TheFunded and the Founder Institute have just released a new "Plain Preferred" term sheet with the support of the blogosphere, including top-rated venture capitalist, Fred Wilson.
Chris Dixon posted about an ideal term sheet for first round funding, which started an blogosphere discussion about terms. Fred Wilson came out in support of this simplified term sheet, so TheFunded Founder Institute has engaged WSGR to author the exact template agreed on by various entrepreneurs and investors for anyone to use:
Plain Preferred Term Sheet:
The new "Plain Preferred" term sheet compliments the founder-friendly incorporation documents already developed by the Institute, which are being used by approximately 50 start-ups both within and outside of the Institute. TheFunded.com Terms section submission form lists nearly 100 different terms that are in common use by venture capitalists. Fred Wilson, Chris Dixon, and others in the debate agree to a dramatically simplified term sheet with some significant changes against the norm:
- The elimination of participation, which has become a common request since the Internet bubble burst. "Participation" means that investors "double dip" by getting both their liquidation preference and their equity allocation.
- A 1x liquidation preference, versus a 1x to 3x range in recent deals reported on TheFunded.com. A "1x liquidation preference" without participation means that investors choose to either (a) get their money back or (b) convert to equity and get the equity value only. This is a downside protection term.
- Single trigger vesting, which allows founders to vest all of their equity and make money in an exit. Many investors require "double trigger vesting," which means that the company needs to sell and the founder needs to be terminated for his or her shares to vest.
New and complex terms, such as "Super Pro Rata" investment rights, are removed from the Plain Preferred template, since they add marginal value to investors while adding significant complexity to deals. Legal costs are rising while venture returns are shrinking. The average Series A investment costs $50,000 in legal fees to close. Meanwhile, the founders themselves are being squeezed with more and more terms that lock up exit value, creating a misalignment of incentives.
The Plain Preferred term sheet aligns the investor and the entrepreneur incentives. This is a rare example of a term sheet where the percentage ownership of participants will correlate closely to returns generated in an exit.