Venture capital financing is a critical aspect of starting and growing a successful business. For startup founders, it’s essential to understand the terms and conditions of venture capital financing to ensure they make the best decision for their company’s future. By considering these terms carefully, founders can ensure that their business is well-positioned for growth and success.
In this post, we’ll cover some of the most important venture capital financing terms that startup founders must know to help navigate the process.
Participation: Participation is a term that allows the venture capital investor to share in any upside of the company beyond a certain return threshold. This means that if the company performs well and generates a higher return than what was agreed upon, the investor is entitled to a portion of that excess return. This term incentivizes the investor to support the company’s growth and success, as they will benefit from any positive outcome.
Seniority: Seniority is a term that gives the venture capital investor priority in terms of payment and ownership in the event of liquidation. In the case that the company is sold or liquidated, the investor with seniority will be the first to receive payment and will have priority over other investors. This term provides security for the investor and helps to ensure that they receive a return on their investment.
Block on Sale: The block on sale term restricts the sale of the company below a certain multiple, providing stability and protection for the investor’s return. This term ensures that the investor’s return is protected in the event of a sale, as the company must be sold at a certain multiple of the initial investment. This term also helps to ensure that the investor receives a fair return on their investment, as the company cannot be sold for less than the agreed-upon multiple.
Liquidation Preference: Liquidation preference refers to the amount of money that a venture capital investor is entitled to receive in the event of a liquidation or sale of the company. This term sets the priority of payment in the event of a sale, with investors receiving their liquidation preference before any other investors or shareholders. This term helps to ensure that the investor receives a return on their investment and provides security in the event of a liquidation or sale.
Conversion Rights: Conversion rights refer to the right of a venture capital investor to convert their preferred stock into common stock. This term allows the investor to convert their preferred stock into common stock at a predetermined price, providing an opportunity for the investor to receive a higher return on their investment. This term also incentivizes the investor to support the growth and success of the company, as a successful company will result in a higher return for the investor.
Anti-Dilution Provisions: Anti-dilution provisions protect the venture capital investor in the event that the company issues additional shares, thereby diluting the value of their investment. This term ensures that the investor’s ownership percentage is maintained, even if the company issues additional shares. This term provides security and protection for the investor and helps to ensure that they receive a fair return on their investment.
Drag-Along Rights: Drag-along rights give the majority shareholder the right to force the minority shareholders to sell their shares in the event of a sale of the company. This term helps to ensure that the majority shareholder can control the outcome of a sale and provide an easier exit for the buyer. This term also helps to ensure that the minority shareholders receive a fair return on their investment, as the majority shareholder has a vested interest in securing the best outcome for all shareholders.
The National Venture Capital Association (NVCA) has published a model term sheet that provides a good guide to how these terms are applied in practice.
In conclusion, understanding these key venture capital financing terms is crucial for startup founders looking to secure financing for their business. These terms help to align the interests of the investor and the company, and provide mechanisms for the investor to realize a return on their investment. As a startup founder, it’s important to carefully consider these terms and negotiate the best terms for your company. By having a solid understanding of venture capital financing terms, you’ll be in a better position to make informed decisions about financing your company and securing the best outcome for your business.