1. Term Sheet [R]Evolution:
Notes, Caps, & Other
Josh Cook

2. LETS TALK ABOUT ME
> 2,000 company clients
> 950 venture financings annually
>60 venture fund formations annually
Oh, by the way, we have been #1 firm in Dow Jones survey 3 years in a row and #1, #2
or #3 in every year the survey has been done. (true story)

3. And, of course,
for

4. My mantras . . .
REMOVE FRICTIONS
DO ONLY WHAT WE MUST
FAST AND EFFICIENT
DON’T INNOVATE ON SEED STAGE
LEGAL

5. ANCIENT HISTORY
Several years ago . . .
• Very few angel investors
• Many companies start with $3-5M Series A
• 4-6 weeks close
• Board seat and negotiated investor rights
• $50K legal fees for both sides
• Fewer “forms”
• Lucite deal toys () and velobound closing books ()

6. AND NOW?
• Lots of seed deals and even more angel investors
• Sub $1M with varying “caps” or valuations
• Close within days and floating or rolling closes over
months
• No board seat and limited investor rights
• $5-15k legal fees
• “Preferred forms” for YC, Techstars, seriesseed, and
varying institutional angels
• No Lucite toys () and no velobound books ()

7. THE BASICS
Two types of investments
• Convertible Notes
• Series Seed Preferred Stock
Rule of thumb:
• > $1M tend to be Series Seed
• < $1M tend to be convertible note

8. THE LINGO (NOTES)
Material Note terms:
• The “cap” and discount
• Other stuff:
– Conversion triggers
– Sale of company treatment
• Participation rights (i.e. preemptive rights, the ROFO, or Pro Rata Rights)
• Maturity
• Interest

9. THE LINGO (SERIES SEED)
Material Series Seed terms:
• “pre-money” valuation
• Sale of company treatment (i.e. preference, almost
always “non participating”)
• Participation rights
• Most Favored Nations – ie don’t treat me worse than
the next guy
(Notice I left out board seat and protective provisions)

10. notes can suck

11. why notes can suck
Do you know what you own? (Hint: You don’t)
• Confusion about how these convert: pre- or
post-money?
• New investors may ask you to do something
different from your NPA with the company

12. Other Issues
“Phantom preference” or “preference premium” on
conversion
• $1M convert with 50% discount, can mean
noteholders end up with $2M in preference
(Pro tip: there are some ways to solve this)

13. Other Issues
Full Ratchet (search “Full ratchet mark suster” for
more detail)
• Hasn’t been an issue recently since valuations have
generally been going up
No Stockholder Rights
( But you do have creditor rights: you can allege things like fraudulent conveyance
instead of appraisal rights)
(With acquihires it really doesn’t matter)

14. NOTES STILL COOL FOR SOME REASONS
• Paperwork still simpler (although only just slightly)
• Less governance overhang
– Investors generally accept no board seat and few or no
veto rights
• Avoids valuation for 409A purposes –
– Valuation firms don’t see a “cap” as a valuation (as they
would treat a valuation in a preferred equity round)
• Investors are accustomed to them now

15. I’m a Series Seed Fanboy
Certainty around ownership !!! (Pro Tip: That’s a really good thing)
Paperwork about as simple as convertible debt
Investors have rights as “stockholder” (but remember
that stockholders stand behind creditors (noteholders)
in line for payment)

16. But Series Seed has issues . . .
• Investors tend to want to negotiate board seats and
protective provisions (when they otherwise
wouldn’t if it were a convertible note)
• Can make for complicated cap table if raising at
multiple valuation (compared to multiple caps with
notes)

17. Context
CONTEXT
CONTEXT
CONTEXT

18. remember:
high failure rate for
many of these
companies

19. Thanks for the photo Dave

20. Worth Repeating
REMOVE FRICTIONS
DO ONLY WHAT WE MUST
FAST AND EFFICIENT
DON’T INNOVATE ON SEED STAGE
LEGAL

21. Don’t sweat the small stuff
KEEP IT SIMPLE AND ACTIONABLE
- dave mcclure
Who gives a sh*t about interest?
How do lengthy reps and warranties protect you? (Hint: They
don’t. But get some basics, IP and litigation.)
Maturity only kinda matters

22. STANDARD DOCS ARE YOUR FRIEND
500 startups YC SERIESSEED Angelpad AngelList
OTHER INVESTORS ARE YOUR
FRIENDS
Piggyback off their efforts. Talk to the anchor investors.
MOST LAWYERS CARE TOO MUCH
Find one that can address your goals without driving up costs.

23. SO WHAT MATTERS?
Conversion Triggers for Notes
MFN – For both Notes and Series Seed
Company Sale – What are your rights and what are
EXPECTATIONS?
Participation rights – Try to lock these in (Pro tip: Harder
for the 25k and under crowd)

24. Conversion
• Ask what happens in three events:
– Equity financing – most important to trigger to a “qualified financing.”
No need to solve for a non qualified financing (although you’ll see that in
many forms). Company typically incentivized to want to convert you.
They can ask.
– Sale of company – ask for either multiple return (2x or 3x) or ability to
convert. (Maybe both – we’ll talk about that in acquihire protections.)
– Maturity – There a some nuances here in corner cases worth
considering.
• But generally, you don’t want the company to pre pay when you don’t want
them to – either before or after maturity.
• Most deals 18-24 months

25. Despite what I said We SHOULD Innovate In Legal
• Don’t be an “early adopter,” but be an active lurker
• Capped deals – that’s a relatively recent change
• Seriesseed.com forms
• “Convertible Security” (http://bit.ly/OGgJnF)
• Others:
– AngelList
– Clerky
– Eshares
– Digital signature services

26. Josh Cook, Gunderson Dettmer
650-463-5267
jcook@gunder.com
@joshcook
Gunderson Dettmer LLP
@gundersonlaw
www.gunder.com