Understanding Term Sheets during Fundraising

SDS 026: Navigating Startup Crises

Hey! thank you for reading issue 026 of Startup Definition Sunday (SDS).

SDS is the newsletter for founders, bringing you clarity one actionable tip at a time.

SDS arrives every two weeks (you guessed it) on Sundays.

In every issue you can expect:

• 1 Definition of startup jargon

• 1 actionable tip you can implement right away

• 1 article you should read

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Hello there!

I'm thrilled to share this issue with you! In case you missed the last one, you can find it here.

Last week, Marge and I held the last session of our biweekly office hours for Q4 2023.

If you missed the last session, you can catch it here.

We will announce dates for the Q1 2024 season soon.

I recently shared a tweet that resonated with many people, and it didn't come as a surprise.

Over the past three years, the majority of early-stage African founders have raised funds through Simple Agreements for Future Equity (SAFEs), with very few closing a priced funding round.

While SAFEs have their advantages, they often lack the legal clarity and protection that institutional priced rounds offer. That's why it's crucial to understand the intricacies of term sheets, especially the less common items that can easily go unnoticed. Let's dive in:

What is a term sheet?

Term sheet: a non-binding agreement that outlines the basic terms and conditions for an investment in an early-stage startup. It serves as a blueprint for the final legally binding documents in a priced funding round..

3 Less-Known Details to Watch for in Term Sheets

As more early-stage founders venture into raising priced rounds, I want to emphasize three uncommon areas in term sheets that require attention.

Liquidation preference: One critical item to focus on in a term sheet is the liquidation preference clause. This provision determines the order in which investors and founders receive their proceeds in the event of a liquidity event or exit. Understanding whether the term sheet includes a participating or non-participating clause is essential, as it significantly impacts the distribution of funds. Founders need to be aware of the potential dilution of their ownership stake and the implications it may have on their long-term vision for the company.

Anti-dilution protection: Another aspect that often catches founders off guard is the inclusion of anti-dilution protection in term sheets. While these provisions are crucial safeguards for investors, they can have a significant impact on the founder's ownership and control of the company. Anti-dilution protection aims to protect earlier shareholders from future down rounds by adjusting their ownership percentage if the company raises funds at a lower valuation. Understanding the different types of anti-dilution provisions, such as full ratchet or weighted average, can help founders negotiate fair terms that align with their long-term goals and aspirations.

Board composition and voting rights: Lastly, founders should carefully review the section on board composition and voting rights. This aspect often goes unnoticed, but it can profoundly impact the decision-making process within the company. As an investor, I understand the importance of having a balanced board that brings diverse perspectives to the table. However, founders need to ensure that they maintain a level of control over key decisions and strategic direction. Pay close attention to the composition of the board, supermajority voting provisions, and any potential veto rights that could limit the founder's autonomy.

Navigating the world of term sheets can be daunting, especially for African founders who may not be familiar with the legal intricacies. It's crucial to seek legal advice from experienced professionals who can help you understand the nuances and implications of each item in the term sheet. Remember, knowledge is power, and being well-informed will allow you to negotiate fair and favorable terms that align with your vision for the company.

If you have learned something valuable today, consider joining SDS so you don't miss exclusive sections in future editions.

If you only read one thing this week, read this...

SiftedEU published a great piece on: "What founders need to know about term sheets in a downturn".

Why should you give it a read? This article is a must-read for founders as it provides key insights into how term sheets change during a downturn and their significant impact on stake and control. It highlights the importance of understanding valuation, governance, and liquidation preference, and emphasizes the need for negotiation and legal advice.

Founder's Corner

As an investor, I know how challenging it can be for founders to get noticed by angel investors, especially without the right connections.

That's why I created an inbound form to allow founders to share their decks directly with me. It takes less than 5 minutes to complete. By breaking the mold and providing an alternative way for founders to connect with investors, I hope to help level the playing field.

That's all for today! As always, thank you for being a fantastic reader.

Until we meet again in two weeks, here's how we can stay in touch:

• 🐦 Find me on Twitter

• 💬 Hit me up on Linkedin

• 💌 Email me

• 🚀 Sponsor SDS (Reply to this email)

Let's chat again in two weeks,

Jasiel