We are often asked what to watch for when reviewing or negotiating US term sheets. Below are

a group of reasonably sophisticated venture capitalists (“VCs”) believe your sweat and tears

should be worth prior to their investment. In a term sheet, this often is expressed in terms of a

“pre-money” valuation, i.e., the value of your company prior to the investment round at hand.

Your “post-money” valuation reflects the value of the company following the investment round.

For example, if you have a pre-money valuation of $3,000,000 and your investors are putting in

$2,000,000, your post-money valuation is $5,000,000.

Your valuation establishes what percentage of your company your investors will own following

their investment, and the terms of that valuation will dictate some of the most critical aspects of

control and capitalization. In the example above, your investors will own 40% ($2M out of $5M)

of the company following the round. Assuming there aren’t any special controls in place or stock

Keep in mind is that a high valuation may not always lead to the best outcome for the company.

Many founders pursuing a high valuation inadvertently cede control and value that can

demotivate early employees. A high valuation can be enticing, but if it requires you to relinquish

a significant percentage of equity or accept draconian terms, you need to consider how that will

impact the business going forward. For many US-based companies, equity is the best way to

retain strong employees; devaluing and diluting them can trigger an often-irreversible exit in

top talent.

Non-US founders should preempt and address any weaknesses in areas where you may be

uniquely disadvantaged compared to your US peers. If most of your team is located outside the

US, be ready to explain how that helps to maximize efficiency across time zones. If your team is

mainly experienced in non-US markets, stress how that expertise paired with your investor’s US

network makes you an ideal match to create a dominant global player. The founders who will

have the most success in obtaining a favorable valuation from US investors are those who have

invested time and resources into identifying the US investors who will be most interested in the

opportunities these dynamics present.

A standard term sheet in a major financing round (e.g. Series A, Series B, etc.) will usually

entrepreneurs from similar industrial backgrounds, and a great VC can complement the

management team to stimulate growth.

However, the influence a board member can have on an early-stage company’s direction and

dynamics requires founders to be vigilant in vetting potential new additions. This can be a

particularly thorny issue where there are three founders; in many cases, one of the founders will

be asked to step down to accommodate the first “Preferred Director.” As the company raises

more in financing, the board composition will change such that the founders may eventually lose

majority control. In these instances, without certain protections the board may be able to

demote or fire the founders, change the company’s direction or sell the company over the

founders’ objections. For these reasons, choosing good board members is critical. As the board

legalese, but these letters help investors without board seats or board observer seats satisfy US

requirements for laws pertaining to certain types of capital allocators and are not an overreach

Prior to getting to this point, a non-US founder should be familiar with the general model of a

US venture capital fund.

US venture capital funds generally invest on behalf of other entities often known as limited

partners (“LPs”). They typically try to guarantee some return on the LPs’ investment over a 5-10

year life cycle of the fund in exchange for a minor initial percentage (1-2%) of the investment

and a larger percentage of successful investments over time (20%+). Rather than making

relatively limited, targeted investments based off of conventional metrics with the aim of steady

returns on the LPs’ investment over time, the venture capital model relies in large part on

“casting a wide net” and investing over a range of companies. VCs do so with the expectation

that a majority will not fully return their initial investments or return their investments at a rate

to satisfy the LPs in isolation. Instead, they rely on investing in the next “big thing,” such that

“home runs,” to borrow a term from American baseball)

company or where the company is acquired for an amount less than the value in which it is

warranted for the VCs to convert into common stock to sell their shares.

The liquidation preference will be expressed as a multiple of the initial amount of invested

capital for the investor, and will usually start at 1x. That is, in the event of a liquidation, for every

$1 they put in, investors will get back $1 according to a 1x liquidation preference. If a company is

doing poorly or in particularly bad investment climates, investors may attempt to negotiate this

up to 1.5x or, in extreme cases, 2x and beyond. In the latter’s case, this would mean that an

investor is entitled to receive $2 for every $1 they initially contribute. Generally, where there

aren’t enough funds to pay out everyone as part of liquidation, this liquidation preference will

require that the preferred holders be paid before the founders or other employees get paid.

Participating means that after the preferred investors receive their initial liquidation preference

today’s venture world for healthy companies, and non-US founders should be skeptical of

investors requesting such rights absent other relevant factors. A non-participating liquidation

Closely related to the concepts of valuation and ownership are terms related to voting and

control rights. In the term sheet, voting rights pertain to and cover a broad spectrum of terms

(which we’ll discuss in our upcoming article series dissecting US term sheets in more detail), but

there are two key concepts that non-US founders should understand about US corporations to

understand how the rights and privileges they give to investors can affect the control of the

company and ultimately, how and whether it succeeds.

and major shareholders to vote in favor of a “change of control” (usually a merger or sale of the

company) if the board of directors and a certain percentage of the stockholders vote in favor of

the transaction above the founders’ objections.

Understanding the relationship of these voting rights and control dynamics to the company’s

valuation is critical to non-US founders negotiating term sheets with US investors familiar with

capitalization changes. It is not uncommon for a US VC to request a founder or key employees

who are substantially vested in or outright own their shares to subject their stock to

“revesting.” Put simply, this means that the employees grant the company a right to repurchase

their shares if the employment relationship is terminated, although there may be exceptions

granted for certain types of terminations. VCs may also request that all employees be subject to

standard vesting terms moving forward.

Companies raising US venture capital may also be asked to make substantial capitalization

changes before being funded. For companies with large teams or inactive founding members

holding substantial equity stakes, they may be asked to repurchase the shares or terminate

relationships. Having these conversations can be difficult for those unprepared to navigate those

issues.

term sheets proposed by potential US investors is crucial to ensuring the company is in the best

possible position to capitalize on the opportunity.

and should not relied upon for business or legal decisions.