Making Sense of Termsheets

Nishant Verman

July 2013

Investor Yatra

My Background

Startup

Corporate

Education

Termsheet = Valuation

» Termsheet is the blueprint for your future relationship with your

investor

» Encapsulates two aspects:

› Economics: investor returns in liquidity event

› Control: mechanisms for investors to exercise affirmative or veto

» As with other things in life – there is no good or bad term!

› Depends on demand vs. supply of capital, market conditions,

your business etc.

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What is my company worth?

Valuation

» Pre and Post: Pre-money is value of your company before you raise

funding; Post-money is the value including the funding you raise.

› Post-money = Pre-money + amount raised

› Investor Ownership % = Amount Raised / Post-money

» Example 10 Cr. raise on 20 Cr. PRE 30 Cr POST.

» Gives investor 33% of the company

» Valuation driven by what market is willing to bear.

» Key : focus on Increasing total value vs. Ownership %

Type of Equity : Preferred Shares vs. Common Shares

» Investors want Preferred shares which come with special rights

» Example all the rights we will talk about now (next few slides)

Liquidation Preference

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Explained:

Quantum of money that investors receive preferentially, prior to other shareholders

receiving any proceeds in case of liquidity (such as sale of a company).

Investor Intent:

• Investors try to balance risk and reward in investing

• Valuation paid in current round is typically in recognition of future expected value

• If business fails to create that value, Liquidation preference is intended to provide

some base level of return

Let’s Do a Simple Exercise

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Series A

Pre-money Valuation = $10M

Investment Size = $5M

Post-money Valuation = ?

Let’s Do a Simple Exercise (cont’d)

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Series A

Pre-money Valuation = $10M

Investment Size = $5M

Post-money Valuation = $15M

VC Ownership = 5 / (5 + 10)

= 33%

Now let’s look at liquidation preferences!

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Exit Value = $30M

1 No Liquidation

Preference 2 1x Liquidation Preference,

Participating

Investor ownership = 33%

Investor Return = $10M

Cash-on-Cash = $10 / $5

= 2x

Investor ownership = 33%

Liquidation Pref. Amt = $5M

Remaining Proceeds = $25M

Investor Participation = $8

Investor Return = 5+8 = $13M

Cash-on-Cash = 13/5 = 2.6x

Anti-Dilution Protection

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Explained:

Provides existing investors ability to get to a lower valuation for the current round by a price

adjustment in case the company raises capital at a lower price than current price.

Investor Intent:

• While investors are willing to take the business risk, at the downside, they are protecting

themselves against a valuation risk.

• They are also protecting themselves against significant dilution due to a low priced

offering in the future.

Protective Covenants

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Explained:

Provides investors an ability to influence key decisions affecting the company. Also referred

to as affirmative rights, these are items to which the investor must consent for them to take

effect e.g., Dividends, M&A, ESOP plans, CapEx etc.

Investor Intent:

• Typically, venture investors take minority stakes in the company

• However, they are desirous of ensuring that they have enough controls to be able to

influence key decisions, and prevent leakage of value.

Exit Rights

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Drag Along

• States that if the company is

unable to provide an exit to the

investor after a certain

amount of time (X years)…

• …the investor can sell his

shares to a purchaser, but if

required can also force (DRAG)

the promoter and other

shareholders to sell some of

their shares, and at the same

price as the investor.

Co-Sale:

• Co-Sale: states that if the

Promoter is selling his shares,

then the investor has the right to

sell their shares at the same

price along with the Promote

Now the fun part...let’s negotiate!

TERM OPTION 1 OPTION 2 Type of Share Preferred Preferred + Common

Valuation $4M $6M

Liquidation Preference 1x 2x Participating

Board Seats 1 Board Seat 1 Board Seat + 1 Board Observer

Anti-dilution Broad-based weighted average

Full-ratchet

Drag Along 6 years from Closing 5 years from Closing

Vesting of Founder Stock Equally over 4 years Equally over 4 years; 1 year cliff

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