The Ideal First Round Term Sheet (continued)

So Adeo Ressi of The Funded has posted his version of the idea first round term sheet. TechCrunch blogged about it here.

I have not had a chance to go through the term sheet line by line and evaluate it against other versions I've seen. I do think it is progress that we've got a discussion going on about this issue and I hope we'll coalesce around something standard that we can all use.

But I thought I'd address the three terms that TechCrunch highlights about The Funded's term sheet:

– A 1X liquidation preference – I am all for this. I cannot imagine why anyone would want a multiple liquidation preference in a first round term sheet. There are reasons why that might make sense in a late round financing, but not in a first round.

– Elimination of participating preferred – I prefer a straight preferred but there are times when a participating preferred makes sense, even in a first round. When the valuation gets bidded up to a price that would not allow the investors to make a return on an exit in the short term, and when the entrepreneur wants to control the exit, it makes to issue a participating preferred so that the investors can still get a return on their capital in the event of an early exit (the quick flip). If a participating preferred is used, it should go away at some multiple of the price paid (I prefer 3x).

– Single trigger acceleration – I don't like this provision for a lot of reasons. Chris Dixon, who started this whole discussion off last week, describes it well in this blog post. Chris recommends a double trigger with a partial single trigger acceleration:

you should have full acceleration on “double trigger” (company is
acquired and you are fired).  In addition you should have partial
acceleration on “single trigger” (company is acquired and you remain at
company).  I prefer a structure where you accelerate such that you have
N months remaining (N=12 is a good number).  This gives the acquirer
comfort that the key people will be around for a reasonable period of
time but also lets the founders get the equity they deserve without
spending years and years at the acquirer.

Chris also has some thoughts on his blog today regarding The Funded's proposed term sheet.

There are now about a half dozen templates out there for the ideal first round term sheet. There is the Y Combinator version, the Wilson Sonsini version, the Cooley version, the Gunderson version, and now the Funded's version. I am on vacation today and trying to unplug as much as possible so I am not going to hunt all these down and link to them. Maybe someone will do that in the comments.

The bottom line is this is a great conversation and we are headed to a place where we will see more standardization of terms, lower legal fees, and better terms for entrepreneurs. But there are times when you need to veer off the standard form and it's important to recognize when that is and why.

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Comments (Archived):

  1. Justyn

    I’ve enjoyed the dialog on this subject from all angles. Really helps me understand not only what a good term shoot looks like, but also what to avoid. Thanks Fred and others who have shared their insight on this subject in the past week! Greatly appreciated!

  2. Jason

    once your your back from vacation, maybe share your views on vesting and acceleration? seems to be a topic that would make another great discussion…

    1. fredwilson

      Chris sums them up nicely in his post

    1. ShanaC

      Does anyone know who lead the team for TechStars and if it was a usual sheet or an unusual sheet?

    2. fredwilson

      Brad is the ace on this topic. He has consistently been at the forefront of educating about terms and evangelizing for simplification and standardization

      1. valto

        at Startup Commons we have created this 3 item list to tackle this whole issue and would love to get your and the whole community’s ideas and feedback to this first item

  3. FounderInstitute

    There are different stages and goals for the various templates. TheFunded Founder Institute template is designed to cover a “Plain Preferred,” likely a Series A, Meanwhile, the Y Combinator documents are meant to cover a plain angel round, and so on…The goal should be to move away from expensive custom deals to standards that align incentives.

    1. fredwilson

      Yes. But the founder institute term sheet is a non starter in a few places for me

      1. FounderInstitute

        How would you specifically make changes to turn it into a template that you would use? What clauses are missing?

        1. fredwilson

          I wrote a post called the ideal first round term sheet. In it I pointed to chris dixon’s post. I think chris has largely got it right

        2. fredwilson

          I wrote a post called the ideal first round term sheet. In it I pointed to chris dixon’s post. I think chris has largely got it right

  4. Ted Wang

    I agree with the general line of thinking here and have been pushing in this direction for two years (See…. My only objection to the samples I’ve seen is that they do not go far enough. If it is a true seed round, we should dramatically reduce the amount of paperwork as I suggest in my prior post.

    1. fredwilson

      Hi Ted, nice to hear from you.can you imagine a one page document for a seed investment?

      1. markslater

        i’ve seen it in a 2 pager – neighbours of yours in NYC fred.

      2. Ted Wang

        Fred, I can not approach the one page Nirvana, but we can do better than the proposals that are floating around out there. There are two ways to skin this cat:1. “Priced debt” which is essentially a convertible note with a ceiling on the conversion price (e.g. no matter what the note will not convert at a price higher than $4m pre money). This is the cheapest and fastest way to do a seed round while maintaining price. The docs are only a couple of pages long. The problems with this approach area) Fear that the notes are more likely to get “reset” (i.e. the terms are disregarded): Concept is that a subsequent investor will just disregard the note terms. There’s no logical reason why this should be the case, but in practice I have observed notes getting reset in the past.b) Harder to do Board of Directors: for some technical reasons you would need a separate voting agreement to effectuate this and now we’ve just made the short version of the docs longer.c) Don’t get all of the details: If you do a note deal, you are essentially relying on the next round’s counsel to look out for your terms and frankly there’s a misalignment of incentives. A successful seed investor is more closely aligned with common stockholders so you won’t have a set of eyes on some of the smaller detailed points.Even with these draw backs, I think priced debt makes a lot of sense for a true seed raise.2. The “Simple Series A” is the approach that I’m suggesting. It’s really just (a) a charter (b) a slimmed down purchase agreement and (c) an investor’s rights agreement that contains the items that seed investors want (pro-rata participation and information rights) and omits the stuff that later investors might care about (registration rights, indemnification etc).I think this approach is ideal for a true seed stage investment, maybe one that is north of $1m but south of $2m and has a VC involved. It addresses all of the issues with priced debt but does so in a way that is more slimmed than the current model.I’ve got a pretty decent draft of Simple Series A documents on my desk. I’ve been hoping to find a deal to test them out (I’d be happy to do it with Gunderson whom I find very thoughtful and reasonable on these issues). If we can make this the default for seed rounds, I think this will be a big contribution to the venture ecosystem.

        1. fredwilson

          I like the simple srs A. I don’t like convertible debt. I understand the price is capped, but I I’m taking equity risk, I want equity returns

  5. Raja Bhatia

    I am curious as to why many VC’s are so adamant against single trigger acceleration on a liquidity event. If the concern is that single trigger acceleration clauses could kill a scare off a potential acquirer due to lack of retention mechanism, wouldn’t structuring the transaction so that there is a large earn out component work not only work to the same effect but could essentially reduce risk by tranching the acquisition cost by attaching performance milestones. The same thing would play into effect if many of the key players were already fully vested. Would love to know your thoughts on this as well as @cdixon’s…

    1. Tyler Willis

      Hey Raja, Earnouts aren’t always the ideal strategy as they require a great amount of autonomous control to be left in hands of the acquired company. The newly acquired team usually doesn’t want rely on the performance of unvetted members of a completely different corporate culture for their payday. Yet often the goals of the acquirer include eliminating redundant roles and running both orgs at a higher profit margin.I went to a chat at Wilson Sonsini recently where the partner speaking described earnouts as being a fantastic mechanism to facilitate acquisitions in unique circumstances like down markets — but he advocated strongly against using them as retention mechanisms or a new default deal structure.Also, it’s worth mentioning that most big acquirers like Microsoft seem to prefer large cash bonuses over earnouts as retention vehicles.

    2. fredwilson

      if you accelerate everyone’s vesting on exit, you signal that is the end of their work. and often it is not.

  6. Guest

    Fred, on participating preferred: do your LP’s have participation preference? Your position would be much stronger if what you are proposing mirrors to some extend the terms by which you guys play. I just don’t see how some of you guys can collect carry on a 1.15x multiple, that’s just wrong.

    1. fredwilson

      that is a bullshit argument. they are not the same thing at all. i give my LPs their money back before i take a penny of carry. and then i take 20pcnt of whatever profit we generate. many entrepreneurs own 50% or more of their companies.i’ll do an 80/20 deal with an entrepreneur if that is what they want. they don’t want it.

      1. Guest

        n many startups the VCs do own 80-90%… I reread your post and am a bit confused: we are talking about _standard_ term sheets, but on the participating preference you talk about _specific_ cases, where it is needed. In a negotiated term sheet this is a matter of give-and-take, you get the PP but give something else. Now, if you are saying that PP should be standard because in SOME startups the VC own less than 50%, that’s BS. I guess it could standardized with further prescription; say VCs get PP if the preferred class as a whole is 50% or less… I don’t know.The argument is not different at all for the LPs, in fact it is exactly the same: how to lock-in some return in the border-line payouts. I see what you are saying re the 80:20, but it still does not feel right to take carry on sub-treasury returns. Perhaps your industry should move to 30% carry with 7-8% preferred divident. Punish mediocrity, reward performance…

  7. Pascal-Emmanuel Gobry

    You’re right that some terms are better for some cases and others not. Even though it’s broadly good that different people are putting forward their versions of the “ideal” term sheet, which allows to have a conversation and competition, I think what’s needed is more like a term sheet “spectrum” (which is what these various term sheets are in effect creating, I agree).If law is code then many legal documents need an API. As an ex-future lawyer I often thought that for the vast majority of legal documents there should be a website where you simply choose what you want from a set of drop-down menus (and other basic HTML forms), and it spits out your legal document. Most lawyers would say that that wouldn’t be adequate for the many documents where there are specific provisions to watch out for — and they’d be right. But there’s definitely an 80-20 rule when it comes to legal documents/contracts/etc.(Might make a great startup too.)

  8. Mark Essel

    I used to fantasize about women, future tech, and supernatural mysticism.Now all I do is daydream about investments without strings so I can build a long term business.I’d say I’m devolving.

  9. Guest

    If participating preferred is used, what do you think of letting the pref shares get their money back (1x investment) then the commons get the same amount, then you share the balance ro-rata?

    1. fredwilson

      That’s the same thing as a straight preferred

  10. Guest

    duplicate deleted

    1. fredwilson

      Re-read the post. At the end it says ‘but the are times when you need to veer off the standard form’Don’t worry too much about VC economics. They work just find for the firms that put up the numbers. The other ones won’t be around in ten years

    2. fredwilson

      Re-read the post. At the end it says ‘but the are times when you need to veer off the standard form’Don’t worry too much about VC economics. They work just find for the firms that put up the numbers. The other ones won’t be around in ten years

      1. Guest

        O, I see… So you are proposing that the PP stays negotiable. Makes sense to me. cheers

  11. jsrand

    I’m glad to see the interest that this series of posts is generating. I think you’ll find that most lawyers who practice regularly in this area would love to be able to work with simplified documents in true first-money financings. We don’t expect to get rich (or maintain a good realization rate) from the fees generated in seed stage financing rounds, either on the company side or the investor side. The goal is to build a long-term relationship and there is little to be gained from sending a bill that is out of proportion with the dollars being raised.The key issue I see is convincing investors to take the leap of faith to move towards simpler documents. I’ve tried to use reduced-fat documents, similar in concept to those referred to here, when representing companies in seed rounds, and the typical response from investors or their counsel (even in angels-only rounds) is that they want to go with the full-text (and sometimes full-text-plus) versions of the NVCA model documents. While those forms have been useful in standardizing arcane provisions such as antidilution and rights of first refusal, they are best suited for later-stage financings and are overkill for a first round. Can you envision a tipping point coming on this issue?

    1. Ted Wang

      To me the tipping point is getting a few VCs on board. Unless investors take the plunge this is somewhat academic. I’m working on that issue. Fred seems game!

      1. jsrand

        Agreed, Ted.I think the only real way to templatize these documents is to develop Blumberg-like forms for them, like we have in New York for real estate contracts. And then, of course, each investor or law firm will develop its own 50-paragraph “rider”.

        1. fredwilson

          Negotiating the rider instead of the docs is a start

  12. ptanthos

    Fred,Love the dialog and earnest efforts to simplify things. Could not agree more that giving even 10k to lawyers to execute a legal agreement between two excited parties is a crime against humanity.But, one provision that seems to be in every one of these ideal term sheets that can be much more injurious to the common and way too protective of the preferred is anti-dilution protection. I may be missing something, but while the intent of this provision may be to prevent the common from issuing more stock without providing benefit to the preferred, it is very one-sidedly harmful in cases where the economy has dictated a change in valuation as in last October. Unless you were Twitter (congrats) last year, you most likely were looking at a value in November that was well below what that same company was worth in August or September.If that company had to raise money last winter it was very likely that the common would take the lion share of the hit while the preferred would benefit from the anti-dilution provision and reap additional stock, albeit at a lower valuation.Seems to me if I am reading the spirit of this discussion is that interests should be shared wherever possible other than on a few terms like valuation.Perhaps some justification of this provision might be in order…

  13. Mark Mc Laughlin

    Enterprise Ireland through their HPSU (High Potential Start Up) programme have a standard SSA that they use for the 70-80 companies in which they invest in each year, one of whom was Ticket Text. The term sheet has been signed off in advance by a handful of the best known law firms in Ireland who will represent the start up for a price within a fixed range. Although there is some deviation in terms of additional clauses that are required on a case by case basis, the structure of the investment is the same for each company.

  14. paramendra

    Good stuff.

  15. valto

    We too have been working on this subject to simplify this term sheet issue. Instead pondering on it just by ourselves, we decided to spin-off this part of our internal development at grow vc, to a separate non-profit.IE. “open source” this part of development, to tackle this problem with following approach: 1. create categorizing model to identify different types of early start-ups quickly 2. find/build/attach high level sets of terms for different categories 3. develop efficient web tool to better manage the logistics and communication of the agreeing process (start with high level term sets by category with “blog style” commenting per each term)As a non-profit SC will make all of the work freely available to it’s members. We also hope this non-profit will have a great life of it’s own, since it’s a vehicle that nobody can own, acting only to support global startup ecosystem.Anyone wanting to participate, you are welcome to join us. We need plenty of resources.