What to watch for in a VC term sheet

Published March 15, 2019

Mital Makadia
Contributor

Mital is a partner at Grellas Shah, focusing on representing tech startups and startup founders. She provides counsel on a variety of corporate and transactional matters and negotiates and structures equity financings, M&A transactions, and commercial and intellectual property transactions for her clients.

When startup founders review a VC term sheet, they are mostly only interested in the pre-money valuation and the board composition. They assume the rest of the language is “standard” and they don’t want to ruffle any feathers with their new VC partner by “nickel and diming the details.” But these details do matter.

VCs are savvy and experienced negotiators, and all of the language included in the term sheet is there because it is important to them. In the vast majority of cases, every benefit and protection a VC gets in a term sheet comes with some sort of loss or sacrifice on the part of the founders – either in transferring some control away from the founders to the VC, shifting risk from the VC to the founders, or providing economic benefits to the VC and away from the founders. And you probably have more leverage to get better terms than you may think. We are in an era of record levels of capital flowing into the venture industry and more and more firms targeting seed stage companies. This competition makes it harder for VCs to dictate terms the way they used to.

But like any negotiating partner, a VC will likely be evaluating how savvy you appear to be in approaching a proposed term sheet when deciding how hard they are going to push on terms. If the VC sees you as naïve or green, they can easily take advantage of that in negotiating beneficial terms for themselves. So what really matters when you are negotiating a term sheet? As a founder, you want to come out of the financing with as much overall control of the company and flexibility in shaping the future of the company as possible and as much of a share in the future economic prosperity of the company as possible. With these principles in mind, let’s take a look at four specific issues in a term sheet that are often overlooked by founders and company counsel:

What counts in pre-money capitalization
The CEO common director
Drag-along provisions
Liquidation preference.

What counts in pre-money capitalization

Startup Law A to Z: Employment Law

Published March 12, 2019

Your startup will not succeed unless you, the founder, build an exceptional team. Great teams are built on top of great culture. Yet any venture-backed startup founder will tell you, myself included, that developing a positive corporate culture is more art than science, requiring constant and creative recalibration as your company grows. What then does this have to do with employment law?

First, building an exceptional team means hiring great people; whether that involves W-9s for consultants, I-9s for employees, lengthy H-1B visa applications, or a new employee handbook, you need to hire the right people in the right way. Second, one bad employment-related legal dispute can have ripple effects throughout an organization, undermining employee morale and executive credibility in one fell swoop, with palpable culture fallout.

Fortunately, when working to promote healthy company culture, founders can look to employment law for some preventive medicine. In fact, transparency through written policies, clearly communicated in advance and followed in practice, can help create the trust and accountability which are foundational to positive company culture. Moreover, in the event employment disputes do arise, well-drafted employment policies actually provide valuable guidance through difficult to navigate situations, while limiting downside risks to the company, as well.

This article, the fourth in Extra Crunch’s exclusive five-part “Startup Law A to Z” series, follows previous articles on customer contracts, intellectual property (IP) and corporate matters. This series is calculated to provide founders the information needed to assess legal risks in the areas common to most startups.

After reading this article, or other “Startup Law A to Z” articles, should you identify legal risks facing your startup, Extra Crunch resources can help. For example, the Verified Experts of Extra Crunch include some of the most experienced and skilled startup lawyers in practice today. So use these resources to identify attorneys focused on serving companies at your stage and then reach out for further guidance in the particular issues at hand.

The Employment Law checklist:

Employee vs. independent contractor classification

Payroll Taxes and Payroll Providers
Federal Classification: 21-Part Test
State Classification: Various tests, e.g., Dynamex in California
Intentional vs. Unintentional Misclassification and Penalties

Minimum wage and hour laws

Application to founders
Federal Fair Labor Standards Act (FLSA)
State Laws

Meal and rest breaks, vacation pay

Federal Fair Labor Standards Act (FLSA)
State Laws

Deferred compensation

Rule 409A
Founders
Employees

Sexual harassment, discrimination, and related claims

Federal:
- Civil Rights Act of 1964
- Age Discrimination in Employment Act of 1967 (ADEA)
- Americans with Disabilities Act of 1990 (ADA)
- Equal Pay Act of 1963
- Genetic Information Nondiscrimination Act of 2008
State Laws
Employee Handbook
Documentation and Investigation

Work authorization / immigration

Form I-9 (Employees) and W-9 (Independent Contractors)
For Temporary Workers:
- Visa Waiver Program
- B-1
Employee Visas:
- H1-B
- L-1
- O-1
Students:
- F-1 with OPT STEM Extension
Other Visas:
- EB-5
- E Visas (E-1, E-2, E3)

Employee vs. independent contractor classification

One of the biggest employment law issues that startups get wrong, often willingly, is “employee” versus “independent contractor” classification. For employees, a startup must withhold and pay federal, state, and local income taxes, state disability, and payments under the Federal Unemployment Tax Act and Federal Insurance Contribution Act (i.e. Social Security and Medicare), not to mention contributions for federal and state unemployment and workers compensation insurance. Given this complexity, startups should absolutely hire a payroll provider to help manage the process, such as ADP, Gusto, Paychex or Quickbooks.

Of course, all of this gets expensive. Instead, far too many early-stage startups simply hire “independent contractors” to avoid everything mentioned above, often misclassifying these workers in the process, whether under federal law, state law, or both.