01
Equity instruments and liquidation preference
Sell the company for two million after taking one at a five-million valuation, and the VC takes the first million back before anyone splits anything.
Equity shares go to founders and sit at the bottom of the rights pyramid. Preference shares are the VC class and carry liquidation preference: in an exit the investor is repaid first (USD 1 m in at a USD 5 m valuation, sale at 2 m: VC takes 1 m, the remaining 1 m splits pro rata). No preference matters if the company shuts with nothing; it matters little in a huge outcome. CCDs (compulsorily convertible debentures) and convertible notes (debt) defer the valuation conversation.
Why it mattersThe clause that makes two 'equal' offers unequal.
02
Valuation methods, pre- vs post-money, primary vs secondary
Early-stage valuation is arithmetic, not art: what you need, divided by the twenty percent you will give up.
Mature companies: discounted cash flow with a risk premium; comparables and precedent transactions at multiples. Early stage: the dilution method - the amount needed at a standard 20-25% dilution implies the valuation; check that the next round can be 2-3x higher. Later: multiples of ARR or run-rate revenue, GMV (marketplaces), contracted revenue (SaaS), trailing or forward revenue (B2C); varies by stage and geography. Pre-money is the value before the round; post-money = pre-money + raise; stakes are computed on post-money. Primary issuance dilutes everyone; secondary sales move existing shares and dilute nobody. Why ~20%: founders still own enough to care by Series C or D.
Why it mattersThe numbers behind every headline valuation.
03
The term sheet, the shareholders' agreement, and the articles
A term sheet is a formal commitment, not a definitive one. Deals die after signing. The SHA is where it becomes real.
Term sheet items: transaction overview (instrument, amount, valuation, use of funds), ownership, broad-based anti-dilution (protects investors if a later round prices lower), liquidation preference (1x typical, 1.5-2x for risky deals), board representation, affirmative/protective provisions, information rights, pre-emptive rights (because of the power law - 1-2 deals return 80%+ of a fund), founder vesting with clawback to the ESOP pool, exit rights (5-6 years, since VCs must return capital to LPs). Then 2-3 months of diligence; findings feed the SHA, which is reflected in the articles of association filed with the ROC. The SHA also governs co-founders (non-compete, vesting). Clauses: board seat, information and affirmative rights (mergers, share sales, new issuance), tag-along, anti-dilution, liquidation preference, ROFR (lead investor may buy shares smaller holders sell), ROFO (vested founders must offer to the investor first), 4-year vesting with a 1-year cliff then quarterly, exit order: IPO, strategic buyback, company buyback, else forced sale.
Why it mattersThe documents, in order, with the clauses that bite.