The Wall Street Journal has a good post on Term Sheets for entrepreneurs.  I really enjoyed how it has “red markup” in there.  Classic.

Here is the example they use:

As an example, longtime angel investor Michael Cann brings up a story about a first-time entrepreneur who early last year shopped around a term sheet for an online media company.

Entrepreneur:

– Seeking $4 million on a $12 million pre-money valuation;
– Multiple closes but no warrant coverage for early investors;
– 1x liquidation preference (not participating);
– Series A gets one board seat and the common stock elects the other two;
– No covenants to restrict how money is spent;
– No vesting;
– Founder and CEO immediately starts paying himself a $225,000 annual cash salary;
– Founder and CEO will reimburse himself for $37,500 for legal expenses; and
– Option pool is 8.3% of the common stock

Cann (the investor) says he would have agreed to the following terms:

– Seeking $4 $2 million on a $12 $4 million pre-money valuation ($4 million in capital gives them too much runway, Cann says);
– Multiple closes but no warrant coverage for early investors;
– 1x liquidation preference (not participating);
– Series A gets one board seat and the common stock elects the other two Five board members: Two company employees, two representatives of Series A investors and one outside director selected by both company and investors (not typical for angel rounds, but $2M is a big angel round, Cann says);
– No Typical covenants to restrict which govern how money is spent;
– No vesting CEO and CTO get 25% of their shares up front to reflect value already created, the rest vests monthly over three years
– Founder and CEO immediately starts paying himself a $225,000 $125,000 annual cash salary;
– Founder and CEO will not reimburse himself for $37,500 for any legal expenses; and
– Option pool is 8.3% 25% of the common stock

My comment on the above Term Sheet is that the salary might be light if in Silicon Valley and if the entrepreneur has a family and the option pool post is too high.  Other than that it’s a great term sheet.  I might call this guy Michael Cann.  :-)

I really think this hits on a great point. The entrepreneur at the early stage needs a partner not a passive investor. It is a mismatch on the risk stage. Take Twitter for example now that’s an example where the management can dictate terms. The risk is reduced.

For me the dilution issue, who owns what percentage, is about getting the investor their percentage they need for the appropriate level of cash needed to get to a key risk reducing milestone – 20-30% range.  My advice to entrepreneurs is to try to keep control of the board and >51% after a Series A or Series B.

One thing that is often missed by both the entrepreneur and/or the investor is the aligned incentives. It is critical to success that the incentives and rewards are all matched up and aligned perfectly.  The creativity and execution required at the early stage demands a partnership without “noise” from both sides.