How does the pie get divvied up when an entrepreneur sells his company? Who gets the biggest slice? And, importantly, who or what sets these terms? The answer to all of these questions is in one eponymous document: The Term Sheet. But, term sheets can be complicated, convoluted, and confusing especially for an entrepreneur who might be negotiating for the first time with a financing partner. To demystify this process, Endeavor Insight has created an educational tool designed to help entrepreneurs understand at a high level how to best raise smart capital. The Endeavor Term Sheet Calculator helps entrepreneurs who are entering their first round of funding understand how changes to critical parts of the contract can dramatically alter how entrepreneurs, investors and employees share money upon the sale of a company.
Users can input key variables, including pre-money valuation, pre-money employee options, investment value, anticipated exit value, preferred participating cap multiple and liquidation preference, to see how exit scenarios would play out under capped, full and no participation models. Below is a glossary of these key term sheet “buzz words” and a description of what they actually mean:
Pre-Money Valuation: the value of a company before it receives any funding from external investors
Pre-Money Employee Options: the percentage of common stock allocated to employees for motivation, reward, and incentive before VC investment
Full Participation: The investor’s right to collect the cash equivalent of his equity after he collects his liquidation preference multiple upon exit. For example, if an investor gives $10 million for 50% of a company with a liquidation preference multiple of 2x, when the company is sold he would receive $10m x 2 plus an additional 50% (due to full participation) of the remaining cash.
No Participation: The investor’s right to collect either the cash equivalent of his equity or his liquidation preference multiple upon successful exit. In our example, the investor would be entitled to either 2x of his initial investment or 50% of the company and would choose the higher value.
Capped Participation: The investor has a right to collect the cash equivalent of his equity after he collects his liquidation preference multiple up to a certain amount upon successful exit. In our example, the investor is entitled to receive 2x his initial $10 million investment plus 50% of the remaining value of the company, if it does not exceed a certain cap or ceiling (typically a multiple). If that amount does exceed the cap, then the investor would just receive the cap
Liquidation Preference: The multiple by which the investor is entitled to increase his initial investment upon successful exit.