Term sheet

Seed Round Term Sheet

Daniel Eberhard CEO, Koho

July 23rd, 2013

Hi FD'rs. 

My colleague and I are currently in early stage term sheet discussions around a seed round. There is promising interest from a number of parties. I wanted to get your insights on term structures. Our goal is just to create a fair relationship between the parties. I pinched a few clauses from a sheet we expect to see. Any insights around some or all of these clauses are appreciated. Thank you 

Requires a majority of non-management shareholders. Our company has 2 co-founders, indicating 3 non management shareholders.  

Founding partner vesting structures - I have heard of these in VC term sheets but in a modest equity seed round, is it standard to strip founders of equity and build out on a 4 year cliff? 

Shares transferable to any type of future share issued at a 1:1 level?

In the event that future shares are issued at a lower price, additional shares will be issued at no cost to investors so their average cost per share is the same as the current round. 

Investing body may require that company engage 'investing body' management services. 

Permanent put option (at specified terms). 

It's worth mentioned we have bootstrapped thus far. We can continue to do so but want to target some aggressive growth strategies and a seed round will be required to do so. Thanks again. 

Oliver Roup Founder / CEO at VigLink

July 23rd, 2013

Daniel - Norms vary by region but in Silicon Valley these would be considered harsh (or perhaps "investor friendly") terms. The best general source on this stuff that I know of is still VentureHacks.com although it's now several years out of date. It sounds like you are contemplating a priced equity round vs (the now more common for seed rounds) convertible note. There's room for honest disagreement on whether this is a good or bad thing, but in either case these terms are not great. Specifically:
  • Majority non-management shareholders - Assuming you mean directors and not shareholders. Without reading the rest of the doc I can't know for sure but this sounds like you're being asked to give up control with the seed round. (IE, "they" have 3 votes to your 2.) I'd say this alone is a show stopper and very uncommon in a seed round. Typical is 0-1 seats on a 3 member board in a seed round. Note that it's almost never as simple as who has how many votes - usually you need approval of each class of voter, but still this appears bad. Particularly combined with vesting they have the opportunity to fire you on day 0 and effectively steal your company.
  • Vesting for founders - Again, assuming you mean a 4 year vest with a 1 year cliff. (4 year cliff is out of the question bad.) I'd say this is pretty common for a priced equity round and uncommon for a convertible note. Depending on how long you've been at it and how much value you've created, you can push back on 100% vesting, but you will certainly see a substantial amount.
  • 1:1 share transference - impossible to say without reading the rest of the doc. Might be a pari passu which is not uncommon or could be something more sinister.
  • Dilution protection - This is what's known as the "full ratchet" and is on the unfavorable end of common. ("broad based weighted average" is more entrepreneur friendly.)
  • Investing body management services - Show stopper. At what price? For what? Sounds shady. 
  • Permanent put option - Again, this sounds horrible but without the full doc hard to know for sure. It's common to have a board declared dividend that can force a sale, but it needs full board approval and it only ratchets up over time. (IE 8% p.a. on the amount offered.)
Overall I'd say these terms sound onerous bordering on unethical. Combine no board control and full vesting creates an opportunity for misbehavior. Mandating hiring of their management services is shady.

Best of luck


Bart Bohn CEO, Founder at Embrace

July 24th, 2013

I am in Austin and these would be considered harsh.  This sounds like east coast private equity type terms, not seed stage VC.  

The 3:2 on the board is a no go.  The management services seems shady and likely a showstopper too.  Assuming the above comments on the vesting are correct, that is fairly standard, but it sounds like you may have enough traction / progress to get some of the shares vested immediately.  

If this is a full rachet, I haven't seen one of those in Austin in a very long time, although there were rumors of a few in Fall 2008 - but definitely NOT anymore (unless you are pushing for a stupid high valuation that is almost certainly not going to stick in the next round).

I have never seen a put option - again, sounds like later stage private equity stuff.  

I would counter with the generic seed docs from angelist or WSGR or YC or etc. (pick any SV media source) to reset the conversation.  

Michael Barnathan Adaptable, efficient, and motivated

July 23rd, 2013

"is it standard to strip founders of equity and build out on a 4 year cliff?"

I've never heard of this and would refuse it. Are you sure they don't mean a 4 year vesting with a 1 year cliff? That's more standard.

Michael Barnathan Adaptable, efficient, and motivated

July 23rd, 2013

As for the rest:

"Shares transferable to any type of future share issued at a 1:1 level?"

That's pretty standard: Seed Preferred is probably the most flexible form of share you're going to issue. 1:1 to common is usually what they want, so they can cash in on an IPO. Transferring Seed Preferred to Series A preferred would be weird, since the seed investors are usually at the top of the pecking order in terms of payout.

"In the event that future shares are issued at a lower price, additional shares will be issued at no cost to investors so their average cost per share is the same as the current round."

This is known as anti-dilution protection. It's pretty common. Ask them whether they're doing full-ratchet, broad-based weighted average (what this sounds like), or narrow-based weighted average. Full-ratchet anti-dilution terms are pretty draconian, weighted average less so.

"Investing body may require that company engage 'investing body' management services."

This is too vague. Are they requiring that you do business with their management firm in exchange for the investment? That's kind of sketchy.

"Permanent put option (at specified terms)."

Depends on the terms. Treat it as part of their equity.

Matt Farnell

July 23rd, 2013

Hey Daniel, My advice is to stick as closely to 'market' standard docs as possible, and to that, I'd look to use https://angel.co/docs, second to that choose a lawyer that specializes in startups (like wsgr, orrick, gunderson etc), as they will have best practice term sheets. Just my 2c :), Good luck, and congrats! cheers, Matt

Umed Latifov New Ventures

July 23rd, 2013

These are not good terms, assuming your company/product/traction is somewhat solid. If you don't need to raise money, don't! Wait till you build more leverage to negotiate better tens, if pertinent to wait. Message might have typos, errors, mistakes ....

Tony Rajakumar Founder/CEO at SnugBoo

July 23rd, 2013

In Silicon Valley, these terms would be considered harsh. Not sure what stage you are, which industry you are in or how much you are raising, but assuming it's a standard seed round, and especially if you can operate without raising money, then I would imagine a simple convertible note would work. It allows you to retain control, which is key, and kicks all of these issues down the road to a later financing.

Phil Mitchell Founder at Larkwire

July 24th, 2013

Daniel, read Brad Feld's Venture Deals book.