The VC term sheet: Securing investment

When you apply for venture capital (VC) funding, you may have worked long hours and expended a great deal of energy proving your worth. If you eventually receive a VC term sheet, what are your next steps? In order to effectively manage the process, founders should have a basic understanding of the legal aspects.

Proposed terms and conditions for an investment are outlined in a term sheet

There is typically a lot of detail in the institutional venture capital term sheet, and the lead investor (called a "lead") mostly writes it.

With the exception of certain confidentiality and exclusivity rights, most of the terms of angel investments are non-binding. Due diligence or expense fees should not be paid upfront by founders. Credible venture capital investors do not do this in Canada or the United States.

Term sheet key provisions

VC term sheets should include the following key provisions:

Investment structure

It is the investment structure of choice for institutional venture capitalists to use convertible preferred shares. In accordance with a formula, such shares are convertible into residual value common shares in the event of a liquidation preference. A per share investment price is set by the term sheet based on an enterprise valuation.

Key economic terms

This sheet consists largely of the following economic terms:

  • An investment's preferred return can be quantified

  • An investment's accrued earnings should be quantified

Preferred returns: In order to distribute assets (payments) to equity holders, the startup must return preferred returns to the venture capitalist.

An investment's original amount is considered to be the preferred return rate. Occasionally, investors will require an additional payment on liquidation if founders aggressively negotiated the startup's valuation. In addition to the amount invested (2X or 3X, for example), investors can also receive a "double-dip"—a refund of their money along with an amount equivalent to the amount that would be received if the investor converted preferred shares to common shares on liquidation.


Accruing returns: Dividends are the form of accruing returns for convertible preferred shares. Generally, dividends of this type are not paid in cash. In the same way as preferred shares, such amounts accrue and are converted into common shares. A common accruing return rate ranges between 4% and 8%, though it is a matter of negotiation. Over 10% is a rare occurrence.

Board structure and reporting

VC term sheets often stipulate that both the founders and institutional investors must be represented on the startup's original external investment round.

It is typical for independent directors to hold the swing votes on the board, as they have no formal employment relationships or affiliations with either camp and have industry expertise.

In the term sheet, founders and investors will specify how independent members will be nominated and approved. In addition to the term sheet, the investor will typically require standard financial reports, such as audited annual statements, management statements prepared on a monthly or quarterly basis, and immediate notice of certain significant events (such as lawsuits).

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