17 Fundraising Terms Founders Need To Know

It’s the end of August which means one thing: fundraising season is about to kick off.

There’s no “right” time of year to raise but the markets are always busy from early September until mid-December, as investors are back between their vacations to the Amalfi Coast and Mexico City.

Though uncommon, there are reports of some pretty bad behavior from investors already. There’s a direct correlation between bad investor behavior and how hard a time they’re having getting LPs to invest in their funds.

You don’t want to end up in a situation where a bad-actor investor snuck something through in their term sheet that leaves you in a tough spot later on.

But the truth is that investors understand term sheets better than most founders.

So this week I’m breaking down the terms and types of provisions you may see on term sheets, and what they mean so you can be equipped to protect your own interests in negotiations.

17 Fundraising Terms Founders Should Know

Preferred Stock & Liquidation Preference

As opposed to common stock, which is what founders typically have themselves, preferred stock offers the holder rights to get their money back first in a liquidation event.

They can take this one step further and ask for a liquidation preference, which is typically thought of as a multiple of their original investment.

For example, a 2x liquidation preference means that the investor gets paid back double their initial investment before other shareholders get paid back anything (even other investors!).

Right of First Refusal

If you give an investor the ROFR, they basically get the “first look” at the next round, and at whatever the best price is that you offer to any other investors.

There are two types:

• Unconditional → The investor gets the lowest price in the next round no matter what.

• Conditional → This protects you in the case of a down round. You set a minimum price for the ROFR. If the next round is under that price, it doesn’t kick in. Technically this can be any condition but price is the most common inclusion by far.

Pre-Emption Rights

This takes it one step further and lets current shareholders purchase new shares before they are offered to new investors.

This is typically used as a way to allow them to maintain their ownership percentage in the company.

Conversion Ratio

The specific number of shares an investor receives when converting an initial SAFE (or another type of convertible note) into equity when you eventually raise a priced round.

If an investor holds a note with a 1:5 conversion ratio they receive five shares for every dollar invested that they convert.

Anti-Dilution Provision

VCs often have ownership targets for each company they invest in.

But when you take on additional capital, the % of the company that existing investors own goes down.

Anti-dilution provisions give investors the option to either fully maintain their ownership percentage (“full ratchet”) or not fall below a certain percentage.

Drag-Along & Tag-Along Rights

Drag-along rights can work in your favor. Majority shareholders can include these to force minority shareholders to participate in a sale.

On the other hand, tag-along rights give minority shareholders the ability to sell their shares alongside majority shareholders. This can complicate secondaries that founders may want to participate it in the future.

Voting Rights

Typically 1 share = 1 vote in company decisions, but investors may request more influence by asking for super voting rights.

Super voting shares are most often reserved for founders after a Series A, when the founders begin to own less than 50% of the company (but still want to have full control over decisions).

It’s a huge red flag if investors are asking for super voting shares, it means they don’t trust the founders.

Information Rights

This is a contractual agreement to provide requested information about the startup to investors, whenever they’d like.

Most of the time this is innocuous (and founders should always be transparent with their investors about company performance) but just make sure that the requests are reasonable.

Side Letter

Highly strategic investors may ask to include additional provisions that you’re not giving to the rest of the investors participating in your round.

Side letters can include a wide variety of the provisions I’ve mentioned already, or they could be entirely unique.

Pro Rata

If investors are particularly excited about your startup, they may ask for pro rata rights.

These give them the ability to maintain the ownership percentage in future rounds by giving them the right to participate again.

Change of Control Provision

If investors have one of these and you ever end up selling your startup, it’ll get triggered. It can theoretically include anything an investor chooses to include, even to be able to block the sale, so many sure to read the fine print.

Tranched Investment

One of my first newsletter issues (and still a favorite!) was about how founders can use tranches during their raise.

Well, it turns out investors can use them too.

A tranched investment is one where the investor puts part of their investment in after milestones are hit.

Let's say a VC invests $5 million in a startup. They could choose to release the funds in 2 tranches:

• $2.5 million now

• $2.5 million later

Co-Sale Rights

Sometimes investors want to make sure they can cash out when founders do, regardless of it it’s through a secondary sale or at an acquisition.

At the time they invest, they can ask for this to be explicitly guaranteed.

Founder Vesting Schedule

When you first set up your corporate entity and took ownership of stock in your startup you likely set a vesting schedule for yourself and your cofounders.

Typical vesting schedules for founders are monthly vesting over 4 years, with a 1 year cliff.

It’s unlikely that investors will require you to adjust this vesting schedule as part of their investment, but it’s happened.

Pay-to-Play Provision

Very uncommon, but you can ask investors to include a provision that further incentivizes them to participate in future rounds by only guaranteeing them certain rights that they want to include if they do.

Clawback Provision

Also uncommon, investors can ask for the ability to take their funds out in the future if certain conditions or events either take place or are not accomplished.

Secondaries

Secondary sales are when shares of a startup are sold by an existing shareholder directly to someone else.

Founders often take secondaries in later fundraising rounds as a way to ease the financial stress of working on a startup for many years.

Investors may include provisions around when they, or the founders, can or can’t take secondaries.

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