Proposed Investment Terms - Investment Friend

investment terms beginners

Here’s a breakdown of typical investment terms, formatted for HTML display:

Understanding proposed investment terms is crucial for any founder considering fundraising. These terms define the relationship between you and your investors, and they have long-term implications for your company’s future. Here’s a look at some key elements:

Valuation

Perhaps the most talked-about aspect, valuation determines the company’s worth before the investment (pre-money valuation) and after (post-money valuation). The difference between these two numbers is the amount of the investment. A higher valuation is generally favorable for founders, as it means less equity dilution.

Amount of Investment

This is the specific dollar amount the investors are putting into the company. It’s tied directly to the valuation and the percentage of ownership the investors will receive. Consider if the amount is sufficient to achieve your milestones and whether it creates pressure for a quick exit.

Equity

Investors receive equity in exchange for their investment. The percentage of equity depends on the valuation and the amount of investment. It’s critical to understand how this equity is structured – common stock, preferred stock, options, etc. Different types of equity have different rights and privileges.

Liquidation Preference

This determines the order in which investors and common stockholders receive proceeds in the event of a sale or liquidation of the company. Often, preferred stock held by investors carries a liquidation preference, meaning they get their investment back (and sometimes a multiple of it) before common stockholders (founders and employees) receive anything.

Anti-Dilution Protection

This protects investors from dilution of their equity if the company issues new shares at a lower valuation in the future (a “down round”). Common types of anti-dilution provisions include full ratchet and weighted average. Full ratchet is the most protective for investors, essentially re-pricing their shares to the lower price. Weighted average is more common and provides a less severe adjustment.

Control and Governance

Investment terms outline investor rights regarding board seats, voting rights, and information rights. Investors may require a board seat to have a say in major decisions. Information rights ensure they receive regular updates on the company’s performance. Significant control by investors could limit a founder’s autonomy.

Dividends

Some preferred stock agreements include dividend provisions. Dividends can be cumulative or non-cumulative. Cumulative dividends accrue over time and must be paid out before common stockholders receive any dividends. While less common in early-stage investments, understanding dividend terms is essential.

Protective Provisions

These provisions require investor consent for specific company actions, such as selling the company, issuing new shares, or taking on debt. They are designed to protect the investors’ investment and ensure they have a voice in key decisions.

Vesting

While primarily relevant to founder and employee stock, understanding vesting schedules is important. Vesting ensures that individuals earn their equity over time, encouraging long-term commitment. Investor agreements may also include provisions related to accelerating vesting in certain situations.

Negotiating investment terms is a complex process. Seek advice from legal and financial professionals to ensure you understand the implications of each term and that the agreement aligns with your long-term vision for the company.