CTAN joined in a “Mock Terms Sheet” exercise last evening. In the exercise, angels are paired with entrepreneurs, given a case study, and a sample terms sheet. The two then negotiate the closing of the deal. It’s a great exercise in understanding deal structuring as well as honing negotiation skills. The event was sponsored by Andrews Kurth and led by Matt Lyons. To make things interesting Matt placed a few “gems” into the terms sheet to see if people would catch them.
The case study had a convertible note and a preferred equity terms sheet that were negotiated at the same time. The entrepreneurs at first felt that was unrealistic, but I raised the point that angel investors want to see a valuation set and so convertible notes are not entirely satisfactory to the investor. We all agreed to negotiate both at the same time.
The entrepreneurs were quick to figure out that their stock was taken back to zero and they had to work another year for 20% to vest. For an entrepreneur to start a company and work for several years and then see his equity position taken away is quite an emotional thing. We agreed not to press the point. Matt indicated that was the first thing most entrepreneurs look for.
The entrepreneurs were also quick to figure out that the investors had most of the board seats from the get go. This also is anomalous among deals as control needs to be divided among investors, founders, and independents.
Each point in the terms sheet is there for a reason. As an investor you want to identify the risks in the deal and then apply the terms that mitigate the risk. In the end, it’s important to negotiate a deal that incentivizes both investors and entrepreneurs to the same goal and exit. If the goals are misaligned then things get difficult.