11 July 2011
Review of the Seedsummit Term Sheet
Please read the summary post (above) before reading this one.
Summary: Last week, Seedsummit released a Term Sheet intended to be (or become) standard across Europe for early stage investment. To achieve this, 21 European VC firms convened and agreed on a ‘standard’ set of terms. The aim of producing this document is to make “… seed funding easier to access, better to understand, and fair for all parties”. If you want to, you can download the general term sheet for yourself. I’ll go through this document below.
Things to note
Before I get into the document itself, there are a few things I should point out:
- The most important is that I Am Not A Lawyer. Anyone dealing with legal docs should obviously get legal advice. However, since this term sheet is meant to be “reader-friendly” (as SeedSummit says), I’d hope that someone like myself should be able to understand and interpret it to some degree. If not, one of the benefits of this document diminishes since I still need a lawyer to translate it for me.
- I’m only reviewing the general term sheet, not the EIS specific sheet.
- I’ve read typical angel investment docs since I’ve led one angel investment before (for someone else). Hence my point of view is likely to be influenced by that.
- I’ve never seen a term sheet from a VC so I can’t make any specific comparisons between the new SeedSummit sheet or a prior VC term sheet (though I’d like to).
- Obviously, everything you read is here is just my opinion. Whether you agree or disagree, I just want to see some discussion.
About Seedsummit
I realised I know very little about Seedsummit itself so I looked around their website and also for other links via Google.
In a few words, SeedSummit is Europe’s answer to AngelList. More specifically, it’s SeedCamp’s answer to AngelList (it’s run by the same people rather than independently). It seems there are about 120-ish investors (assuming all profiles are visible) and the investment range is from 10k to 500k EUR (which is the kind of range I consider to be ‘seed’). Randomly clicking through the profiles, I see that the majority of them say “I am investing: My own money”. At first, I took that to mean there were more Angels on the platform but looking closer I noticed that some of those profiles are of Partners in VC funds. Although these folks have ‘skin in the game’ I expect they only invest via their funds so it would have been more appropriate to say “Money from a fund”. In any case, this made it more tricky to guess at the ratio between Angels and VCs on Seedsummit, so I gave up trying. If anyone else knows the answer, please let me know.
Comments on the Seedsummit Term Sheet
I’ll go through this term by term and note my comments so you can follow along with the document. I’ll skip the stuff that doesn’t warrant much discussion (e.g Company, Founders, etc). Since this document was based on the Series Seed documents from the US, I’ll also make a quick comparison between them.
Structure of financing
The pre-money valuation includes the employee share option pool, which effectively dilutes the founders a little more than they would otherwise have expected. There’s a pretty good post by Fred Wilson on valuations and option pools and I’d recommend people read that for more information.
Type of security
This basically says that the new shares have preferential rights (i.e they are not common stock).
Liquidation preferences
There are two options here and both state “… one times the original purchase price …”, in other words it’s the same amount of money the investor put in. Had this been anything other than ‘one’ it would be cause for concern. The main difference between the two options is whether the investor is non-participating or fully-participating which are quite different.
Non-participating means that the investor can do one of two things when there’s a ‘liquidity event’ (e.g acquisition). They can either make sure they get their money back (i.e one times the purchase price), with any left over being divided amongst the other shareholders. Or they can choose to get an amount in proportion to the shares they hold. They will take whichever returns the most money. Obviously, both the founder and investor want the sale to be as large as possible so both will be aiming for the latter case. In the case where the exit isn’t quite what the investor imagined, then they’ll try and get their money back. It seems there is an example of this in practice when Fred wrote about Slide.
Fully-participating means the investor gets to do both of the above. They will get their money out first and then will also take a share of any left over money (sometimes referred to as ‘double-dipping’). This is definitely the less founder-friendly option and I expect founders would not accept it (assuming they have enough bargaining power to push back). It does seem a little odd to me that this is listed as an option in an early stage term sheet, especially since terms usually get carried forward into subsequent funding rounds. For an example of how liquidation preferences can affect the way money gets distributed, you can read VentureBeat on liquidation preferences (scroll down to the example).
Anti-dilution provisions
This term, which is indicated as optional, dictates what happens if a subsequent round of funding occurs at a lower valuation than the current one. Except it doesn’t. Those deceptive square brackets could hold a range of scary sounding words and in some cases you might even find equations in there. Since there’s no suggested text here, I don’t have much to say. Feel free to google and you’ll find some variations on what could end up in here.
Important Decisions
A list of things you can’t do without the investor’s consent. The options here basically whether the list is written in the terms or referred to in an appendix. From the suggested list, there isn’t anything I haven’t seen before.
One thing that might be missing is the proportion of shares that must be maintained by these investors to maintain this right. As it stands, the investor could hold any amount of shares and still maintain the right (e.g they could hold less than 5% and still block a sale of the company even if the other 95+% agreed to it).
Pre-emption, Right of first-refusal and Co-sale
I’ve seen most of this before but there are a couple of things I don’t understand. Firstly, for pre-emption, “The Investors my assign this right to another member of their fund group”. I have no idea what this means since I can’t figure what ‘fund group’ is being referred to. Secondly, for the Right of first-refusal, I’m not sure what “…transfers by Investors to affiliated funds” means either.
Drag Along
The important point here is that both a majority of the Preference shares and of the Ordinary shares is required to enact it. Had it only been a majority of Preference shares then it would be drastically one-sided.
Restrictive Covenants and Founders Undertakings
Other documents come into play here, for example the employment contracts. An interesting point is that the founders shouldn’t work on anything else during their ‘business time’, which mean any side projects might need permission from the investors. It’s reasonable to expect founders to commit themselves to the business but they would need to check the employment contract to make sure there isn’t anything untoward. The last sentence referring to immediate dismissal for cause seems a little harsh.
Founder Shares
Apparently the shares held by founders would be subject to reverse vesting. In effect, whatever shares you thought you ‘owned’, you don’t really have anymore. Reverse vesting means that although you have your shares the company will repurchase them from you (at practically no cost) if you leave or are fired. That ‘right-to-repurchase’ diminishes over time. This doesn’t sound like a good deal for the founders but it’s understandable that the investor wants to keep the founders committed to the company.
The interesting part are the suggested figures. 25% of the founder shares vest after a year and the rest on a monthly basis over another two years. This seems a bit excessive to me. Firstly, I don’t see any reason why more of the shares can’t vest immediately and the rest on a monthly basis thereafter. Secondly, I think a three year time frame is quite long and although I’ve seen it for employee options it doesn’t seem appropriate for founders at an early stage. (edit to add: I’ve heard from friends in San Francisco that four year vesting with a one year cliff is pretty standard out there)
For the kinds of startups I’ve dealt with, I’m generally of the opinion that if a founder leaves, then the company is effectively over. Provisions for clawing back shares, like the one one here, seem largely pointless to me. In any case, I think founders will have to look carefully at what the vesting looks like and see if it works for them
Expenses
Option 1 just plain sucks. I find it slightly ridiculous that the investor expects the company to pay for their legal fees and the amount isn’t even capped. Option 2 is slightly better in that everyone pays their own fees but it also includes a caveat that if the founders decide to withdraw, then they’ll have to pay the investor’s legal fees to date. That would seem fair enough but notice there’s no caveat for the case where the investor decides to change their mind. I’d certainly push for that to be added too.
Brief comparison with Series Seed
The Seedsummit term sheet is itself based on the Series Seed documents so I thought it would make sense to do a quick comparison between them.
There are a handful of things I noticed which were:
- Series seed only mentions a non-participating liquidation preference (Seedsummit includes an option for fully participating)
- In the Series Seed document, the investor’s legal expenses are paid for by the company but they’re capped ($10,000).
- Series Seed’s founder vesting is over 4 years (but gives no suggestions).
- No anti-dilution provisions in Series Seed term sheet
If you got this far then congratulations on your patience!
You can either go back to the summary post or upvote and comment on HN
