Convertible Notes and Startup Funding
February 12, 2025
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In the previous article, we have already learned that term sheets are the basis on which the entire relationship between the entrepreneur and the investor rests. Since there are several different aspects to running a business, there are several key terms and conditions which need to be worked out between the two parties. A collaborative approach on these key terms and conditions can spell success for the venture.
In this article, we will have a closer look at the terms and conditions which are commonly negotiated before an agreement is reached between two parties.
Voting is an important act that allows investors and entrepreneurs to influence the future of the company. Hence, the absence or presence of voting rights can be considered to be a make or break factor in many startup deals.
It is possible for the entrepreneur to provide voting rights to certain types of investors while refraining from providing the same to certain others. The thumb rule is that an investor only needs to be provided voting rights if they will be involved in the day-to-day operations of the firm.
For now, it is important to understand that vet rights can be very important when several investors are involved in funding a startup. Hence, it is important for the term sheet to clearly specify which investors have veto rights and when these rights can be used.
Many entrepreneurs are wary of providing this influence to their investors since it could mean interference in day to day operations of the firm. The details about the access to the board of directors must be clearly mentioned in the agreement between the two parties.
Investors often decide on the information that they would require from the company beforehand. The manner in which this information will be collected as the frequency with which the data will be published needs to be decided beforehand. It is imperative that these details be included in the term sheet in order to avoid conflicts later. Opacity can lead to a lack of trust which can be detrimental to the growth of any organization.
At the same time, investors also have securities that allow them to convert debt to common stock. The details of these options as well as the time frame in which they can be exercised need to be clearly mentioned in the term sheet.
It is common for term sheets to mention the legal clause that the first right of purchase must be given to the stakeholders of the company viz. employees, entrepreneurs, etc. Only if these stakeholders do not want to buy the shares or do not have the financial wherewithal to buy them, can third parties be involved. It is also possible that the entrepreneur may have the power to stop certain investors from obtaining a stake in their business.
From the above points, it can be clearly seen that the term sheet is a very important document. It enumerates the rights and duties of the different parties in different situations and hence forms the basis on which all cooperative action is undertaken.
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