The Only 3 Terms That Truly Matter In Your Term Sheet
Originally posted on 1/15/20
Collin Gutman is a Co-Founder and Partner at SaaS Ventures, with over a decade of cumulative experience as both an investor and a startup founder. Prior to founding SaaS Ventures, Collin co-founded Acceleprise, the world’s first pure enterprise tech accelerator. Collin also has been an entrepreneur, having founded WorkAmerica, a social impact workforce development startup. Collin holds a BA cum laude from Yale University, and is an avid DC sports fan.
There have been countless dissections of term sheets, including an entire book written by Brad Feld (an excellent primer, if you want to learn more about each term). But I find that, when asked about their fundraise, entrepreneurs either show little understanding or feel compelled to list and explain every single term. If you understand every term in depth that’s wonderful, but you and your investors shouldn’t really care about the overwhelming majority of legalese in the term sheet.
While non-standard terms should be a red flag, and while this advice does not pertain to rounds Series B and beyond — where term sheets change dramatically, a standard vanilla Seed or Series A term sheet has lots of things that don’t matter. When a VC asks about your fundraise, they’re not interested in whether drag-along rights are included (it’s assumed), liquidation preference (if it’s not 1x in a seed round, something is funny) or whether your interest rate is 4% or 6% or 8% (a negotiated term with the lead). But none of those will govern whether an investor participates, and none really govern whether the term sheet is “fair” for the company. The three terms that drive the economics are:
Valuation, or valuation cap: In a later post, we will explain how investors perceive a valuation as compared to a valuation cap, but we will lump these two together for the time being. This is the largest governing term. It determines how much ownership investors receive for their capital. While we will also dissect the importance of price in different scenarios in future posts, just know that price is usually the first piece of a fundraise that will be relevant to investors. Some investors will pass solely based on price or be unable to look at the deal. Others will find the price exciting. Lead with that.
Amount being raised: Typically if you’re raising an amount that means you’re selling less than 20% of the company, investors will believe (usually for good reason) that the amount of capital being raised won’t let you reach a valuation inflection point, and your next raise will be at a not-substantially higher price, so they’ll want to wait. Similarly, investors tend to have check sizes they like to write, and round sizes in which they like to participate. So investors will want to ensure the round is appropriately sized for the company and their appetite.
Board composition: This one may be a surprise to most entrepreneurs, but it’s crucial to investors. A great investor won’t try to run your business, but a strong board member can provide the perspective and pattern-recognition to help the company avoid potential snags and obstacles, can problem solve with management when times get tough, can leverage their network to help the company and can provide or find follow-on funding in the future. While founders are often reluctant to share the decision-making burden, a stellar board can make a massive difference in a company’s trajectory — so investors will care whether a strong board is being composed or whether the round is a “party round” where the board continues to consist of the founders and an “independent” friend of the founders.
That’s it. If the rest of your term sheet is standard and in line with industry best-practices (look up any Series Seed docs online) that’s all I need to know. Don’t sweat the small things — focus on these terms.