Being presented with a term sheet can be an emotional experience. That emotion can be excitement about what is perhaps the first firm commitment received from an investor ever. Or it can be a sense of relief, as demanding fundraising efforts seem to come to fruition. Indeed, in some cases, a wave of anxiety as you glance over the terms and become unsure as to what really matters.
Fret not, there have been countless guides written about how to negotiate your term sheet — and we are not going to repeat that great advice. Our recommendation is to start with Brad Feld and Jason Mendelson’s classic: Venture Deals. Its subtitle “Be Smarter Than Your Lawyer and Venture Capitalist” is spot on.
Nevertheless, in the spirit of transparency, we wanted to share our Term Sheet and our thoughts behind some of the clauses we deem most important. We recently spilled the beans about what makes up the byFounders' Secret Sauce: access to top-notch operational expertise, our global network, and a founder-friendly core. The latter is so ubiquitous these days, however, that without concrete facts to back them up, such claims become dull clichés.
As such, the time has come to lift the veil off the most tangible feature founders can use to assess the degree of a VC’s founder friendliness: the Term Sheet.
Our term sheet illustrates how we continuously question the status quo. When establishing the fund, our founders and managing partners, Eric Lagier and Tommy Andersen did not just want to do a copy-paste of existing VC practices, but rather ensure that they showcased byFounders’ values. Their backgrounds as serial entrepreneurs, having been on the other side of the table multiple times, enabled them to take a fresh approach when crafting our terms.
You can see our entire term sheet here:
Below, we will highlight and comment on the elements we think are the most important for founders at a seed round financing.
One of the first things you may notice is that our term sheet is written in English as plain as a legal document allows for. When we discuss terms with founders, as in all other interactions, it’s important to us that all parties see themselves as equals. It wouldn’t be in our interest to shroud predatory terms in complicated language to unsettle or confuse. We’re playing the long game, and our relationships with founders are our most valuable assets.
Our business is called venture capital for a reason. A VC’s fund success is made on a few huge wins, whereas most of our investments will never even get close to returning our fund. While we believe that every single one of our investments can become a unicorn, we know that statistically, this is highly unlikely.
Because of our unwavering commitment to the upside — this is what we optimize for and focus on. We are less concerned with protecting our downside, as we don’t think unicorns are conceived while haggling with founders on things like liquidation preferences and anti-dilution rights.
We prefer only to take common shares and no liquidation preferences. We ask existing investors from previous rounds to convert any preferred shares to common when we lead pre-seed and seed rounds. We take these steps because we believe that aligning our interests with those of founders is critical.
Anti-dilution means that if we pay EUR1/share in a company that goes on to raise money at a price-per-share (PPS) lower than EUR1, our share price will be recalculated retroactively to a lower price, meaning we would be able to protect our share of ownership in the company while founders would get diluted.
We do not think this kind of clause supports the alignment of interests between founders and investors — on the contrary. We’re working to level the playing field between investors and founders; hence we avoid these clauses ourselves, and upon leading a new round of investment in a company in which existing investors have these rights, we push hard for their deletion.
The journey to startup success is not exactly a walk in the park. We know this first-hand. Founders go through these trials with the reasonable expectation that their hard work will materialize into great, tangible results, also financially. Unless explicitly designed so, this is not the same for employees.
The best talent out there is aware of this, and they will be discerning when evaluating whether your company is where they want to spend their best years. If you’re going to build the strongest team, it is imperative that you offer them to take part in your success.
When you set up your company, set aside 20% of your shares for an ESOP pool. This allocation will only become more challenging to make as you grow, and at the latest, it should be in place before we invest.
From time to time, we may allocate part of the ESOP to the founding team to bring them back up in ownership, as this is the single most crucial element of founder incentivization.
We’ve previously shared the sage advice that your board should not be made up solely of investors. When we work with our portfolio companies, however, we don’t first and foremost consider ourselves financial investors. We aim to be the “wingman/woman” to the founders and their company by helping and guiding rather than controlling and dictating.
When evaluating whether to invest in a company, we must understand how we can help the company move forward. We want to ensure that founders call on us when they need our help. Not because they are obliged to do so, but because they appreciate our contribution. If we don’t see that we can provide value, we don’t invest. Simple as that.
As long as it is the founders’ wish, we are happy to serve on our portfolio companies’ boards. What matters to us is that the board member can provide real value to the founder and the company, so whether it is someone from our team or somebody from the byFounders Collective is less important.
Either way, we believe most of the value of any board member, investor, or advisor is to be had outside of the board room.
We believe it’s essential that founders sit on most of the board seats from pre-seed through Series A. The board should be composed in such a way as to reflect relevant competencies rather than shares held.
Read more about our recommendations for building your board here.
Co-founder dynamics can be challenging to maneuver. Many promising companies have gone under because the founders’ relationship went sour, making it difficult to manage and grow. As much as we vet the founding team, there will always be cases where a founder leaves the company. Sometimes this is due to external factors as well.
Whatever causes a founder to leave, the best way to deal with the situation is proactively.
Like a good couples’ counselor would say: have the hard talks when things are still rosy. Draft up the most difficult parts of contracts — such as key man clauses — before things go south, and listen to experienced people with skin in the game. We’ve seen enough of these scenarios play out to the detriment of promising founders and teams, and we can help you set up foolproof provisions.
Our key man clause terms are standard: 48 months with a 12-month cliff. Terms of a scenario in which a founder leaves the company within the 48 month vesting period depend on what causes the departure. The leaving founder shall in any leaver scenario sell all unvested shares at par value.
The latter is important for two main reasons. One, if a co-founder decides to jump ship after just a few months or a year, it would be unfair to let the remaining co-founders keep building without being properly incentivized. Two, having “dead equity” on your cap table is not favorable at later financing rounds.
Some VCs operate with clear cut definitions of what constitutes a good vs. a bad leaver scenario. Our position is that each situation is unique and requires individual assessment. We characterize as “bad” any leaver scenario in which a founder:
Everything other than the above is a good leaver scenario, in which the shares are sold at fair market value. In a bad leaver scenario, the shares are sold at par value. Should the remaining founders refuse to buy the shares, they should be offered to existing shareholders on a pro-rata basis.
Paramount to our relationship with founders is trust. This may partly be a product of our Nordic roots, partly the outcome of observing what characterizes the most successful founder-investor relationships over the years. Trust lets us quickly get to the core of any issue and find solutions, rather than getting obstructed by more or less concealed efforts to control risk and flatter egos.
We work hard to establish trust early in the relationship — this is what we talk about when we keep referring to the Ugly Slide:
“If you come to us without an “ugly slide,” we will assume one of two things. Either you’re not telling the truth, or you’re ignorant and don’t understand your business. The ugly slide is your “get out of jail free card” and we won’t hold what’s on it against you. On the contrary, it builds trust and shows that you know your business and the dynamics of the market you are entering — as well as your own limitations.” — Eric Lagier, Managing Partner
This attitude is reflected in our Warranties terms, which establish the founders’ legal responsibilities related to the company’s operations at the time of our investment. We require founders to declare compliance with relevant laws and regulations to their knowledge. This means that should anything come up later suggesting a breach; it is the company, not the founder, that is liable. However, we run a tight due diligence process, so this has not happened to date, neither do we expect it to — but we do think founders appreciate the level of trust we offer them.
We don’t interfere more than necessary in how founders run their business. Of course, it’s our wish that founders see the value in conferring with us on difficult matters. As per our term sheet, however, we only require to weigh in on a few material decisions:
All these points represent actions that can change a company’s trajectory fundamentally. Given that we have partnered with you, we want to participate in such decisions.
A note on board votes: we don’t often, nor do we wish to, see board debates get to this point while a company is still young. Board meetings should be kept solution-oriented, and board members should focus on how they can provide value and point in the right direction, not extract or control anything.
At the time of an exit, we require that a majority of the shareholders may drag shareholders who are hesitant or opposed along in a sale of their shares on equal terms.
We think it’s important for a founder to be aware of this because the absence of such a clause can lead to scenarios where hold-out shareholders need to be bought out last minute. While some VCs will include a drag-along provision that only requires the preferred shareholders’ approval to trigger it, we insist that the drag-along be triggered only by a qualified majority.
We've shared our thinking on the term sheet, and will happily discuss it further with those interested. Our primary advice to founders is, however: Educate yourself. Make sure you understand what's on the table, and decide what matters to you before you start negotiating. Work with advisors you can trust, and who are experienced in structuring startup deal terms. Ask for recommendations from other founders.
As always, if you're a startup and think we should talk, please submit your deck here: