Review of Gust Series Seed Term Sheet

How founder-friendly is it?

I led a study in 2019 with attorneys who reviewed the six most popular startup financing documents—all of which were produced by investor-funded organizations. After pouring through 298 pages of legalese, the attorneys found the top six financing documents were, on average, only 38% compatible with Founder Friendly Standard. The Gust Series Seed Term Sheet was one of the least compatible with the Founder Friendly Standard. See for yourself by viewing our infographic where you can drill down and compare the term sheets.

Gust Series Seed Term Sheet does not guarantee founders any control of their companies

Review written by Jennifer Rohleder, Principal of J. Rohleder Law, on July 25, 2019.

If you can muster the patience to build what John W Mullins calls a customer-funded business, you can reject the terms of the Gust Series Seed Term Sheet that you don’t like. (Always consult with an attorney when negotiating a term sheet.)

As Mullins writes in The Customer-Funded Business, “Making do with the probably modest amounts of cash your customers will give you enforces frugality, rather than waste… and will force you to run your business better.” Customer-funded companies have the option to walk away from angels and venture capitalists (VCs) and grow organically until they command investment terms in line with the Founder Friendly Standard.

This review is for Founders who want to build companies their way.

Comparing the Gust Series Seed Term Sheet to the Founder Friendly Standard

How do you define founder-friendly? For this comparison, I used the Founder Friendly Standard to grade Gust Series Seed Term Sheet (“the term sheet”) for founder-friendliness. Before I get started, Gust is a trademark of Gust, Inc., which is not affiliated with this content and does not endorse it. This content is not legal advice. See disclaimer below.

Section 1.1 of the Founder Friendly Standard says:

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.

The Gust Series Seed Term Sheet doesn’t meet Section 1.1 of the Founder Friendly Standard. There is no mention of a super-voting class of shares for Founders. This is not surprising, and can be remedied by already having super-voting shares included in the company’s bylaws.

Section 1.2 of the Founder Friendly Standard says:

Investors receive a class of equity such as Class A Preferred Stock which will have one vote per share with a higher par value justified by a liquidation preference.

The Gust Series Seed Term Sheet doesn’t meet Section 1.2 of the Founder Friendly Standard. While the terms sheet provides a liquidation preference of 1x the original issue price plus accrued and unpaid dividends, it lets investors elect one member (“Preferred Director”) of a three-person board. This is akin to giving investors super-voting equity, not one vote per share. (Section 1.4 below describes the powers given to the Preferred Director)

Section 1.3 of the Founder Friendly Standard says:

Employees and contractors receive a class of equity such as Class B Common Stock which carries one vote per share and does not have a liquidation preference.

The Gust Series Seed Term Sheet does meet Section 1.3 of the Founder Friendly Standard. While the term sheet does not provide for a third class of stock for employees, one would expect employee equity to receive one vote per share with no liquidation preference.

Section 1.4 of the Founder Friendly Standard says:

The first board consists of only Founders. The term of the board is one year. After the first year, a new board is elected by the equity holders at the annual meeting. Board decisions are made by a majority vote of the board. Board members cast no more than one vote each on any decision. Board committees are disallowed for at least the first two (2) years.

The Gust Series Seed Term Sheet doesn’t meet Section 1.4 of the Founder Friendly Standard. The term sheet provides that two directors are elected by the holders of a majority of the Common Stock, and one is elected by the holders of a majority of the Preferred. While it looks like the Founders would control two thirds of the board, further provisions require the Preferred Director’s approval before taking an action. These actions include taking on debt, selling assets, changing Founders or executive officers, and entering into a liquidation event that would result in the Preferred receiving less than 5x the original purchase price. This can put the investors, rather than the Founders, in control of the company. Founders, is this what you want?

Section 1.5 of the Founder Friendly Standard says:

New equity of any kind, including stock option pools, dilutes all equity holders equally. Therefore, no investor in the company has anti-dilution rights of any kind.

The Gust Series Seed Term Sheet doesn’t meet Section 1.5 of the Founder Friendly Standard. The price per share is calculated using a set-aside of 15% of the company’s shares as an option pool. The pool exists after the investment is made but is used in the calculations before the investment is made. This means that all of the shares of the option pool come from the Founders shares, not the investor shares. The investors are protected from dilution for future employees.

The conversion of Preferred into Common shares is subject to the “Broad-based Weighted Average anti-dilution protection.” This means that if the company raises money in the future at a lower valuation than the valuation used in the current round, the current investors will be partially protected. According to Gust, this provision is the “middle-of-road industry standard, halfway between the Founder-biased no anti-dilution approach and the investor-biased full ratchet anti-dilution version.”

The focus on the down-side protection seems misplaced in such an early round of funding. Early-stage companies are risky by definition; that risk should be shared equally. Does that sound right to you?

Section 2.1 of the Founder Friendly Standard says:

Founders agree in writing they will give and receive performance reviews at the end of each fiscal quarter for the first four (4) years.

The Gust Term Sheet doesn’t address the principle laid out in section 2.1 of the Founder Friendly Standard. The term sheet is silent on this issue.

Section 2.2 of the Founder Friendly Standard says:

Sweat equity vests each month over a period of four (4) years with a one (1) year vesting cliff. Vesting begins on the date shares are issued.

The Gust Series Seed Term Sheet does meet Section 2.2 of the Founder Friendly Standard. The term sheet provides for “reverse vesting” so the company can repurchase unvested stock if a Founder leaves before four years. The term sheet provides for full acceleration upon “double trigger,” meaning if the company is acquired prior to the 4-year period and the new company terminates a Founder, that Founder’s remaining stock immediately vests.

Section 2.3 of the Founder Friendly Standard says:

Founders keep all information confidential and assign the company all intellectual property created within the scope of their work for the company.

The Gust Series Seed Term Sheet does meet Section 2.3 of the Founder Friendly Standard. The term sheet requires all Founders to have assigned all relevant IP to the company and executed a non-disclosure agreement.

Section 2.4 of the Founder Friendly Standard says:

Due to potentially devastating tax consequences, the company tells individuals receiving sweat equity in the United States to consult with a tax professional about making an election under Section 83(b) of the Internal Revenue Code. Founders who live or pay taxes outside the United States are similarly advised to consult tax professionals about applicable local and national taxes.

The Gust Series Seed Term Sheet doesn’t address Section 2.4 of the Founder Friendly Standard. The term sheet is silent on this issue.

Section 2.5 of the Founder Friendly Standard says:

Non-compete restrictions only apply to employee or independent contractor agreements and do not survive termination. The company’s bylaws and other investor agreements are either silent on the issue of non-competition or expressly allow competition.

The Gust Series Seed Term Sheet doesn’t meet Section 2.5 of the Founder Friendly Standard. The term sheet requires Founders sign a non-compete and non-solicitation agreement that extend one year after termination. Non-competes can restrict Founders’ ability to find work in their industry.

This isn’t fair for Founders receiving below-market salaries; it’s unlikely they will have enough savings while they look for jobs in other industries. Fired and restricted from finding work, founders can be exploited when it comes time to sell their equity. Have you ever heard of this happening to a founder?

Section 3.1 of the Founder Friendly Standard says:

For at least the first two (2) years of operations, the company will not agree to pay the legal expenses of any investor as a condition of investment.

The Gust Series Seed Term Sheet doesn’t meet Section 3.1 of the Founder Friendly Standard. The term sheet states that the company is responsible for reimbursing a flat fee to the preferred for background check expenses, due diligence, and review of transaction documents by investors’ counsel. This an egregious term; such costs are the costs of doing business for a professional investor.

Section 3.2 of the Founder Friendly Standard says:

For at least the first two (2) years of operations, the company does not agree to binding arbitration with any investor.

The Gust Series Seed Term Sheet does meet Section 3.2 of the Founder Friendly Standard. The term sheet is silent on dispute resolution, which leaves the door open for Founders and investors to go to court rather than arbitration.

Section 3.3 of the Founder Friendly Standard says:

For at least the first two (2) years of operations, the company does not agree to binding arbitration with any Founder.

The Gust Series Seed Term Sheet does meet Section 3.3 of the Founder Friendly Standard. The term sheet is silent on dispute resolution, which leaves the door open for Founders and investors to go to court rather than arbitration.

Section 4.1 of the Founder Friendly Standard says:

Upon any transfer or sale of Founders’ super-voting equity, the portion of equity transferred converts to the class of equity described in Section 1.3. This also includes any transfer to a Founder’s estate, spouse, or heirs.

The Gust Series Seed Term Sheet doesn’t meet Section 4.1 of the Founder Friendly Standard. Founders do not have super-voting equity per the term sheet.

Section 4.2 of the Founder Friendly Standard says:

The company has the right of first refusal on any transfer or sale of equity for up to forty-five (45) days, but it cannot veto a transfer or sale. This provision is void after a company’s stock is listed on a public exchange such as the NASDAQ, OTCBB, New York Stock Exchange, etc.

The Gust Series Seed Term Sheet does meet Section 4.2 of the Founder Friendly Standard. The company has the right of first refusal with respect to any proposed transfer of capital stock at the same price that was offered. The term sheet doesn’t provide a veto right. The term sheet doesn’t limit the amount of time such a right of first refusal is valid.

Should you accept seed investment terms that aren’t founder-friendly?

The Gust Series Seed Term Sheet meets six issues (sections 1.3, 2.2, 2.3, 3.2, 3.3, and 4.2) addressed by the Founder Friendly Standard. The terms sheet doesn’t meet seven issues (sections 1.1, 1.2, 1.4, 1.5, 2.5, 3.1, and 4.1), and is silent on two issues (sections 2.1 and 2.4). Nearly all the issues carry long-term ramifications.

José Ancer says in his article, Legal Technical Debt, “The entire point of contracts is that they are permanent and cannot be fixed unilaterally. That makes legal mistakes far more costly to fix than coding mistakes.” Have you seen or experienced this? If you’ve built a customer-funded business, you might hold off fundraising until you can get terms you can live with permanently.

If your startup has received a term sheet from an investor and you would like to talk through the issues, visit my website to book a consultation.

INFOGRAPHIC: How does Founder Friendly Standard compare to term sheet templates from 500 Startups, Y Combinator, NVCA, Gust, and Sam Altman?

Limit of Liability/Disclaimer of Warranty: Jennifer Rohleder (“Author”) is not providing any financial, economic, legal, accounting, or tax advice or recommendations on this site. Although Author is an attorney licensed in the District of Columbia and Virginia, the information contained on this site was prepared for general information purposes only, does not constitute research, advice, or a recommendation from Author to the reader and is not a substitute for personalized financial or legal advice. Neither Author nor any of her affiliates make any representation or warranty as to the accuracy or completeness of the statements contained on this site. Author and her affiliates expressly disclaim any liability (including any direct, indirect, or consequential loss or damages) for all posts and their content.

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