A Guide to Venture Capital Term Sheets

AGuidetoVentureCapitalT[e-mail]:30:019/10/0713:30:01OriginalcoverconceptandguidelinesbyIUVO:30:389/10/0713:30:38PageIIntroduction2IIWhatisaTermSheet?4IIITheinvestmentprocess6IVWhattermsmaybeincludedinaTermSheet?81.Typeofshare82.Valuationandmilestones83.Dividendrights94.Liquidationpreferenceanddeemedliquidation105.Redemption126.Conversionrights127.Automaticconversionofshareclass/series128.Anti-dilution(orpriceprotection)139.Foundershares1410.Pre-emptionrightsonnewshareissues1511.Rightoffirstrefusal,co-saleandtagalongrights1512.Dragalongorbringalong1613.Representationsandwarranties1614.Votingrights1715.Protectiveprovisionsandconsentrights(classrights)1716.BoardofDirectors/BoardObserver1817.Informationrights1918.Exit1919.Registrationrights2020.Confidentiality,IntellectualPropertyAssignmentandManagementNon-competeAgreements2021.Employeeshareoptionplan2122.Transactionandmonitoringfees2123.Confidentiality2124.Exclusivity2125.Enforceability2226.Conditionsprecedent22VVenturecapitalglossaryofterms23VIExampleofaTermSheetforaSeriesAround351IndexW3858Termsheetstext.indd1W3858Termsheetstext.indd19/10/0712:15:15pm9/10/0712:15:15pmTheBVCA-TheBritishPrivateEquityandVentureCapitalAssociationistheindustrybodyfortheUKprivateequityandventurecapitalindustry.OurmembershiprepresentstheoverwhelmingnumberofUK-basedprivateequityandventurecapitalfirmsandtheiradvisers.TheBVCAhasmanyyearsofexperiencerepresentingtheUKindustry,whichontheworldstageissecondonlyinsizetotheUnitedStates,togovernment,theEuropeanCommissionandParliament,themedia,regulatoryandotherstatutorybodiesathome,acrossEuropeandaroundtheworld.Wepromotetheindustrytoentrepreneursandinvestors,aswellasprovideservicesandbestpracticestandardstoourmembers.Theventurecapitalinvestmentprocessisnowawell-establishedmeansofraisingfundsforearlystagecompanies,usuallythoseinvolvedinseekingtoexploitnewdevelopmentsintechnologyorlifesciences.Aprivatelyfundedcompanymighthaveanumberoffundingrounds.Thefirstroundisoftentoraiseasmallamountofmoney(seedcapital),theinvestorsoftenbeingfriendsandfamilyoraspecialistearlystageventurecapitalinvestor.Forroundswithoutaventurecapitalinvestortheremayormaynotbeformalinvestmentdocuments.Thereisabigdifferenceinthenatureofventurecapitalinvestmentdependingonthestageofinvestmentanditisimportanttotrytomatchtheskillsofaninvestorwiththoserequiredforaparticularbusiness.AfirstroundofinvestmentfromventurecapitalistsisusuallycalledaSeriesAround,withsubsequentroundsprogressingthroughthealphabet.ThisGuidereviewsthosetermsthatmaybeincludedinaTermSheetforaSeriesAorforsubsequentinvestmentrounds,althoughnoteverytermdiscussedwillbenecessarilyappropriateforeveryinvestment.Sometimesinvestmentsaremadebywayofdebt,butthemajorityofinvestmentsaremadebywayofapurchaseofshares.ThisGuidedealsonlywiththelatter.TheaimofthisGuideistoprovidethosewhoarenotfamiliarwiththeventurecapitalinvestmentprocesswithanoutlineofhowinvestmentscanbestructured,thetermsandterminologytypicallyusedinaTermSheet,andthebroaderinvestmentprocess.Itishopedthatthisfamiliaritywillassistthosewhoaretryingtoraiseventurecapitalbyhelpingthemtounderstandthecommercialimplicationsofthetermsbeingoffered.ThisinturnwillhopefullyexpeditethenegotiationofTermSheetsandcompletionoftheinvestmentprocess.AfterthesectionoutliningthepurposeofaTermSheet,thereisasectiondescribingtheinvestmentprocesswithsomeworkedexamplesofhowthesharestructurealtersincertaincircumstances.Thereisnextaglossaryoftermsmostoftenusedinventurecapitaltransactions.WhereeachtermisusedforthefirsttimeinthisGuideitisinitalics.Finally,thereisanexampleofaTermSheetforaSeriesAround.ThishasbeenincludedtoshowhowthevarioustermsdescribedinthisGuidemightbesetoutinaTermSheet.IIntroduction2W3858Termsheetstext.indd2W3858Termsheetstext.indd29/10/0712:15:16pm9/10/0712:15:16pm3TheselectionoftermsaddressedinthisGuidewillnotbeappropriateforeveryventurecapitalinvestment,butshouldcovermostofthetermstypicallyusedintheUKtodayandpointoutafewofthemajordifferenceswiththepracticesinContinentalEuropeanjurisdictions.TocomplementthisguidetherearenowavailableontheBVCAwebsite()standarddocumentsforventurecapitalinvestment,namelyasubscriptionandshareholders'agreementandarticlesofassociation,togetherwithexplanatorynotes.Itshouldbenotedthatprivateequityisthegenerallyacceptedtermusedtodescribetheindustryasawhole,encompassingbothmanagementbuy-outandbuy-inactivityandventurecapitalwhichrelatesexclusivelytotheseedthroughtoexpansionstagesofinvestment.ThisGuideisrelevantprimarilytoonlytheventurecapitalstagesofinvestmentandsothiswillbethetermused.TheBVCAandIwouldliketothanktheVentureCommitteeworkinggroupforthetimeandeffortmadeinpreparingthisGuide.Thiswasco-chairedbyJohnHeard(AbingworthManagementLtd)andSimonWalker(TaylorWessing)andalsoincludedFr