How to read an Investment Termsheet: the Economic Terms — Further Reading

Deeper dives and investor perspectives on the valuation, preference, and pro rata

Hopefully my series on investment termsheets has been giving you a user-friendly overview of the terms that, in some shape or form, you should expect to see. I’ve got a few more articles planned, going through the investor protections and powers as well as the terms relating to the actual transaction.

What I haven’t done is give opinions on what you should expect or accept.

I’ve focused on what a liquidation preference is, for example, not whether you should accept it if your investor wants a 2x participating preference on your round. There are two main reasons for this:

  1. If you need investment, the acceptable terms for that investment are the best terms you can get.
  2. What’s “standard” varies from market to market, from time to time, and from round to round.

The most useful thing I can do is give you some hints to find and understand the terms, and help you form your own judgements as to what’s acceptable.

That said, I do think some perspectives can be useful — and, as we’ve now dealt with the key economic terms (the valuation, the preference, and the pro rata) this seems a good time to present some further reading on that. The purpose of this post is to collect some other people’s thoughts that give more colour on some of the terms that I’ve laid out.

There is always something good to be taken from these posts but do bear in mind that the market may have moved on from when they were written, and they may never have been about companies in your geography or at your stage. These are not rules, but points of view; don’t assume they apply directly.

Always ask yourself when reading investors’ posts: what geography do they invest in? what round? when was the post written?

Understanding Valuations

rob go (link) and Albert Wenger (link) on pre-money vs post-money valuations in termsheets. There are more subtle points here than just “don’t agree a valuation until you’re sure if it’s pre- or post-money” (though, for the record, don’t agree a valuation until you’re sure if it’s pre- or post-money).

Tom Tunguz on building “auction pressure” in a transaction, which is a key tool in getting the best valuation. It can be incredibly tricky to do, but there’s no better tool I know of for improving economic terms. (link)

The Liquidation Preference and Waterfall

Brad Feld on “cleaning up your cap table”. Simplifying and rationalising stacked-up liquidation preferences is discussed in the second half (link). I mentioned in my article that the investor issues around preferences grow dramatically as you do subsequent rounds — this gives you depth on the point.

Fred Wilson in defence of the 1x non-participating liquidation preference; the investor protection against only downside risk (link). An old example, but a clear illustration of how things can be misaligned without one.

The Pro Rata and the Ratchet

Mark Suster on the tensions that pro rata rights can create between existing and new investors, and how investors can deal with them. I touched on this towards the end of my article, but this is a proper deep dive. (link)

Nic Brisbourne on how to handle existing investors when you start your next round. Point 2 is a (much!) more succinct explanation than mine of how to build the pro rata discussion into that. (link)

Christoph Janz on later-round investors putting money into earlier rounds to get a pro rata on the next round. An aspect of portfolio strategy we didn’t cover in my article, which comes with some substantial “signaling risk”. (link)