If you are looking to raise funds you are going to encounter a term sheet. A term sheet is a legal document prepared by venture capitalists that states the important terms of a proposed investment. If you receive one, don’t celebrate too hard by acting like a rock star by recklessly smashing your old Macbook pro. Its time to contact an experienced attorney (yes that is yours truly) and negotiate the terms.
There are a couple of points that you will have to negotiate with your investors before placing your John Hancock on the dotted line.
VALUATION. When you receive the term sheet for the first time, you will likely focus on what the company is worth. You will see the terms pre-money and post-money valuations. As you can probably guess, pre-m0ney valuation is the price of the company before investment and post-money is after investment. If you are an entrepreneur, your goal is to have your pre-money and post-money valuations to be as close as possible. These means that you get to claim more of your company.
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PREFERRED STOCK. When you start your company, the shares you create are called common or founders stock. Investors do not like common stock. They want preferred stock, which grants them a number of protections.
LIQUIDATION PREFERENCES. If a liquidity event occurs you need to know how money will be shared. A liquidity event can include a variety of scenarios, including bankruptcy and a sale of the assets. Your goal as an entrepreneur is to limit any liquidation preferences.
NO-SHOP PROVISIONS. Toward the end of the Term Sheet, there is usually a provision that will not allow you to obtain additional funding. You should limit this provision to 30 days.
FOUNDER VESTING. Once you learn about this concept, you may jump out of your seat. You actually have to earn your shares. With reverse vesting a certain amount of shares are put aside and are earned over a period of time. Basically the founders want to ensure that you don’t leave the company.
ANTI-DILUTION. This provision is used to protect the investment if the start-up obtains additional financing at a rate lower than the previous round. As Brad Field explains, there are two types: weighted average anti-dilution and ratchet based anti-dilution.
OPTIONS. Usually, the term sheets will reserve some stock for stock options. This will be used to compensate employees. You may dicker with your investor whether the size of that pool is determined using the pre-money or post-money valuation.
Term sheets are complicated and this discussion is by no means complete. It is vital to understand the nuances of specific clauses within the term sheet as it could make a huge difference in the final sum that you earn when you cash out.
The Law Office of Frederic R. Abramson represents both entrepreneurs and investors in New York. If you have a question regarding term sheets, contact me at 212-233-0666.
Angel Investing is expected to pick up in 2011. In the past, tapping a home equity line of credit was a critical way for entrepreneurs to fund their business. But since that avenue for for borrowing has dried up, entrepreneurs have had to look for alternative ways to fund their business. Todd Taskey, writing in Small Businesses Trends takes a “look behind the curtain” to see how one very successful angel investment group tracks and considers its investments. He looks at 3 factors- 1) Pre Money Valuation, 2) Liquidation Preference and 3) Market Perspective.
by Fred Abramson on December 12, 2010 · 2 comments
With theunemployment rate a hair under 10 percent, the job outlook for many college students is not bright. With the mountain of debt that awaits upon graduation, many are starting their own businesses.
The road to creating a successful business is not easy. The stats show that most businesses fail within the first five years.
In an effort to help young entrepreneurs, Scott Gerber has started the Young Entrepreneur Counsel. Mr. Gerber and the Counsel were featured in the New York Times. The Counsel’s mission “is to teach young people how to build successful businesses and fight the devastating epidemics of youth underemployment and unemployment.” After perusing the website, the group looks like a great resource.
The group has hooked up with a who’s who of all the big players of the Entrepreneurial media scene, including Mashable and Business Insider (my two favorite business blogs).
Mr. Gerber has also started the Gen-Y fund , which helps entrepreneurs obtain funding.
The life of a start-up can be like riding the Taconic State Parkway, a single mistake can cause serious damage. Many entrepreneurs try to “play lawyer” to try to save money. I don’t really understand the concept. Simply because you know how to change the oil in your car does not make you a mechanic.
Recently Harvard Business School professor Constance Bagleymade a list of the most frequent legal mistakes made by entrepreneurs, everything from hiring the wrong lawyer to puffing up the business plan. I bring you his list, along with my 2 cents.
Thinking any legal problems can be solved later. If you are an entrepreneur, you don’t need me to tell you that you are probably engrossed by your idea. You think night and day about bringing your business to market. I see it all of the time. But when it comes time to thinking about the legal implications 0f your ideas, you procrastinate. “We don’t have enough money.” “Let’s focus on producing the best product and we’ll deal with the legal issues later.” Huge mistake. Legal issues not addressed at the start, such as an inexpensive contract with a web developer can result in expensive litigation later.
Promising more in the business plan than can be delivered and failing to comply with state and federal securities laws. In your business plan that present to potential investors, you have to be honest about valuating your business. If your valuation has no reasonable basis, you can be sued for fraud. Be aware that there are securities laws that protect your grandmother’s friend Matilda from investing in your venture.
Disclosing inventions without a nondisclosure agreement, or before the patent application is filed. Non-Disclosure Agreements also known as NDA’s are surprisingly cheap for a lawyer to draft. For less than an iPad 3G you can protect your business from someone stealing your ideas.
Waiting to consider international intellectual property protection. First off, my firm handles only trademarks so I won’t discuss the legal ramifications of patents. However, if you have any inkling that you want you brand to go global, do an international trademark search and register. You don’t need the headache of dealing with a trademark infringement suit with a company from China.
Negotiating venture capital financing based solely on the valuation. Valuation is not the be all and end all when it comes to financing.
Issuing founder shares without vesting. Some entrepreneurs are great at creating ideas, but hate running a business. If you are planning to start your company with a number of founders, especially a serial entrepreneur, you must protect the founders who stay. If a founder exits the venture early, then you can get back the shares.
Failing to make a timely Section 83 (b) election. Your eyes are probably glazing over this one. But the Section 83(b) election is vital for tax purposes, especially if you plan on paying the founders shares rather than a salary. An 83 (b) election allows the tax computation to be made based on the value at the time the shares are issued, which is often minimal.
Failing to incorporate. Without incorporating, your personal assets would be put at risk.
Starting a business while employed by a potential competitor, or hiring employees without first checking their agreements with the current employer and their knowledge of trade secrets. Your employer can argue that the company is theirs, especially if you worked on your project on company time.
Hiring a lawyer not experienced in dealing with entrepreneurs. It is amazing how many entrepreneurs contact my office and only focus on price. “How much do you charge to review my contract.” Business law is a specialty and requires experience. Many lawyers don’t understand the 83(b) election, which if improperly drafted, could cost you hundreds of thousands of dollars. A Venture Capitalist will have a seasoned attorney representing them and they will provide you paperwork that may contain traps. Why risk it?
The Law Office of Frederic R. Abramson represents entrepreneurs and start-up companies. Contact me at 212-233-0666.
Thinking startup? Since you are reading this blog, you probably are. David S. Rose‘s rapid-fire TED U talk on pitching to a venture capitalist tells you the 10 things you need to know about yourself — and prove to a VC — before you fire up your slideshow.
Here are a few talking points:
Integrity and passion are the 2 most important characteristics of an entrepreneur.
There is an interesting guest post on Techcrunch Europe by Richard Leyland, an entrepreneur who started WorkSnug, a location-based service for mobile workers. His company has launched in sixteen cities and may be considered a global company. What is unique about his company is its committment that none of his employees will fly in the […]
On July 4, we celebrate the entrepreneurs who were our founding fathers who made a difference by bringing social change to America. Unlike July 4, there is nothing particularly unique about the date of March 4. On that date back in 2006 final contact was attempted with Pioneer 10 by the Deep Space Network. Unfortunately, no response was […]
Senators Dick Luger and John Kerry introduced today a new piece of legislation entitled “The Startup Visa Act of 2010.” This visa would permit immigrant entrepreneurs to stay or immigrate into the United States if they have secured “significant” funds to start a new company. The goal of the act is to bring new jobs, […]
Calvin Chin, an American entrepreneur in China, wrote an insightful guest post in Techcrunch about startup culture in China. He recently attended the World Economic Summit in Davos, so you know that he has his ear to the ground on what’s going on in the largest country in the world. Calvin Chin believes that the […]
