Venture Financing Tips: Price Protection, Pre-Emptive Rights, & Board Matters
Hear from Jesse Jones, Fourscore Business Law Founder, about How To Structure an Equity Deal. In this video, learn about 3 important terms when structuring an equity deal: price protection, pre-emptive rights, & board matters. He'll discuss what these terms mean, how they relate to your investors, and how they can help structure your equity deals. Stay tuned for the next video in our Venture Financing Tips series and subscribe to our monthly newsletter full of resources here.
For entrepreneurs, the prospect of raising funds to propel business growth should come with a mix of excitement and fear. While taking angel and venture capital isn’t right for every startup, it may be the ideal financial structure to help you scale.
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Venture capital gives you the opportunity to raise significant amounts of funding by essentially selling a part of your company as you build it. For that reason, entrepreneurs should understand that angel and venture capital is typically expensive money, so the smartest entrepreneurs will make sure to seek outside capital from those that can provide value in terms other than simply dollars.
If you are planning to meet with a potential investor, understanding what to expect when it comes to structuring venture deals will help ensure you get started on the right foot.
Venture Financing Tips: Price Protection, Pre-Emptive Rights, & Board Matters
Hi, I'm Jesse Jones, founder of Forest Corps Business Law. Thanks for tuning in to this quick video on how to structure an equity deal. This video we're going to cover three standard terms that you're going to see in a venture term sheet.
Number one is price protection, number two preemptive rights, and number three board matters. Price protection is a right that investors commonly negotiate for that says if the company sells shares of stock to other investors later on for a price that is less than the price that the investors are paying today, then that price is going to be adjusted and reflected in the conversion ratio.
That can get pretty technical and we're happy to walk you through that if you're dealing with it, but I'm going to leave it at that. Basically, if you sell shares for a lower price later that's going to affect what happens now.
Number two is preemptive rights. So often, this is not in every deal, but often investors want to know that they are going to have the right to hold their ownership position for the next round. So if you have an investor come in, he buys 20% of the company, he may have a preemptive right to buy whatever number of shares he needs to in the next round in order to keep 20% of the company after that round is done. So he doesn't want to get diluted, but he has to pay for it. It's not that he just gets, you know, additional shares.
He will be allowed and have the right to come into the next round at the same terms that the other investors are on in that later round and be able to hold that 20%. Number three, board matters. This is not, this is also not in every deal, but often you'll see investors negotiate for a board position.
They want to make sure that they have someone that they know is on the board of the company helping to direct sort of the high level movement of the company, but also has some relationship with the investor. It doesn't absolve that director of acting in the best interest of the company, but it does give investors comfort often. And frankly, a lot of times it makes a lot of sense because if you've picked a good investor, they probably have some experience or contacts that would be really, really helpful for the company.
And so having an investor board member can really be a win-win in many situations. Thanks for tuning into this video. For more information on how to structure an equity deal, check out the Venture White Paper on fourscorelaw.com. Thanks.
Common Questions About Price Protection, Pre-Emptive Rights, & Board Matters
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A: Price protection means if a company later sells shares at a lower price, the earlier investor's conversion ratio gets adjusted to reflect that lower price. It protects investors from paying more than future investors for the same company.
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A: Preemptive rights give an investor the option to buy enough shares in the next funding round to maintain their current ownership percentage. They have to pay for those shares at the same terms as new investors.
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A: Yes, investors often negotiate for a board seat as part of their investment deal. This gives them a voice in the company's direction while potentially adding value through their experience and connections.
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A: A board member appointed by an investor is still legally required to act in the company's best interest. Many founders find it a win-win when the investor brings relevant experience or valuable business contacts.