I was speaking with an entrepreneur the other day about what valuation they were looking for in a fundraising round. The conversation quickly evolved into what terms they were getting. Remember valuation is just one part of a term sheet; also make sure you understand the terms as well.

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Basic economics

I hear many entrepreneurs just say they received an $XM valuation. For starters, is the valuation you are getting pre-money or post-money? Is there an option pool added (and does that factor in pre or post)? Some of these basic things make a difference in dilution and the true valuation. 

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Preferences

Preferences on shares can influence how the waterfall works in the event of an exit. The two most common components are type of preference (participating vs. non-participating) and multiple (1x, 2x, 3x). Participating preferred means the investor gets their preference back first AND still gets their percent ownership in the waterfall. Non-participating preferred means the investor gets their preference back first OR gets their percent ownership in the waterfall. The multiple is based on the capital invested. Here are some examples to follow along. As you can see a high participating preferred (even at a good valuation on the term sheet) can really affect the payout waterfall.

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Control rights

There are many types of control rights that may be put into a term sheet. Things around board composition influence who and how many people are on the board and what they control. Protective provisions can impact any changes to bylaws, issuing shares, dividends, selling the company, etc. There are also further areas like drag along and tag along rights that can impact the company in the event of a takeover offer.

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As you can see, there are many other factors in a term sheet besides the valuation that can impact what the entrepreneur would receive in the event of a sale and who controls the direction of the company. There are also other things that can impact the entrepreneur like vesting, pro rata rights, anti-dilution, and many more terms. Make sure you understand all that is included in the term sheet (hint - if it seems overly complex it is probably not in the entrepreneur’s favor).