What does a good Series AA (seed term sheet) look like? - Part1:Liquidation Preferences

1. I have several entrepreneurs asking me for templates of our “series AA” or seed series term sheet. Unfortunately, most of our deals are convertible debt (for companies based in the US, even though they have Indian entities). There is only 1 company we have invested in that is incorporated in Indian alone. I asked a few fellow angel investors to understand what terms and conditions they were seeing in their term sheets. I also got 5 term sheets from recently funded web and eCommerce startups. Some important points that you should keep in mind before you read this post.There is no “standard” term sheet. The reason for that is all deals are unique, dependent on the supply – demand characteristics between the startups and angel investors. If any of your investors say “That’s what the lawyers told me to put in the agreement. Its industry standard practice”, realize that there is nothing the lawyers can or cannot do without the consent of the investors. Everything is negotiable.
2. Just because other startups are able to get favorable terms does not mean you will get the same terms. Numbers and percentages are purely representational, not standard.
3. “Good” in the title of this post means, both entrepreneur and angel friendly, and one that’s not skewed towards one party.

In India seed rounds funding as convertible notes are rare and not the common practice.

Liquidation preferences are one of the key areas for entrepreneurs & angels to discuss and negotiate

Liquidation preference: This means when there is an exit (company gets sold or goes public) what distribution of the proceeds goes to the investors as preferential payment (meaning, they get paid first) before any other shareholder.

Let’s take an example. If you raise 1Cr with a pre-money valuation of 4Cr, your investors will own 20% of the company after their investment – 1cr divided by 5Cr (which is the valuation of the company post their money). Now after 18 months another company decides to buy your company for 4 Cr (it’s a aqui-hire – hiring for resources). Since the investors own 20% of the company, with NO liquidation preferences they would get (20% of 4 CR) which is 80L. The other share holders will get 1.2 Cr (which includes founders).

If they had liquidation preferences (with a rate of return they mention in your term sheet), they will get 1 Cr plus their ROI, which might be 1 CR, plus 20% (example rate) and the other share holders will get 80L.

I think providing liquidation preferences to the amount of capital put into the company makes some sense, because you want investors to at the least get their money back if they can, but anything more than that is negotiable. A good term sheet will maintain liquidation preferences to the amount of capital invested at the most.