First, there’s the Class F stock documents created by Wilson Sonsini and hosted on TheFunded Founder Institute.  This is by far the most entrepreneur friendly of the three example term sheets.

Second, the Y Combinator hosted Series AA documents, available here. These are representative of Angel funding documents, and were created by Wilson Sonsini.

Third, the NVCA hosted documents, available here. These are more representative of Venture Capitalists, as you may expect.

Last, but certainly not the least, is Wilson Sonsini again (seeing a pattern?) providing an exceptional tool to automatically generate term sheets after answering a questionnaire.

External Links

Guy’s original post

The second set of documents is from the The National Venture Capital Association (NVCA) and was created by a leading set of VC lawyers.

The intention is similar with both sets of docs, to reduce the time and money required for early stage investments. If you have never seen a Term Sheet before, these might be a bit much to dive into. We’d suggest starting with our Term Sheets topic page or one of our guides.

External Links

Y Combinator hosted Series AA documents, available here.

NVCA hosted documents, available here.

1. Pre-money valuation
2. Investment amount
3. Option Pool creation
4. Liquidation Preference
5. Dividends
6. Convertible vs. Participating Preferred Stock

Negotiating all of these terms in parallel is the suggested method, as all of them together influence the complete valuation.  Let’s take an example…

Example

• $4M investment
• Case 1: $6M pre-money valuation with a 15% option pool created from the pre-money side
• Case 2: $4.5M pre-money valuation with a 15% option pool created from the post-money side
• Both result in the same shares and % ownerships for the investor and entrepreneur.

By understanding each of the these individual levers it is possible to understand the implications of all of the levers acting together.  In the future, we will provide a more complete perspective into all of the levers

• Founder’s Stock (owned outright from formation, no vesting)
• Restricted Stock (same as founder’s, but with vesting)
• Option Pool (usually for incentive plans)

Types of Preferred Stock

• Convertible Preferred
• Participating Preferred

Types of Stock Options

• Incentive Stock Options (ISO)
• Non-qualified Stock Options (NSO)

NOTE on Preferred Stock

Preferred Stock is different than stock market, as it includes:

• Conversion Rights (go from Preferred to Common)
• Liquidation Preferences
• Dividends
• Antidilution Rights
• Redemption Rights
• Protection Provisions
• and many more

External Link

Comparison of ISO and NSO

Let’s start with stock options.  Stock options are created from the Option Pool, which was described in an earlier post.  Warrants are not created from the Option Pool.  They are unique in that they can be used with Preferred Stock.  Both have to be exercised to get voting rights.

Another major difference is that warrants are not tied to an employee’s (or outside Board Member’s) employment time frame. Instead, warrants are typically valid for a longer term (3-7 years) and are transferable during that period.  Stock Options are instead tied to the employee and employment period.

Warrants are often used as an “equity kicker” for investors, meaning that they give upside potential for risk taken by the investor’s.  An example would be a bridge loan utilizing convertible debt.  In the External Links section below there are two good resources provided that go into more detail on how warrants are used in financings.

External Links

Terms of Bridge Loans
Pre-VC investment structures

Let’s look at the example shown on the right. First, let’s take the initial exit amount at $15M. In this example, everyone walks away with some money. Now, change the exit amount from $15M to $5M (just enter and hit return). First off, you may notice is that the Convertible Preferred stock is no longer converting to common. Instead, it is staying as preferred during the exit. Also the liquidation stack takes over, and you see that the last investor (VC2) walks away with all $2M of their initial investment as this was a 1x liquidation preference. The first investor (VC1) only receives $3M of their original $4M investment. Last, you’ll notice that the founders receive $0.

In this example, the seniority of the liquidation stack was on the last money-in. You can edit the exit amount and see various scenarios for what happens with the liquidation stack.

Illustrated on the right is the difference for methods used to create an option pool. In both pie charts, you’ll notice that the option pool size is 10%, as this is computed on a post-money basis (after the investment). On the top is the option pool created from the pre-money side. As the Investor bought 40% the company ($2M investment on a $3M pre-money valuation), that leaves 60% for the founder and option pool. Since the option pool accounts for 10%, logically the founder own’s 50% of the company. In the bottom the option pool is created from the post-money side, which dilutes both the founder and investor. Before the option pool, the founder owned 60% while the investor owned 40%. Dilution to both sides is based on the 60/40 ratio. Therefore, the founder goes from 60% ownership to 54%. The investor goes from 40% to 36%.

The equations are shown for these two situations. Please note that you can update the values and watch the equations solve for other values as you desire.

The example to the right illustrates how each type of preferred stock behaves given the same exit event. Participating will always give a higher return to the investor than convertible. Try some different exit values to see how each type of stock behaves.