What to watch for in a VC term sheet

When startup founders review a VC term sheet, they are mostly only interested in the pre-money valuation and the board composition. They assume the rest of the language is “standard” and they don’t want to ruffle any feathers with their new VC partner by “nickel and diming the details.” But these details do matter.

VCs are savvy and experienced negotiators, and all of the language included in the term sheet is there because it is important to them. In the vast majority of cases, every benefit and protection a VC gets in a term sheet comes with some sort of loss or sacrifice on the part of the founders – either in transferring some control away from the founders to the VC, shifting risk from the VC to the founders, or providing economic benefits to the VC and away from the founders. And you probably have more leverage to get better terms than you may think. We are in an era of record levels of capital flowing into the venture industry and more and more firms targeting seed stage companies. This competition makes it harder for VCs to dictate terms the way they used to.

But like any negotiating partner, a VC will likely be evaluating how savvy you appear to be in approaching a proposed term sheet when deciding how hard they are going to push on terms. If the VC sees you as naïve or green, they can easily take advantage of that in negotiating beneficial terms for themselves. So what really matters when you are negotiating a term sheet? As a founder, you want to come out of the financing with as much overall control of the company and flexibility in shaping the future of the company as possible and as much of a share in the future economic prosperity of the company as possible. With these principles in mind, let’s take a look at four specific issues in a term sheet that are often overlooked by founders and company counsel:

• What counts in pre-money capitalization
• The CEO common director
• Drag-along provisions
• Liquidation preference.

What counts in pre-money capitalization