Decoding Deals: How 2 Come to Terms with Angel and Venture Term Sheets
Term sheets: Can’t live with them, can’t live without them, definitely can’t make sense of them. Mike Conza, Partner at Morgan Lewis, walked us through some of the complexities in How 2 Come to Terms with Angel and Venture Term Sheets.
He opened the session by explaining the difference between angel and venture capital. Angel capital is money invested directly by an individual investor, in the form of convertible notes, SAFEs, common stock, and seed or other preferred stock. Venture capital, on the other hand, is investor money actively managed by investment professionals, generally in the form of Series A and later preferred stock.
In either case, think about what you’re receiving. As Mike explained, “What you’re looking for is more than just money.” You hope to gain active, strategic business advisors who can offer perspectives and access to their own networks.
Convertible Notes and SAFEs
Convertible notes and SAFEs (Simple Agreement Future Equity) are very similar. They are mechanisms that can help you fundraise when you don’t know or can’t agree upon the valuation of your company, and they both convert to equity at a trigger point: a qualified financing round, which often happens one to two years out. Mike summarized the benefits of notes: “The beauty of a note is that you’re punting on the valuation point.”
Often offered with a convertible note or SAFE, discounts are a perk for investors. 20% is a common discount or, expressed differently, the investor is exchanging the note for shares at a per share price equal to 80%.
Maturity and interest are important considerations as well. While both convertible notes and SAFEs pertain to equity and contain terms like discounts and conversion caps, SAFEs aren’t technically debt and therefore won’t ever come due.
Common and Preferred Stock
Stock, on the other hand, is a direct equity investment that comes along with economic and voting rights. Valuation must be set, and this is when you will hear terms like pre money valuation and post money valuation come into play.
Venture capitalist will always be looking for preferred stock while angel investors are often looking for common stock. What’s the difference? As Mike explained, “Common stock is the baseline of equity in a company.” Common stock tends to be very simple (for example, one share = one vote), while “preferred stock starts layering in other concepts.” Preferred stock tends to come along with priorities, namely liquidation preference, and control, such as special voting rights and anti-dilution provision.
Don’t forget about pre money shares, or the total shares prior to a financing round. Pre money shares can include founders’ shares, stock option pools, and convertible notes. They matter because they are the denominator in the equation to determine the share price. The bigger the total of pre money shares is, the higher the share price and the fewer shares that will ultimately be issued to your investors.
- Share Price = Pre Money Valuation / Pre Money Shares
- Shares Issued = Investment / Share Price
Interested in learning more about investors and terms?
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