Wed, 10 August 2022
Startup Boards -- 3X in 3 Terms Sheets
Hello, this is Hall T. Martin with the Startup Funding Espresso -- your daily shot of startup funding and investing.
The biggest challenge in investing in startups is finding the exit.
Time value of money is important and should be part of your return metrics.
Startup investors look for a 44% IRR.
IRR is Internal Rate of Return and represents the return on investment with respect to time, unlike ROI, which is return on investment without respect to time.
Startup investors occupy a unique place in the startup funding ecosystem.
Startup investor funding is the first money in after family and friends funding.
The longer you stay in the deal, the greater your risk for dilution by follow-on investors.
The key to a successful exit is a deal structure that gives some control after making the investment.
Equity-only term sheets give investors little say in the future of the company or how to exit.
To achieve an exit, you must define it yourself, as the vast majority of startups will not do so.
You must have it in writing before you invest.
Trying to come to an agreement with the startup after investing is almost impossible as the gap between the startup and the investor is too great to close.
One way to define the exit is to add redemption rights into the agreement.
An example of this is the 3X in 3 terms sheet.
The deal structure is a Convertible Note with a redemption right for 3X your investment to be returned at year 3 of the investment at ‘Investor Sole Discretion.’
At the third anniversary of signing the note, the investor has the option to convert the original investment to a three times return ($100K in is $300K out) or to go on the cap table as an equity investor.
In reality, there are many choices. In most cases, the startup is motivated to keep your funds in the deal and will negotiate terms to achieve it.
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