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MONEY

Term Sheets

Give seed investors too many rights, and it could hurt your ability to raise money later. Below, five deal items mom and dad can live without.
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  1. Ratchets A ratchet automatically awards extra shares to prevent your original investors from having their stakes diluted. If you've given these to seed investors, get them to give them up--or forget about raising VC funds.

  2. Preemptive rights Related to ratchets, preemptive rights give investors the option to buy more shares during a subsequent round, thus maintaining a large stake. Remind friends-and-family investors that small is beautiful. Dilution is not necessarily a bad thing if the company's overall value increases.

  3. Liquidation preference Shareholders with this status get paid first in the event that the company is sold or goes bankrupt. This will decrease your chance of a windfall and put off VCs, who almost always demand that they get paid before your seed investors do.

  4. Veto rights These give friends and family the right to veto a subsequent investment. Most professional investors will force you to waive veto rights before beginning negotiations.

  5. Board seats It's okay to create a board that contains seed investors, but friends and family should understand that they'll probably have to give up their seats in the event of a deal.
Last updated: Jul 1, 2007




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