Defining a “Fair Deal”

22nd June, 2017 No Comments Blog , Fundraising , Startups , Venture Capital

I was recently asked by a new entrepreneur for thoughts on “fair terms” for a preferred equity financing.  I have been through the negotiating process for a new round, as the new investor and as a company representative, many times, but admit I had never written down how I think about what is “fair” concerning the major terms.  What follows is what I shared with the entrepreneur as a basic primer on the topic.  (Note that this primer is not a substitute for a good attorney – which all entrepreneurs should have – and should be considered in the light of a company’s specific situation.)


  • Be sure you understand whether the proposed valuation is pre-money or post-money, and whether any option pool expansion will happen before the round closes or after.
  • The best way to increase a valuation is by creating other options (e.g. multiple lead investors or a path that does not require immediate investment).
  • The new money typically buys 10-33% of a company, with the mean probably between 15-25%.

Dividends are not typically a source of a lot of negotiation.  They are generally paid only if declared by the board or are non-cumulative, and if specified are 2-8%.

Liquidation Preference is typical, with the preferred holders getting 1x their money back OR getting their pro-rata share of exit proceeds (non-participating preferred).  Some investors seek to get the 1x preference AND share pro-rata in remaining proceeds thereafter (participating preferred) – this is less common today than it once was but still happens.  The compromise position is that investors get to participate until they have earned a specified return multiple, usually 3-5x, above which the participation right no longer applies.

Pro rata rights enable investors to buy shares in future equity offerings sufficient to maintain their ownership level as of the close of the current round.  This right is very common for “major investors” – the largest investors in a financing.

Governance clauses concern the board and board voting.  Often, a Series A or Series B company will have a board with 5 directors:  2 representing common (one of which is the CEO), 2 representing investors, and 1 independent (usually nominated by the CEO or investors and approved by the other party).  The board oftent grows larger at or after a Series B round.  Sometimes investors or common holders will end up with more directors if one side has a lot more negotiating leverage than the other.

Vesting provisions will specify how employee options vest (usually over 4 years with a 1-year cliff).  It’s common for founders to be required to vest, and in many cases to reset their vesting schedules as of the close of the first outside venture financing so that a majority of their shares are unvested as of that closing.  It’s common for founders to therefore have 25-50% of their shares vested as of the closing of a Seed or even  Series A round, with the balance to vest over the subsequent 4 years.

Voting Rights usually specify that the preferred votes on a 1:1 basis with common, but may have special rights (like the ability to pick a board member).

Protective Provisions require that the preferred (and/or preferred board directors) approve any significant corporate actions, like future fundraising, a sale, licensing of IP, taking out big loans, etc.  The voting threshold (% of preferred required to approve these actions) is important – you want to figure out how many and which investors might be needed to take these actions and ensure you are comfortable with that.

Anti-dilution protection is either weighted average, full-ratchet, or non-existent.  Weighted average is typical.

Redemption rights allow the investors to put their shares to the company after a specified period (usually 5+ years) at a certain price (usually fair market value).  These rights are often stricken from Series A docs during negotiations, but are sometimes retained if the investors believe the company may become a free cash flow business and want to be able to sell their shares (particularly if they are investing from a fund with a defined life).

Legal fees are usually all paid by the company, up to a limit (maybe $25-50k) assuming the investors do not walk away (in which case each party covers its own legal costs).

Registration rights concern the rights of investors to sell shares on an IPO.  Whether the investors can demand registration of their shares (typically major investors can do so 1-2 times), piggyback on other registrations (typically yes an unlimited number of times with certain parameters), are subject to a lockup (usually yes for up to 180 days), and other terms are spelled out in these clauses.

There are other terms you should read and make sure your attorney reviews regarding non-competition, non-solicitation, right of first refusal, co-sale, etc, but the above are the ones that tend to be most relevant and to get the most attention in negotiations.

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