By Fernando Berrocal

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The moment when your startup business is established is typically an exciting aspect for the business founder, regardless of whether you are a first-time player or a veteran entrepreneur. The moment you obtain a term sheet from a venture capital fund for your organization's initial preferred stock funding round is crucial in this business process, and a reason to celebrate. Aside from the understandable enthusiasm that you might have, it's crucial to thoroughly grasp (understand properly) and negotiate the term sheet's major clauses without any hesitation.

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When you haven't negotiated any term sheets, it might be difficult to comprehend what's truly important. However, it is crucial to remain focused and vigilant because many of these terms could have a long-lasting impact on your small business in the long term. That can be even if the term sheet is only about one or up to two pages. Small business attorneys and other competent startup advisors (such as mentors) are helpful in this situation.

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In the following points in this blog post, we have included a few of the most typical clauses that need to be carefully negotiated. As business lawyers do, we have disclaimed this post by noting that this list isn't meant to be a comprehensive breakdown of all pertinent clauses; before negotiating and signing a term sheet, do you a favor and speak with experienced startup experts.

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Valuation and Ownership Stake: This is one of the core business items of any term sheet. The question to ask yourself will be:  What is the investment's "pre-money value" about the sum invested? Or how much ownership will the investor(s) have in the business? This will not only show how much of your organization you are ready to give the investors as ownership, but it will also have a long-term impact on the firm's capital-raising activities in terms of future financing rounds, anti-dilution measurements, and option awards.

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It is crucial to always pay close attention to the business valuation and to remember that a greater value does not necessarily equate to a better valuation. The best advice we can provide you in this situation is to review and complete a pro forma cap table before signing a term sheet to ensure that you are aware of all the moving parts and the dilution effect of a round.

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The Directors' Board: This might be "your startup" but the term sheet will represent how much authority and influence, both in the boardroom and through shareholder protection clauses, which will grant the venture capital investor. Often, a term sheet from an investor would suggest a three-person board made up of two common stock representatives (founder and/or members of the founding team) and an investor representative.

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A bigger board, the use of an "independent" director to fill one of the common stock seats, the need that there always be a Chief Executive Officer (CEO) director, and other options are just a few of the many ways this may happen. To further complicate matters, even though the default rule is that a majority of the board members must agree to act, it's crucial to comprehend firstly the quorum and written consent rules. That is because their interactions with the composition of the board may have a greater influence than you might expect on board dynamics. Finally, to expect any proposed preferred director approval rights.

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A healthy, balanced, and effective boardroom is a significant factor in any firm's performance outside of the legal part, therefore it's critical to keep this in mind while considering term sheet offers and conditions from prospective investors. Early conversations with a prospective investor about board dynamics and board members are always beneficial since they enable you to properly assess an offer and make sure that all parties are on the same page.

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Vesting: A startup founder and other members are also being supported by an early-stage investor. Investors will want to make sure that the company's founders and other key employees are given incentives to stay on and continue growing it. Many investors may "reset" or adjust vesting conditions to guarantee important individuals continue around, even whether your share was granted at formation with or without vesting requirements. In addition to the length, it's crucial to comprehend the corresponding vesting clauses, such as what happens to your equity in the event of your termination or the sale of the firm.

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Protective Measures: A term sheet often contains a list of "protective clauses" in the investor's favor (or holders of most of the shares of preferred stock to be issued to the investors). This indicates that the investor is stating that certain business decisions must be made with an agreement. There are undoubtedly certain "industry standard" protection clauses, but before signing a term sheet, each one should be carefully thought through and considered. Understanding the applicability or non-applicability of legal responsibilities to members of a firm's board of directors and/or preferred stock investors is an intriguing discussion topic.

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Preference for Liquidation: This is unquestionably a fundamental economic and legal concept, and it is crucial to understand it and negotiate it since it will affect future fundraising attempts as well as the number of sale profits that may be distributed to common stockholders in the event of a departure. A one-time non-participating preference is the most common construction, although you may also come across terms like accumulated dividends, participating preferences, and other terms. Even though some of these expressions may seem like legalese, the liquidation preference is a crucial business word that affects the deal's finances, therefore it's crucial to comprehend all a term sheet's liquidation preference clauses.

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More importantly, even if you model out the situation and believe that the liquidation preference in a "small" series seed or series A financing round won't have a financial impact on you as an owner of common stock, it's crucial to make sure you can "see the forest through the trees" here when negotiating the liquidation preference. Receiving a term sheet is exhilarating, and executing one under favorable conditions will position you and the firm for an amazing and fruitful journey.

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