WHAT SHOULD THE TERMS BE IN A VENTURE CAPITAL FINANCING?

Series A Table of Terms


This is a comprehensive list of all of the terms you will see in a typical Series A venture capital financing. Follow the recommendations on the right. Focus on and understand the important terms. Don't waste your time worrying about the unimportant ones.

Economic TermWhat it isRecommendations and Comments
Liquidation PreferenceThis is how much investors receive from a liquidity event such as a sale, merger, etc. of the company before common shareholders. It's expressed as a multiple of the purchase price per share. So 2x means that the investor has a right to receive 2 times its original investment amount. If the investors invested $5M at a 2x liquidation preference and if your company gets sold for $100M, the investors will receive $10M out of that $100M before you get any of it as a founder/common shareholder. Or, instead, the investors can convert their preferred shares to common and receive their distribution based on their ownership percentage with the rest of the common shareholders.

Type: Economic Term
Liquidation preference should be 1x. Too high of a liquidation preference is discouraging to founders.

Importance: Very High
Participating/Non-participatingPreferred stock is either participating or non-participating. This term goes hand in hand with the liquidation preference. Preferred stock that is participating allows for preferred investors to receive their liquidation preference and then also participate in the distribution; i.e. receive distributions ratably on an as-converted to common basis. Non-participating only allows for the preferred to receive their liquidation preference (the preferred are of course allowed to instead convert to common and receive proceeds pro-ratably.)Founders and investors should both strongly oppose participation as this is a form of double dipping.

Importance: Very High
PricePrice per share is what the investors will pay for equity in the company. This is based off the valuation of the company (what the company is worth.) Be careful to differentiate between "pre-money valuation" and "post-money valuation." Pre-money valuation means the valuation of the company before the investment while post-money means valuation of the company with the investment included. Founders want the price to be high. Investors want the price to be low.

Importance: Very high
Anti-DilutionAnti-dilution protection protects investors from being diluted (i.e., their ownership percentage of the commpany going down) when additional shares of the company are sold for less than what the investors paid for them.The startup company and investors both should avoid full-ratchet price-based anti-dilution protection to investors.

Importance: High
Pay-to-PlayThese are provisions that cause investors, who do not partake in future rounds of financing, to suffer some consequence such as having their anti-dilution rights stripped away or having their preferred shares convert to common.Pay-to-play provisions can be helpful to encourage investors to support the startup for the long haul. They are used in a minority of financings.

Importance: Moderate
Staggered FinancingsThis is where the company receives additional funding conditional on certain events or certain goals having been met. Avoid this type of milestone approach as goals change and can be subject to too much interpretation.

Importance: Moderate
WarrantsWarrants are the rights to purchase shares in the startup at a pre-determined price. It's a type of option some times issued concurrently with preferred stock. Avoid the warrant route. Investors and founders both get tripped up by them. They can also indirectly lead to a lower valuation.

Importance: Moderate
Dividend RightsRight to receive a payment from the company. This is generally a distribution of profits. Range is 5-12% for startups.Dividends are not a big deal in the startup world. They are not very common. Make sure that if there are dividends that they are noncumulative and only given when approved by a majority or supermajority of the board.

Importance: Low

Control TermWhat it isRecommendations and Comments
Board of DirectorsA group of individuals that are elected that have a duty to govern the company.Typical size for an early-stage startup is 5 board members. Number balance between founder interest and investor interest is crucial. An outsider of the company to serve as a board member can be valuable to provide a different perspective on matters.

Importance: High
Preeemptive Rights (Pro-rata Rights) (Right of First Offer)These are the rights that allow an investor to purchase shares in a future financing round of the company in order for the investor to maintain its ownership percentage with certain exclusions for stock options and similar.Preemptive rights should be granted to only investors who own a certain threshold of shares. Avoid super pro-rata rights where investors are allowed to purchase more than ownership.

Importance: High
Right of First Refusal (Restriction on Sales) (Right of First Refusal on Common)This imposes restrictions on the ability of founders/management to sell their shares to a third-party. If the founders wish to sell their shares to a third-party, the founders must give notice of the proposed sale to the company and allow the company to purchase the shares first. If the company declines, then the investors get the right to purchase the shares. This is a provision good for both the company and the investors.

Importance: High
Voting RightsThese are the rights of the shareholders of a startup to vote on certain matters that affect the company. Most voting within the startup is done on an as-converted basis with the preferred and common stock voting together as one class.

Importance: Moderate
Protective ProvisionsProtective provisions are esentially veto rights for the preferred investors. Basically, unless the investors agree, the company cannot do certain X, Y, or Z.Make sure that there is a proper threshold to keep protective provisions in place (that enough preferred shares exist.) Also try to keep all of the series of preferred to vote together as a single class.

Importance: Moderate
Drag-Along Rights (Bring-Along Rights)This is the right to force others to agree to a specific action. It is a type of voting agreement.Drag-Along Rights are typically relevant to a sale of the company. Have drag-along rights follow the majority of the common stock.

Importance: Moderate
Optional ConversionAllows the preferred stockholder to convert preferred stock into common stock at a pre-determined ratio.Allowing for optional conversion is normal even though most preferred stockholders never exercise this right.

Importance: Low
Automatic ConversionPreferred stock converts automatically into common when there is an IPO of a certain agreed upon size. All preferred stock an also "automatically" convert if a majority of preferred stockholders agree to conversion.Company will want the threshold to convert lower and investors will want them higher.

Importance: Low
Information RightsThis is the right of investors to receive certain information, such as financial information, on a periodic basis.Couple information rights with confidentiality agreements.

Importance: Low


Liquidity TermWhat it isRecommendations and Comments
Redemption RightsThis right allows the investor to force the company to purchase the investor's shares. The investors purchased shares in the company and now want the company to take the shares back.Be careful of these. These rights should not be triggered for at least 5 years. The startup should try to push out the redemption right trigger as long as possible.

Importance: Moderate
Co-Sale/Tag-Along RightsIf the founder wishes to sell stock to a third-party, then the investor gets to sell as well.There should be exceptions to allow the founder to sell to certain parties or in certain amounts (e.g. for estate planning purposes.) Giving flexibility and room to breath for the founder is good for all of the parties.

Importance: Moderate
Demand RightsThis is a registration right. The investors can force the company to register its shares with the SEC. The investors will do this if it wishes for the company to do a public sale of stock.Registering with the SEC is very expensive so the startup should limit this right of the investor. An investor should not be able to demand registration for atleast a number of years.

Importance: Low
S-3 RightsThis is another type of registration right that forces the company to register the investors stock on Form S-3.This is expensive for the company and should be limited.

Importance: Low
Piggy-back RightsA type of registation right that allow investors to have their shares included on a registration of a startup's shares with the SEC.This right is often cut-back by the underwiter of the offering.

Importance: Low


Management TermWhat it isRecommendations and Comments
Employee Option PoolThis is common stock set aside for a stock option plan for employee compensation and for incentive purposes.10-20% is standard. Founder favorable is to keep this amount low around 10%. Investors will typically want higher. See what your hiring needs are to see how much to set aside.

Importance: High
Invention Assignment AgreementThese types of agreements are created in order to make sure that intellectual property created by founders, employees, etc. belong to the company and not the individual.Make sure that even IP created before the company is created belongs to the company.

Importance: High
VestingVesting is a mechanism in which a founder's shares are subject to repurchase by the the company in order protect the company from certain events such as the founder leaving. A time table is set such that, over time, the shares are slowly owned outright by the founder without possibility of repurchase from the company. The usual time table is 4 years with a 1 year cliff (the founder will own 1/4 of the shares after a year, and then more shares will vest to the founder on a monthly basis.) Make an 83(b) election with the IRS. There are circumstances where the vesting schedule can be accelerated.

Importance: High
Founder's ActivitiesVCs may wish to restrict a founder from working on other projects or moonlighting.This is typically not a big deal and any other obligations should be disclosed to the VCs.

Importance: Low


Contractual TermsWhat it isRecommendations and Comments
No-Shop AgreementThis is a mechanism in which the company agrees to not look to shop around with other VCs or other parties for a set period of time. The VC wants to deal with your startup and does not want you to seek a, perhaps better, investment deal elsewhere for a set period of time.A no-shop provision is usually good for around 30-60 days. Any more than that is excessive. A no-shop agreement can be good in that it encourages both parties to get the deal done.

Importance: Low
IndemnificationIndemnification provisions help limit investors' and directors' liability. The company agrees to indemnify them for any claims brought against them by a third party as a result of the financing.This is pretty normal and often the company will be required to purchase Directors' and Officers' Insurance.

Importance: Low
AssignmentAn assignment clause allows for the investors to be able to transfer shares to its partners and other affliates.Make sure that transferees are subject to the underlying financing agreements.

Importance: Low