When an investor finally issues a term sheet, it can be overwhelming, regardless of the actual terms it presents. However, you need to know what each clause means and how they can impact your company. Here are some of the most common problems you’ll encounter that can prevent you getting the money your company needs:
What it is: “Acme ventures will invest $1M in a minimum $1.5M financing”. In this scenario, you will have to raise at least the minimum before this lead investor will close. Given the lead’s commitment you must raise an additional $500k ($1.5M min - $1M from lead).
How it Hurts: This provision can mean your round doesn’t close at all. If you don’t reach the required minimum, this investor will pull out. If other investors see the term sheet, they will worry why your lead lacks the conviction to fund you immediately.
Deadline to Close
What it is: “All participants in this financing must provide signed documents by <date>”. Thus every investor must agree to all the terms, have them approved by counsel and be ready to wire funds by this date.
How it Hurts: If the timeline is 4 weeks or less, it can force quick decisions on investors. If these investors’ process timeline extends beyond the deadline, you could miss out on both their capital and any additional help they might provide.
Post not Pre-money
What it is: “Acme Ventures will invest $1M at a $5M post-money valuation”. This usually indicates that regardless of the total amount raised in the round, this investor expects to own 20% of the company for their $1M investment.
How it Hurts: If you decide to raise more than the term sheet provides, you will suffer dilution but the investor will not. Using the example above, existing stockholders will experience 25% dilution, as the pre-money valuation is $4M ($5M post-money - $1M invested). However if company raises a total of $2M, then stockholders experience 67% dilution as the post-money remains at $5M, meaning the pre-money valuation drops to $3M ($5M post money - $2M invested).
Given the large impact of these common terms, it’s important you understand them and determine their relevance to your company’s situation. Understanding the ‘money’ terms will help you get the round closed quickly.
We’ll address terms related to your company’s board structure in Part 2.
This article is part of a series on Seed Fundraising:
1. When to Raise Money
2. How to Build a Deck
3. The Basics of Meetings
4. VCs vs Seed Funds vs Angels
5. How to get a Meeting
6. The 5 Most Common Pitch Mistakes
7. How to get Early Momentum
8. How to Handle an Angel Investor Meeting
9. How to Close the Lead Investor
10. 4 Investor Gotcha Questions
11. 10 Traits of Successful Founders
Thanks to Kaego Rust, Alec Barrett-Wilsdon and David Smooke for their help on this article.
Photo by Štefan Štefančík