Deciphering term sheets to ensure it’s a good VC deal

Governance and other terms

Board

Investors will often want to dictate the size, frequency and shape of boards. Larger minority investors, generally above ten per cent, will usually wish to appoint a board director to oversee their investment.

Whilst most investors will point to the value that an experienced investor will bring to a company board, it should not be forgotten that investor directors wear two very different hats. Firstly in their director capacity they have a fiduciary duty to represent all shareholders, but this may at times be in conflict to their interests as a representative of their own fund.

The role is hence part monitoring, and the implications of this should be understood by all entrepreneurs seeking investment from a VC.

Fees

Investment costs should not be under-estimated when raising capital. Investors, particularly at later stages, will often require that professional fees, often encompassing lawyers and due diligence, be met by the investee company. In a round with say three institutional investors it is not difficult to see circumstances in which these fees might be in excess of ?50,000.

Some funds will levy fees to cover their board appointments ? often this is part of a funds? business model, or sometimes a fund may appoint external third party individuals to oversee their investments and the fee arrangement then is made directly with the individual to be appointed. This can be in the order of ?15-20,000 for a typical Series A raise.

Some funds may also levy transaction fees for the capital raise, typically in the range of 2-5 per cent. All of these fees serve to reduce the level of net capital available to the business and can be upwards of ten per cent of the round in some extreme cases. Effectively this serves to reduce the effective pre money valuation of the business as the same number of shares are being issued for a lower level of net cash in.

Along with many other leading funds, Forward Partners does not levy any fees on its investment companies. This earlier blog post explains more about the Forward Partners model.

Warranties

Investors will generally require the key executives of the investee company to personally warrant, and for the company itself to warrant, that certain key items claimed during the investment process are true. A warranty is therefore a guarantee given by the company and the executive, against which they might later be sued if items are found not to have been true and can be proven to have caused material disadvantage to the investor.

Warranties are often many and varied, and will include for instance that there has been no material adverse change in the fortunes of the business, that the company is able to issue the shares, and that IP in the business is validly owned. There will often be a lengthy process of ?disclosure? against these warranties, so that certain items are not used by investors to sue the company in the future.

If there are circumstances you are likely to have to disclose to investors it is best to raise them early in the diligence when they can be dealt with constructively. Disclosing significant adverse events such court proceedings or tax liabilities at the 11th hour risks derailing the entire investment.

Conclusion

Raising capital is a like any other contracting process or RFP (request for proposal). Where you receive multiple proposals, it is likely that they will differ along multiple dimensions making direct or straightforward comparison very difficult. A high headline valuation for your business may well not be the best set of terms.

You will likely need to model a range of scenarios and test the impact of the terms on your business within these scenarios. The end choice will be determined by your particular set of circumstances. Good luck.

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