We’ve covered in another post about when it’s appropriate to form a legal entity. Prior to that point, however, there may be a limbo period when you are talking to other potential co-founders and trying to decide if your idea is worth pursuing. It is important to surface all the issues that arise among the founding team before anyone has spent significant time working on what might be false assumptions about “the deal” among the founding team. It’s much easier to discuss these issues early on when it’s all still very hypothetical and no one has become emotionally vested in their role. The best way to do this is to use a Term Sheet.
What is the Incorporation Term Sheet?
The Term Sheet is non-binding, but it serves as a framework or starting point that enables discussion and agreement on important things at a level of detail that helps to avoid disputes later. Nothing kills a startup as quickly as “fighting founders” which happens all too often. Startups are already a very risky venture and the deck is stacked against you, so if you give off signals to others that the founders are having trouble agreeing with each other, you will find no one wants to deal with you. The reality is that you are probably operating as a verbal partnership with your co-founders prior to incorporation and that can be extremely murky to untangle. No one has the time to deal with that headache. It can make a great idea truly un-fundable if the IP doesn’t have clear title that can be traced back to its origins and has been properly assigned to the corporation by all of the initial owners of the IP. So, it’s critical to air the issues early on and come to at least a spiritual agreement among the founders before the IP gets developed by anyone.
Template Incorporation Term Sheet
Here is a template you can use to discuss the key matters among the founding team before incorporation:
SUMMARY OF TERMS FOR THE INCORPORATION AND ORGANIZATION OF [COMPANY NAME]
This term sheet summarizes the principal terms of the proposed incorporation and organization of [Company Name] (the “Company”). This term sheet is for discussion purposes only; there is no obligation on the part of any negotiating party until definitive agreements are signed by all parties. This term sheet does not constitute either an offer to sell or an offer to purchase securities.
| State of Incorporation: | [Delaware]. https://www.startuppercolator.com/what-and-where-initial-issues-to-consider-when-forming-a-new-entity/ |
| Principal Office: | [Company HQ Address, preferably a real street address] |
| Incorporator: | [Usually initial founder or attorney]. https://www.startuppercolator.com/glossary/incorporator/
|
| Board of Directors: | The Company will initially have [1] directors. https://www.startuppercolator.com/glossary/initial-size-of-board-of-directors/ |
Directors:
| Name | Contact Information |
| [List Director Names] | [Director Addresses and Emails]. https://www.startuppercolator.com/glossary/directors/
https://www.startuppercolator.com/board-advice-adding-advisors-versus-adding-directors/ |
Officers:
| Name and Title | Contact Information |
| CEO | [CEO Email] |
| Treasurer | [Treasurer Email] |
| Secretary | [Secretary Email] |
Capitalization:
| Total Shares Authorized: | [12,000,000] shares, all of which shall be Common Stock, $0.00001 par value per share. https://www.startuppercolator.com/anatomy-of-a-startup-cap-table/ |
| Founders’ Shares: | A total of [8,000,000] shares will be issued to the Company’s founders, as set forth on Exhibit A. https://www.startuppercolator.com/glossary/vesting-of-founders-stock/ |
| Equity Incentive Plan Reserved Pool: | A total of [2,000,000] shares will be reserved for issuance under the Stock Plan. |
| Blanket Transfer Restrictions: | The Company’s Bylaws and the Founder Restricted Stock Purchase Agreements and the Equity Incentive Plan will include a provision requiring Board approval of all stock transfers. https://www.startuppercolator.com/should-we-include-transfer-restrictions-in-our-bylaws/ |
| Limited CEO Delegation to Amend Awards under Equity Incentive Plan? | [Yes] |
| Vested Share Repurchase Option for Founders’ Shares: | None |
| Vested Share Repurchase Option for Shares issued under Equity Incentive Plan: | [The Company has an option to repurchase Vested Shares upon all Terminations of Service at a repurchase price equal to the fair market value of the shares on the date or repurchase, provided that if the Termination of Service is for Cause, the repurchase price is the lesser of the fair market value of the shares on the repurchase date or the original purchase price.] https://www.startuppercolator.com/the-human-capitalist-series-11-what-is-a-vested-share-repurchase-right-and-why-does-it-matter/ |
| Fiscal Year End: | [December 31] |
| S Corporation Election: | No. https://www.startuppercolator.com/glossary/s-corporation-s-corp/ |
| Attorneys for Company: | [Perkins Coie LLP] |
| Principal Client Contact for Attorneys: | [CEO Name] [CEO Email] |
EXHIBIT A
FOUNDER STOCK
| Name and Address of Purchaser | Number of Shares of Common Stock Purchased | Aggregate Purchase Price and Form of Consideration | Vesting Start Date | Vesting Schedule and Acceleration Provisions |
| [Founder #1 Name and Address] | [5,000,000] | [$50] in cash, plus assignment of business plans and IP as set forth in the corresponding Purchase Agreement and the Assignment of IP and Other Assets attached as Exhibit C thereto. | [Vesting Start Date] | Four-year vesting with a 25% cliff after the first year and then monthly thereafter. Double-Trigger Acceleration on 100% of the unvested shares. |
| [Founder #2 Name and Address] | [2,000,000] | [$20] in cash, plus assignment of business plans and IP as set forth in the corresponding Purchase Agreement and the Assignment of IP and Other Assets attached thereto. | [Vesting Start Date] | Four-year vesting with a 25% cliff after the first year and then monthly thereafter. Double-Trigger Acceleration on 100% of the unvested shares. |
| [Founder #3 Name and Address] | [2,000,000] | [$20] in cash, plus assignment of business plans and IP as set forth in the corresponding Purchase Agreement and the Assignment of IP and Other Assets attached thereto. | [Vesting Start Date] | Four-year vesting with a 25% cliff after the first year and then monthly thereafter. Double-Trigger Acceleration on 100% of the unvested shares. |
How to Prepare for an Equity Financing
We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.
What Every Startup Needs to Know
On Wednesday, June 26th, Perkins Coie’s Palo Alto office hosted the startupPerColator event, “What Every Startup Needs to Know.” Lowell Ness, a Perkins Coie partner in the Emerging Companies & Venture Capital (ECVC) practice, moderated a panel which included Herb Stephens of NueHealth, Thomas Huot of VantagePoint Capital, Jennifer Jones of Jennifer Jones and Partners, Yuri Rabinovich of Start-up Monthly, and Olga Rodstein of Shutterfly.
Surviving the Series A Crunch: Financing Alternatives
The “Series A Crunch,” which is the significant decline in the number of startup companies per quarter that are completing their first equity financing, appears to be deepening.