Triblr.com by Vlad Stan

Today, I’m presenting the last part of the series of articles about the legal VC terms.

Restriction on Sales
This term sheet provision states that the company has a right of first refusal on all transfers of common stock, which if not exercised by the company will be transferred to the investors.

Proprietary Information and Inventions Agreement
Refers to the fact that every founder, employer and consultant should sign an intellectual property transfer agreement with the company trying to get VC funding.

Co-Sale Agreement
It means that the founders may not sell, transfer or exchange their shares unless each Investor has an opportunity to participate in the sale on a pro-rata basis. This only matters until the IPO.

Founders Activities
This means your funding VC wants you to be spending 100% (actually 120%) of your time and attention on the company. If you are working on other companies, but not disclosing this, you have violated the terms of the agreement and you don’t want that before even starting. There are some exceptions to this previsions, but they are very rare.

No Shop Agreement  (also Unilateral or Serial Monogamy)
It is a provision that commits the entrepreneur not to look for other VCs while negotiating with another. In Brad Feld’s words, “At some level, the no shop agreement reinforces the handshake that says “ok – let’s get a deal done – no more fooling around looking for a better/different one.”

Indemnification
It is a provision that states that the company will indemnify board members and investors for any claims brought against them by any third party (including any other shareholder of the Company) as a result of the financing.

Assignment
The assignment provision allows venture funds to transfer shares between funds and make distributions to their investors.

Read, also, the first and the second part of the article.

Let’s continue with our second lesson of VC language. Today, we’ll explore some more of the frequently used terms of the VC term sheets. Following the links provided upon each definition, you’ll find broader explanations for the terms.

Redemption Rights
Rights to force the company to purchase shares (a “put”) and more infrequently the company’s right to force investor to sell their shares (a “call”). A Put allows one to liquidate an investment in the event an IPO or public merger becomes unlikely.

Conversion
Refers to the fact that preferred stock is convertible into common stock. This allows the buyer of preferred to convert to common stock should he determine on a liquidation that he is better off getting paid on a pro rata common basis rather than accepting the liquidation preference. It can also be used in certain extreme circumstances whereby the preferred wants to control a vote of the common on a certain issue.

Conditions Precedent to Financing
It is a paragraph in the term sheet that you should definitely pay great attention to, as you could not have a deal at all, even if you signed the term sheet, if your company doesn’t meet these conditions.

Vesting
Typically, stock and options will vest over four years – which means that you have to be around for four years to own all of your stock or options. If you leave the company earlier than the four year period, the vesting formula applies and you only get a percentage of your stock. As a result, many entrepreneurs view vesting as a way for VCs to “control them, their involvement, and their ownership in a company”.

Information Rights
It means that the company will have to deliver regularly to the investors, until the IPO, such documents like Company’s annual budget, audited annual and unaudited quarterly financial statements.

Registration Rights 

These are provisions that allow investors to sell stock via the public market (IPO). On the other hand, registration rights are often the only exit vehicle that, as a practical matter, the minority shareholders can compel. Read also on registration rights.

Right of First Refusal
The right of first refusal gives the major investor, in this case, which can be clearly defined in terms of number of purchased shares, the right to buy particular shares before any other proposed buyer is accepted.

Voting Rights
Refers to the fact that preferred stockholders vote like the common stockholders in the affairs of the company, with some exceptions. Anyway, all the heavy rights are contained in other sections, such as the protective provisions, you have to pay special attention to.

Employee Pool
The employee pool section clarifies the capital structure and specifically call out the percentage of the company that will be allocated to the option pool, allocated to directors, officers, employees and consultants financing.

Read, also, the first part and the next part of the article.

It is a simple, well known rule: in order to have a relationship with someone, no matter the type, one have to understand what one say to each other. Basically, you have to speak the same language. So, before hoping that an investor would become your investor, you have to learn to understand and speak his language. That means not only being able to read the lines, but also between them. The between the lines reading comes with practice, but what you can do is start learning the meaning of the words on the lines.

While surfing the web in order to provide a glossary of the venture financing words, I stumbled upon Brad Feld’s blog, managing director at Foundry Group. He published a series of posts that treat separately each of these words. As the author states, this series have been used as the base for a number of college courses.

I will enumerate them here and I will give a short definition for each of them, but of course I encourage you to read the entire posts for a deeper understanding:

Term Sheet

An outline of the terms of a proposed investment deal, typically set up to be a non-binding precursor to the actual financing agreements that will fully document a funding transaction. Term sheets serve the same purpose as letters of intent and are used frequently by venture capitalists to fix the terms of a deal before they complete their due diligence. While generally unenforceable, term sheets, like letters of intent, often contain binding agreements to prevent management from shopping the deal spelled out in the term sheet. Term sheets vary in their level of formality and in the obligations they spell out for the company and the investors. A term sheet is proposed by investors, signed and accepted by the company, and is the precursor to a due diligence effort before the actual investment or plan is made.

Due Diligence

Usually undertaken by investors, but also customers, due diligence refers to the process of making sure that someone is what they say they are and can do what they claim.

Price

This is the form in which the Price is provided in a VC term sheet: The Original Purchase Price represents a fully-diluted (the total number of shares issued by the company on the assumption that all warrants, options and preferred stocks are exercised) pre-money valuation of $ X and a fully-diluted post money valuation of $ Y. The pre-money valuation is what the investor is valuing the company today, before investment, while the post-money valuation is the pre-money valuation plus the contemplated aggregate investment amount.

Liquidation Preference

The liquidation preference determines how the money a company gets are shared on a liquidity event, a liquidity event being not only bankruptcy, but also mergers, acquisitions, or a change of control of the company. In an accurate definition, the term liquidation preference pertains only to money returned to a particular series of the company’s stock ahead of other series of stock, the preferred stock. But the term describes how the money are returned to participating stocks owners, as well.

Protective Provisions

Protective provisions are veto rights that investors have on certain actions by the company. These provisions protect the VC.

Drag Along

A right that allows majority shareholders to force minority shareholders to accept an agreement. In a typical drag-along agreement, if a majority of shareholders agree to sell or liquidate a company then the remaining shareholders must consent and not raise objections.

Anti-Dilution  

The anti-dilution provision is used to protect investors in the event a company issues equity at a lower valuation then in previous financing rounds.
Anti-dilution provisions are almost always part of a financing, so understanding the nuances and knowing which aspects to negotiate is an important part of the entrepreneur’s toolkit.

Pay-to-Play  

An investor must keep “paying” (participating pro ratably in future financings) in order to keep “playing”(not have his preferred stock converted to common stock) in the company.

Continue with Are you speaking VC? (II)