editione1.1.4
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Brad Feld and Jason Mendelson of Foundry Group first encouraged people to view the terms of a term sheet on two axes, economics and control, in a running series of blog posts that eventually led them to create one of the most widely respected books on venture capital, Venture Deals. Economic terms are related to who gets paid how much and when. Those related to control dictate who can or can’t do what with or without permission from the other party. This distinction is a deeply helpful frame of reference for understanding and negotiating term sheets.
Founders often forget that they’re negotiating for good economics—for themselves and their team—and appropriate control dynamics. We encourage founders not to think of control in absolute terms, as once you take money from someone else, you are giving up some control.
For example, founders often obsess over maintaining 50.1% ownership of their company after the Series A. Mistakenly, they think this is a control term when it is actually an economic term. More ownership directly translates to more money for the founders in the event of an acquisition or IPO. Founders may think that the class of stock they sell to investors is an economic term, when it’s actually a control term—preferred stock protective provisions can force founders to bring major decisions to a vote that can only pass with majority support from the preferred stockholders, even if the founders own more than 50% of the company.
As you read through each term and eventually begin negotiating, consider which terms primarily impact economics, and which impact control.
Definition A side letter is a separate contract used in a negotiation to give investors separate terms for an arrangement than those outlined in the primary contract documentation. For example, in the case of a minor investor that wouldn’t normally get information rights, the company can draft a side letter granting that investor those rights.
Side letters are often a fancy way of saying, “Hey, give me rights that no one else gets,” and founders should be wary of giving one investor special rights. On the other hand, some investors, like the venture arms of large corporations, have special reporting requirements that other investors may not require—side letters can be a great tool in a situation like this.