What are the key considerations in structuring a term sheet to protect against conflicts of interest?

2 Liquidation preference and participation

Another key term that can affect the alignment of interests between the investors and the founders is the liquidation preference and participation. Liquidation preference is the right of the investors to get their money back (or a multiple of it) before the common shareholders (usually the founders and employees) in the event of a sale, merger, or dissolution of the company. Participation is the right of the investors to share in the remaining proceeds after they receive their liquidation preference, or to convert their preferred shares into common shares and participate on a pro rata basis. Both liquidation preference and participation can influence the distribution of outcomes and incentives in different exit scenarios. Therefore, it is important to balance the protection of the investors with the motivation of the founders and avoid excessive or unfair terms that may create conflicts or disincentives.

3 Board composition and voting rights

Another aspect of a term sheet that can impact the governance and decision-making of the company is the board composition and voting rights. The board of directors is the body that oversees the management and strategic direction of the company. It consists of representatives from the founders, the investors, and sometimes independent or external members. The board composition and voting rights determine how much influence and control each party has over the company's affairs and how they can resolve disputes or disagreements. Therefore, it is essential to design a board structure and a voting mechanism that ensure a constructive and collaborative relationship between the investors and the founders, as well as respect the interests and rights of the minority shareholders.

4 Anti-dilution and preemptive rights

Another term that can affect the future financing and ownership of the company is the anti-dilution and preemptive rights. Anti-dilution rights are the rights of the investors to adjust the conversion price of their preferred shares in case the company issues new shares at a lower valuation than the previous round. This protects the investors from losing value due to a down round. Preemptive rights are the rights of the existing shareholders to purchase new shares in proportion to their current ownership before they are offered to new investors. This allows the existing shareholders to maintain their percentage of ownership and avoid dilution. Both anti-dilution and preemptive rights can influence the availability and attractiveness of capital for the company, as well as the dynamics and relationships between the existing and new investors. Therefore, it is important to negotiate and specify the terms and conditions of these rights and how they will be applied in different scenarios.

5 Vesting and acceleration

Another term that can affect the alignment and retention of the founders and key employees is the vesting and acceleration of their equity. Vesting is the process by which the founders and key employees earn their shares over time, usually based on a certain period of service or performance milestones. Acceleration is the event that triggers the immediate vesting of some or all of the unvested shares, usually due to a change of control or termination of employment. Both vesting and acceleration can influence the commitment and loyalty of the founders and key employees, as well as their incentives and expectations in case of a sale or departure. Therefore, it is important to agree on a vesting schedule and an acceleration clause that reflect the contribution and value of the founders and key employees, as well as the best interests of the company and the investors.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?