (e.g., cumulative or non-cumulative). These may not get paid out but accrue to increase investor returns on exit.
- Conversion rights state that preferred stock can convert to common stock at the investor’s discretion, and there may be automatic triggers (e.g., IPO at a certain valuation)
→ Why it matters: Preferred shares usually get paid out before common stockholders in a liquidation or sale
Option Pool
- Equity reserved for future team members (10-15% is common in biotech)
- Usually created pre-investment, which means existing shareholders get diluted, not the new investors
→ Why it matters: A larger option pool can significantly reduce founder equity
Liquidation Preference
Investors in a priced round receive “preferred” shares of equity, rather than “common” stock. The liquidation preference term applies to these preferred shares, and defines who gets paid first in a sale or exit, and how much they receive. Note, from an investors point of view, a liquidation event is a good thing – the goal, in fact, assuming that the company has increased its value or the value of the asset. Also keep in mind that preferred stock can be converted to common stock (in a one-way, irreversible process) at any time. Depending on the amount of money the company or asset is sold for, it may be more advantageous for the investor to convert to common stock and receive their share of the sale simply according to the percentage of equity they hold in the company.
There are two components to this term, 1) the preference and 2) the participation. The liquidation preference simply states that upon a liquidation event the investor gets “x-fold” of their initial investment back before any other distributions. In early-stage rounds, this is almost always kept at 1x, and is largely meant to protect investors from losing money if the company sells quickly for a small amount.
Participation rights (often called “participating preferred” stock) build on liquidation preferences. Non-participating terms state that preferred stock holders take the liquidation preference and that’s it. Remember, preferred shares can convert to common at any time if that is a better outcome. Participating preferred stock holders would receive their liquidation preference followed by a share of what’s left – rated according to their percent equity ownership. Often this is capped at some multiple (e.g., 3x) of the investment, but can significantly squeeze founders if the company exit is not enormous.
→ Why it matters: A >2x and/or participating clause can significantly affect what is left for founders
Anti-Dilution Provisions
- Protects investors if the company raises a down round (a round at a lower valuation that the previous round)
- Types:
- Full ratchet: Converts shares that were allocated from the previous round to match the lower new price
- Weighted average: Adjusts share price proportionally
→ Why it matters: Can punish founders and early investors if future rounds are raised at lower valuation
Vesting and Founder Stock
- Specifies vesting schedules for founder shares and the option pool (e.g., 4 years with a 1-year cliff) to ensure founders remain committed to the company
→ Why it matters: Keeps everyone aligned for the long term and protects the company if a founder leaves early
Valuation
- Pre-money valuation: The company’s value before the new investment.
- Post-money valuation: Pre-money valuation plus the investment amount = total value after the deal
→ Why it matters: This determines how much of the company you give away for the investment you receive in cash.
Investment Amount
- The size of the check your investor is writing, at what price per share of stock, sometimes in tranches tied to milestones
Equity and Ownership
- Details how much ownership (equity take) the investor gets, based on the fully diluted cap table (i.e., all outstanding and issued shares are included)
- Investors typically receive preferred shares, which carry special rights and protections
- Preferred stock may carry dividends (e.g., cumulative or non-cumulative). These may not get paid out but accrue to increase investor returns on exit.
- Conversion rights state that preferred stock can convert to common stock at the investor’s discretion, and there may be automatic triggers (e.g., IPO at a certain valuation)
→ Why it matters: Preferred shares usually get paid out before common stockholders in a liquidation or sale
Option Pool
- Equity reserved for future team members (10-15% is common in biotech)
- Usually created pre-investment, which means existing shareholders get diluted, not the new investors
→ Why it matters: A larger option pool can significantly reduce founder equity
Liquidation Preference
Investors in a priced round receive “preferred” shares of equity, rather than “common” stock. The liquidation preference term applies to these preferred shares, and defines who gets paid first in a sale or exit, and how much they receive. Note, from an investors point of view, a liquidation event is a good thing – the goal, in fact, assuming that the company has increased its value or the value of the asset. Also keep in mind that preferred stock can be converted to common stock (in a one-way, irreversible process) at any time. Depending on the amount of money the company or asset is sold for, it may be more advantageous for the investor to convert to common stock and receive their share of the sale simply according to the percentage of equity they hold in the company.
There are two components to this term, 1) the preference and 2) the participation. The liquidation preference simply states that upon a liquidation event the investor gets “x-fold” of their initial investment back before any other distributions. In early-stage rounds, this is almost always kept at 1x, and is largely meant to protect investors from losing money if the company sells quickly for a small amount.
Participation rights (often called “participating preferred” stock) build on liquidation preferences. Non-participating terms state that preferred stock holders take the liquidation preference and that’s it. Remember, preferred shares can convert to common at any time if that is a better outcome. Participating preferred stock holders would receive their liquidation preference followed by a share of what’s left – rated according to their percent equity ownership. Often this is capped at some multiple (e.g., 3x) of the investment, but can significantly squeeze founders if the company exit is not enormous.
→ Why it matters: A >2x and/or participating clause can significantly affect what is left for founders
Anti-Dilution Provisions
- Protects investors if the company raises a down round (a round at a lower valuation that the previous round)
- Types:
- Full ratchet: Converts shares that were allocated from the previous round to match the lower new price
- Weighted average: Adjusts share price proportionally
→ Why it matters: Can punish founders and early investors if future rounds are raised at lower valuation
Vesting and Founder Stock
- Specifies vesting schedules for founder shares and the option pool (e.g., 4 years with a 1-year cliff) to ensure founders remain committed to the company
→ Why it matters: Keeps everyone aligned for the long term and protects the company if a founder leaves early
