Venture Deals, 4th Edition

CHAPTER 5Economic Terms of the Term Sheet

When discussing the economics of a venture capital deal, one often hears the question “What is the valuation?” If you watch Shark Tank (or one of its many derivative programs), you know that the valuation will be some unreasonably low number that makes us cringe every time we see an episode. But while valuation is an important component of the deal, it is a mistake to focus only on this term when considering the economics of a deal.

In this chapter we will discuss all of the terms that make up the economics of the deal. These include valuation, which is often expressed in a term sheet as “price,” liquidation preference, pay-to-play, vesting, the employee pool, and antidilution.

Valuation and Price

The valuation that you and your VC agree upon will determine how much of your company you are selling and, consequently, how much dilution you will take in the financing. The valuation also will determine the price per share at which you sell your stock.

There are two different ways to discuss valuation: pre-money and post-money. The pre-money valuation is what the investor is valuing the company at today, prior to the investment. The post-money valuation is simply the pre-money valuation plus the contemplated aggregate investment amount. In other words, if you raise $2 million at a $6 million pre-money valuation, your post-money valuation is $8 million. Since the investor invested $2 million and the company is now worth $8 million post-financing, ...