Securing funding is a monumental step, and with it comes a crucial phase: understanding and negotiating term sheets and investor agreements. These documents are the legal bedrock of your investment, outlining the rights, responsibilities, and expectations of both your startup and your investors. While they can seem daunting, a solid grasp of their key components will empower you to make informed decisions and protect your company's future.
The term sheet is typically the first legally binding document you'll receive from an investor. It's a non-binding (mostly) outline of the key terms of the investment. Think of it as a handshake agreement on paper, setting the stage for the more detailed investor agreements that follow. It's vital to have a legal professional review this document, even at this early stage.
Key elements you'll find in a typical SaaS startup term sheet include:
graph TD; A[Term Sheet Elements] --> B(Valuation); A --> C(Investment Amount); A --> D(Investor Rights); A --> E(Liquidation Preferences); A --> F(Board Seats); A --> G(Option Pool); A --> H(Protective Provisions)
Valuation: This is the agreed-upon worth of your company before the investment. It's often expressed as pre-money valuation (your company's worth before funding) and post-money valuation (pre-money valuation + investment amount). A higher valuation means investors get a smaller percentage of your company for their money.
Investment Amount: This is straightforward – the total sum of money the investor(s) are committing to invest in your company.
Investor Rights: These can include a variety of protections and privileges for investors, such as information rights (access to company financials), pro-rata rights (the right to maintain their ownership percentage in future funding rounds), and rights of first refusal (the first opportunity to buy shares if an existing shareholder wants to sell).
Liquidation Preferences: This is a critical clause that dictates how proceeds are distributed in the event of a sale or liquidation of the company. Common types include:
graph TD; A[Liquidation Preferences] --> B(1x Non-Participating); A --> C(1x Participating); A --> D(Participating Preferred)
1x Non-Participating: Investors get their initial investment back, and then all shareholders share in the remaining proceeds proportionally. This is generally the most founder-friendly.
1x Participating: Investors get their initial investment back and also share in the remaining proceeds with common stockholders. This can significantly reduce the payout for founders and employees.
Participating Preferred: Investors can 'convert' their preferred shares into common shares, effectively receiving their investment back plus a share of the remaining proceeds. This is the most investor-favorable and can be very detrimental to founders.
Board Seats: Investors often demand representation on your board of directors. The number of seats will typically be proportional to their ownership stake.
Option Pool: This refers to the shares set aside for employee stock options. The size of the option pool is usually negotiated and can impact dilution for existing shareholders.
Protective Provisions: These are clauses that require investor consent for certain major company decisions, such as selling the company, taking on debt, or issuing new stock. They are designed to protect the investor's interests.
Once the term sheet is agreed upon, your legal counsel will draft the definitive investor agreements. These are more comprehensive legal documents that flesh out all the terms outlined in the term sheet. The primary agreements you'll encounter are:
graph TD; A[Investor Agreements] --> B(Stock Purchase Agreement); A --> C(Voting Agreement); A --> D(Right of First Refusal and Co-Sale Agreement); A --> E(Amended and Restated Certificate of Incorporation)
Stock Purchase Agreement (SPA): This is the core document detailing the sale and purchase of the company's stock, including the price, number of shares, and closing conditions.
Voting Agreement: This agreement outlines how certain shareholders (usually founders and investors) will vote their shares on specific matters, such as board elections.
Right of First Refusal and Co-Sale Agreement: This formalizes the investor's right to buy shares before they're offered to others and their right to participate in a sale of shares by founders or other key shareholders.
Amended and Restated Certificate of Incorporation: This document modifies your company's charter to reflect the new terms, such as preferred stock classes and their associated rights.
Navigating these legal documents requires careful attention to detail and expert advice. Don't hesitate to ask your legal counsel to explain anything you don't understand. It's far better to clarify ambiguities now than to face unforeseen consequences down the line. Remember, these agreements are designed to foster a strong partnership between you and your investors, ensuring a clear path for growth and success.