17 Fundraising Terms Founders Need To Know
The investors you're negotiating with understand these... do you?
It’s the end of August which means one thing: fundraising season is about to kick off.
There’s no “right” time of year to raise but the markets are always busy from early September until mid-December, as investors are back between their vacations to the Amalfi Coast and Mexico City.
But the fundraising climate is tough right now — data from PitchBook shows VCs are having a hard time raising new capital for their funds.
Though uncommon, there are reports of some pretty bad behavior from investors already. There’s a direct correlation between bad investor behavior and how hard a time they’re having getting LPs to invest in their funds.
You don’t want to end up in a situation where a bad-actor investor snuck something through in their term sheet that leaves you in a tough spot later on.
But the truth is that investors understand term sheets better than most founders.
So this week I’m breaking down the terms and types of provisions you may see on term sheets, and what they mean so you can be equipped to protect your own interests in negotiations.
Also — I’m hosting a fireside chat and Q&A with a startup lawyer this coming week for community members to go deeper on these and more. Join here.
17 Fundraising Terms Founders Should Know
Preferred Stock & Liquidation Preference
As opposed to common stock, which is what founders typically have themselves, preferred stock offers the holder rights to get their money back first in a liquidation event.
They can take this one step further and ask for a liquidation preference, which is typically thought of as a multiple of their original investment.
For example, a 2x liquidation preference means that the investor gets paid back double their initial investment before other shareholders get paid back anything (even other investors!).
Right of First Refusal
If you give an investor the ROFR, they basically get the “first look” at the next round, and at whatever the best price is that you offer to any other investors.
There are two types:
Unconditional → The investor gets the lowest price in the next round no matter what.
Conditional → This protects you in the case of a down round. You set a minimum price for the ROFR. If the next round is under that price, it doesn’t kick in. Technically this can be any condition but price is the most common inclusion by far.
This takes it one step further and lets current shareholders purchase new shares before they are offered to new investors.
This is typically used as a way to allow them to maintain their ownership percentage in the company.
The specific number of shares an investor receives when converting an initial SAFE (or another type of convertible note) into equity when you eventually raise a priced round.
If an investor holds a note with a 1:5 conversion ratio they receive five shares for every dollar invested that they convert.
VCs often have ownership targets for each company they invest in.
But when you take on additional capital, the % of the company that existing investors own goes down.
Anti-dilution provisions give investors the option to either fully maintain their ownership percentage (“full ratchet”) or not fall below a certain percentage.
Drag-Along & Tag-Along Rights
Subscribe to Houck's Newsletter to read the rest.
Become a paying subscriber of Houck's Newsletter to get access to this post and other subscriber-only content.
Already a paying subscriber? Sign In