Resources

Understanding Our Term Sheet

Joséphine Kant
December 13, 2024

Fundraising shouldn’t feel like decoding hieroglyphics. At Dogwood Ventures, we’re trying to make it simpler. That’s why we made our term sheet public. Read more about that here. But transparency isn’t enough if the terms themselves still feel cryptic. So in this post, we’re breaking down our term sheet. The goal is simple: to help founders understand each term, why they are included, and increase the speed of negotiations and general understanding.

In the process of offering our first term sheet, we realized we needed to add a few important provisions to better align with best practices. We are learning too.

Our recent updates include:

  • Require companies to purchase Key Person and Directors and Officers (D&O) insurance
  • Protective provisions around significant company decisions including stock sales, making loans, taking on debt, selling intellectual property, or entering into economic partnerships

Our pledge to founders is that we will publicly post a new blog if we make any updates going forward, and more importantly why we included (or removed) a term.

Before we get into the terms, here’s a few resources we use and recommend. We pulled from all of these sources to create our standard termsheet:

‍

Below is a run down of the terms in our termsheet, what they mean, and why they matter.

‍

Term What it Means Why it Matters
Securities + Shadow Series Dogwood Ventures (and potentially other investors) is purchasing a specific type of equity that takes “preference” over common stock, in this case Preferred Stock. Convertible notes and SAFEs (if any) will convert into a "shadow series" of preferred stock to ensure any round specific preference is given to only the new investors.

As a startup continues to raise more equity capital in priced rounds over time, you’ll hear the term “preference stack” used. This describes the layers of unique classes of equity shares that exist within the company, all taking preference before common shareholders.

Preferred Stock carries special rights that safeguard investors and their limited partners (investors in a venture fund). The rights listed lower in the term sheet are only applicable to this “preferred” class of shares, not common shares.		 Shadow series shares ensure early investors keep the benefits they negotiate (like discounts and caps) without giving them additional liquidation preference on the interest they may have earned before the conversion event. SAFEs and convertible notes raised early in a company’s life convert to actual shares at the next priced round. Shadow series assist in keeping the terms of the new investors whole during this conversion process.
Investment Amounts The total investment is broken down, with Dogwood Ventures contributing $X million and other investors contributing $Y million. This section shows the total funding being committed and ensures transparency in the allocation of funds.
Valuation The pre-money valuation determines the company’s value before this round of investment. The valuation sets the baseline for determining the price per share and the ownership percentage of all investors and company owners. At Dogwood Ventures, we don’t rely on a single formula for valuations. Instead, we look at the whole picture: growth, revenue multiples, market trends, and how similar companies are doing. We also measure this against a target ownership % range for our fund’s strategy.
Option Pool A portion of the company’s equity is reserved for future employee stock options, set as a percentage of the fully diluted post-investment cap table. A robust option pool incentivises current and future employees, but founders should ensure the size doesn’t dilute their ownership excessively. A pre-money option pool means the option pool is expanded to match the percentage in the termsheet before the new investors enter the capitalization table. This dilutes the earlier stage investors and common shareholders.
Liquidation Preference Investors are guaranteed a 1x return of their investment in the event of a company sale or liquidation before proceeds are distributed to common shareholders. This protects investors’ downside while keeping the structure founder-friendly (no participation beyond the initial investment). For example, if an investor puts $1M into a company today, and the company sells next month for $1M, the investor gets their money back. Non-participating means the new investors in this round either get their original investment amount back, or they get their pro rata share of the company - not both.

A participating preferred liquidation preference means the new investors get both their original money back (times some multiple) PLUS their pro rata share of the company after paying out the preference. This significantly dilutes common shareholders and earlier investors.
Conversion to Common Stock Preferred Stock can convert into Common Stock, either voluntarily or automatically under certain conditions (e.g., an IPO). Since preferred shares are a separate class from common shares, the rules for how and when they convert to common shares need to be defined. Once preferred shares convert to common, they no longer hold the preferred terms negotiated.
Founder Vesting Founders receive credit for one year of vesting upfront, with the remaining equity vesting over three years on a monthly basis. Vesting aligns founders’ incentives with the company’s long-term success and protects the business and investors in case a founder departs early. Providing some percentage of auto-vesting based on time already worked within the company rewards the tenure of early employees.
Voting Rights & Protective Provisions Certain major decisions (e.g., issuing new shares, taking on debt, approving a sale, hiring a ) require investor approval. Otherwise, Preferred Stock votes with Common Stock. This ensures investors have a voice in critical decisions while allowing founders and company leaders to run day-to-day operations.
Drag-Along Founders, investors, and certain stockholders must agree to a company sale if approved by the board, Preferred Majority, and Common Majority. Drag-along clauses prevent minority shareholders from blocking a beneficial exit.
Other Rights & Matters This section includes standard protections like anti-dilution adjustments, registration rights, and pro-rata rights for participating in future funding rounds. These rights safeguard investors from excessive dilution or loss of influence in the company.
Anti-dilution Adjustments This protects the investors from dilution if the company raises a down round. This protects the value of the investor’s initial investment and preserves their ownership.
Registration Rights This allows investors to register their shares for a public sale (during an IPO). This allows investors to participate in an IPO and sell their shares.
Pro-rata Rights This gives the investors the right to participate in a future funding round. This protects the investor from dilution and allows them to maintain their ownership percentage.
Information Rights This gives the investor the right to financial and general updates on the company’s performance. This allows us to keep track of our investment and make informed decisions about our involvement and future funding.
Key Person Insurance An insurance policy on the company’s founders (or key employees) in the event they die or become disabled. Founders are the core of every great startup. Losing them creates immediate financial risk that insurance helps reduce.
D&O Insurance This is an insurance to protect Directors & Officers from personal financial liability. This helps reduce personal financial risk and ensure D&O are protected from any claims. Most VCs also carry their own D&O policy for their firms and investors.
Expenses The company agrees to cover legal fees for Dogwood Ventures, capped at $30,000. Capping expenses protects the company from bearing excessive legal costs.
Board of Directors Depending on the circumstances, Dogwood may designate a board member or observer, with Common Majority shareholders designating an agreed number of board members. Independent Board Directors may also be included. Board composition reflects a balance of oversight between founders and investors. We take a board seat when leading rounds so we can actively support the company’s growth and provide guidance for major decisions.
No Shop For 30 days, the company cannot pursue alternative offers. The period extends if both parties are actively negotiating. This ensures the deal progresses without distractions, protecting our investment of time and resources.