Blogpost series: Demystifying Term Sheets

Blogpost series

For these blogs I will break down the termsheet into 4 components:

  1. Valuation,
  2. Downside Risk,
  3. Upside Sharing, and
  4. Control.

I specifically isolate valuation due to its significant importance and the common tendency of founders to overfocus on it without regard for the other terms. It's crucial to recognize that venture capitalists employ strategic "terms" for example to secure an outsized portion of the return in cases where the valuation is deemed high…


Valuation in a termsheet

Valuation can be expressed in various ways, such as price per share (PPS), pre-money valuation (the price before investment without the new cash), or post-money valuation (the price after investment, which is the sum of pre-money valuation and the new investment). Frequently, the term "fully diluted" is employed in this context, signifying the valuation after all shares, options, and other financial instruments are converted into shares. 

Another way of stating the valuation is through dilution or ownership stake. I will invest 1M for 10% of your business. This implies a 10M post money valuation.

You should always ask for a cap table (table showing ownership) post investment as an attachment to the termsheet so there is no misunderstanding.

A complicating factor is some agreements use tools to make the valuation flexible based on milestones. While this approach can provide a means for both the investor and the startup to factor potential future gains into the valuation, it comes with a drawback. The startup may find itself overly fixated on meeting these milestones, potentially overlooking the option to pivot or concentrate on less immediately profitable clients with greater future potential.

We often encounter termsheets that initially present an inflated valuation, only to have it adjusted in subsequent terms.

For instance, an investor might initially state, "We value your company at $10 million." However, they might add a caveat, such as, "Given the current limited traction, our initial investment will be 50% of the total sum, valuing the company at $5 million. We will commit to the remaining investment at the $100 million valuation contingent upon your revenue meeting our forecasted targets. Should the revenue fall short of these expectations, the second tranche of our investment will be made at a reduced valuation." In this scenario, the effective immediate valuation of your company is realistically $50 million, with the potential for a higher valuation hinging on future performance metrics.

At Volta, our investment focus lies in the very early stages, and we actively steer away from milestone-based investing. We believe that such an approach diminishes the flexibility that is crucial for startups at this initial phase.

Next time we will look at downside risk protection and control.


PPS: price per share.

Pre-Money Valuation: the price before investment without the new cash.

Post-Money Valuation: the price after investment, which is the sum of pre-money valuation and the new investment.

Fully Diluted: the valuation after all shares, options, and other financial instruments are converted into shares. 

Cap Table: table showing ownership


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