Yes, but founders should not trust them. A team of attorneys reviewed six popular term sheets in the infographic below. The attorneys revealed many investor agreements are not founder-friendly. Your first step should be to retain a laywer who represents entrepreneurs.
Ask your attorney about a startup investment contract template called Founder Friendly Standard. Founder Friendly Standard has 17 sections that can lay common disputes to rest such as who gets to vote, who gets liquidation preferences, what is the scope of non-compete, etc.
Here are (3) three of the juiciest sections:
Individuals who work for the company and are instrumental in its inception (“Founders”) receive a class of equity such as Common Stock which provides no less than twenty-four (24) votes to one (1) vote of stock held by investors or employees.
If you’re the founder, why not control your own company? This can lead to better business performance for investors according to Credit Suisse’s Family 1000 research.
Founders agree in writing they will give and receive performance reviews at the end of each fiscal quarter for the first four (4) years.
Have you ever seen conflict fester and erupt? Famous examples include Bill Gates & Paul Allen, Evan Spiegel & Bobby Murphy, and Mark Zuckerberg & Eduardo Saverin. This provision facilitates giving and receiving feedback at least every quarter to address conflict before it becomes a risk to your startup.
For at least the first two (2) years of operations, the company does not agree to binding arbitration with any investor.
Since arbitration is often more expensive than public court, why do investors commonly insist on binding arbitration? According to the startup attorneys in our 2019 term sheet comparison study below, arbitration often requires meritless cases to be tried – even when public courts might dismiss those cases. The legal process can be abused by the party with the most cash, and trying meritless cases can wear founders down. This is why forced arbitration between parties of unequal bargaining power is unfair.
I encourage you to study Founder Friendly Standard and send it to your attorney as an agenda for your next conversation.
How our startup investment contract template was born
After getting pushed out of a successful company I started, I teamed up with my former business partner and my outside attorney to create a checklist of legal issues to help entrepreneurs keep control of their startups. We wrote Founder Friendly Standard in 2017 to help other entrepreneurs avoid our mistakes and go further.
- Read “I’ll be the Sean Parker to your Mark Zuckerberg” for our story.
- Learn to manage 10 of the top 20 startup failure risks with Founder Friendly Standard.
Comparison of six “standard” startup investor agreements
Six popular (and so-called “standard”) startup investment agreements tested only 38% compatible with Founder Friendly Standard. This finding is from a 2019 study I led with six attorneys who reviewed 298 pages of legalese from 500 Startups KISS, Y Combinator Safes, NVCA Model Legal Docs, Gust Series Seed, Sam Altman Term Sheet, and the Y Combinator Series A.
Investors can trade Founder Friendly Standard terms for valuation discounts
Entrepreneurs often focus on how many dollars they are raising in exchange how much equity they are selling. However, the other terms in a startup financing—e.g. the terms in Founder Friendly Standard—also have value. That value can be traded for discounts on a startup’s valuation.
According to Gompers and Lerner, buying low is the largest driver of venture capital returns. In my experience, control is the largest driver of entrepreneur happiness. I’ve written extensively about how investors can trade control for valuation discounts in my December 2020 book, Innovation Casino.