# Venture Term Sheet Concept Card: [Your company, case or course]

> A concept card for reading, modelling and negotiating a venture capital term sheet beyond price: liquidation
> preference multiples, participation and caps, seniority, cumulative dividends, price-based anti-dilution (full ratchet,
> broad-based and narrow-based weighted average), pay-to-play, redemption, and the control terms (board composition,
> protective provisions, drag-along, rights of first refusal and co-sale, pro rata and information rights). It is for MBA
> students in the venture capital and entrepreneurial finance electives, founders and early employees facing a round,
> and candidates for venture investing roles. It builds on mba/mba-venture-finance-cap-table-card, which you should read
> first: that card teaches pre-money and post-money, the option pool shuffle, 1x preferences and the basic exit
> waterfall, and this card continues its Corvane Robotics cap table into a down round. Source basis: the NVCA model
> legal documents (nvca.org, checked October 2026) for the structure and common wording of terms, Kaplan and Stromberg
> (2003) and Hellmann (1998) on venture contracts and control rights, and Gornall and Strebulaev (2020) on how terms
> change value, all summarised in original words. Replace every [bracketed] value and every row marked *Example*. This
> is a learning aid, not legal, tax or investment advice: a term sheet leads to binding legal documents, and the signed
> text and qualified counsel govern.

<!--
Guidance: How to use this template
- Read mba/mba-venture-finance-cap-table-card first, especially "Liquidation preferences and the exit waterfall".
  This card assumes you can run a 1x non-participating waterfall by hand.
- Read "The idea in plain language", then use the term-by-term table as a checklist on any real term sheet you see.
- Rebuild Worked example A in a spreadsheet: one tab for the down round and anti-dilution, one tab for the waterfall
  at five exit values. Every share count should match to the unit.
- Fill every [ ] in Worked example B before you look at the answer key. Do Exercise C on paper first.
- Answer the self-test from memory, then check the answer key. Log misses in mba/mba-error-log.
- All companies, funds, people and numbers are fictional and were computed in Python; the calculation script is kept
  with the library sources so a reviewer can re-run it.
- Related templates: mba/mba-venture-capital-guide, mba/mba-vc-method-card, mba/mba-venture-finance-cap-table-card,
  mba/mba-vc-portfolio-construction-card, mba/mba-entrepreneurship-guide, mba/mba-negotiation-planner,
  mba/mba-options-real-options-card, mba/mba-deal-structuring-card, mba/mba-corporate-governance-card,
  mba/mba-electives-roadmap, mba/mba-error-log, finance/investment-committee-memo, finance/due-diligence-request-list,
  startup/board-deck, startup/investor-update.
-->

## Document control

<!-- Guidance: Record which version of the term sheet you modelled and against which cap table, so that every number can be traced to a document. -->

| Field | Value |
|---|---|
| Company, case or course | [Company name / course, session 7] |
| Learner or analyst | [Your name] |
| Term sheet version | [Draft from lead investor, date] |
| Cap table used | [Cap table export, date] |
| Model documents referred to | [NVCA model documents, revision dates / local equivalent] |
| Spreadsheet used | [Excel / Google Sheets / LibreOffice Calc] |
| Reviewed by | [Study partner, tutor or company counsel] |
| Version | [0.1] |
| Last updated | YYYY-MM-DD |

## Contents

- [When to use it](#when-to-use-it)
- [The idea in plain language](#the-idea-in-plain-language)
- [The terms one by one](#the-terms-one-by-one)
- [Formulas and notation](#formulas-and-notation)
- [Assumptions and limits](#assumptions-and-limits)
- [How founders, investors and boards use this](#how-founders-investors-and-boards-use-this)
- [Worked example A (fully solved): Corvane Robotics raises a down round](#worked-example-a-fully-solved-corvane-robotics-raises-a-down-round)
- [Worked example B (half solved): dividends, participation and a ratchet at Start-up Q](#worked-example-b-half-solved-dividends-participation-and-a-ratchet-at-start-up-q)
- [Exercise C (unsolved): pay-to-play at Company R](#exercise-c-unsolved-pay-to-play-at-company-r)
- [Process diagram](#process-diagram)
- [Connections to other cards](#connections-to-other-cards)
- [Common mistakes and misconceptions](#common-mistakes-and-misconceptions)
- [Self-test questions](#self-test-questions)
- [My notes and next steps](#my-notes-and-next-steps)
- [Sources and further reading](#sources-and-further-reading)
- [Answer key](#answer-key)
- [Revision history](#revision-history)

## When to use it

<!-- Guidance: Pick the question you are answering. A term sheet review that tries to answer all of them at once usually misses the one that matters. -->

| Question | Where this card answers it |
|---|---|
| Which terms change who gets paid, and which change who decides? | The terms one by one |
| How much does a down round really cost the founders once anti-dilution applies? | Worked example A, steps 1 to 3 |
| How much does a 1.5x participating preference cost the founders at each exit, compared with a clean 1x? | Worked example A, step 4 |
| What does an 8% cumulative dividend add to a preference after four years? | Worked example B |
| What happens to an investor who does not take up its share of the next round? | Exercise C (pay-to-play) |
| Which terms are market practice and which are unusual? | The terms one by one, Common mistakes |

| Use this card when | Use another tool when |
|---|---|
| You compare term sheets or prepare a negotiation | You set the price itself (mba/mba-vc-method-card) |
| You model a down round, a bridge or a recapitalisation | You model founding, SAFEs and up rounds (mba/mba-venture-finance-cap-table-card) |
| You explain to employees what their common shares receive | You value an option grant with volatility (mba/mba-options-real-options-card) |
| You structure a minority growth investment | You structure a buyout or a merger (mba/mba-deal-structuring-card) |

## The idea in plain language

<!-- Guidance: Be able to sort any term into "cash flow rights" or "control rights" in one second. That is the frame the literature and negotiators use. -->

A term sheet is a short, mostly non-binding summary of the deal that the lawyers then turn into the full financing
documents. Price gets the headlines, but a venture investment is a bundle of rights, and the bundle matters as much as
the price. Kaplan and Stromberg (2003), studying real venture contracts, showed that investors separate and allocate
three kinds of rights: **cash flow rights** (who receives what in which outcome), **control rights** (board seats,
votes and vetoes) and **contingent rights** that shift control or cash to the investor when performance is poor. Hellmann
(1998) explained why entrepreneurs may rationally give up control rights such as the power to replace the CEO.

Three ideas carry most of the economics.

- **Downside protection.** The liquidation preference pays investors before common. A multiple above 1x, participation
  and cumulative dividends make the protection larger. They matter most in modest exits, exactly where founders and
  employees are most exposed.
- **Price protection.** Anti-dilution adjusts an earlier investor's conversion price when the company later sells
  shares more cheaply (a down round). A full ratchet resets the price to the new, lower price; a weighted average
  adjusts it part of the way, by how much new money came in at the lower price.
- **Control.** Board seats decide strategy and the CEO; protective provisions give preferred holders a veto over listed
  actions (new senior securities, a sale, changes to the charter); drag-along lets a majority force a sale.

The trade-off is constant: a founder can often obtain a higher headline price by accepting stronger protection, and the
higher price can be worth less. Gornall and Strebulaev (2020) show that because each new round's terms differ, the
headline post-money valuation (newest price times all shares) overstates the value of the company, sometimes by a
large margin. Read price and terms together.

## The terms one by one

<!-- Guidance: Use this table as a checklist on a real term sheet. Mark each term as "standard", "negotiate" or "walk-away" and write why. -->

The table describes common forms of each term in original words. The NVCA model documents page (nvca.org, checked
2026-10-28) lists the model Certificate of Incorporation, Stock Purchase Agreement and Investors' Rights Agreement as
updated October 2025, the Voting Agreement as updated June 2026 and the Right of First Refusal and Co-Sale Agreement as
updated April 2026, and describes them as starting points to be tailored. A stand-alone venture financing term sheet
was not listed on that page when checked. Check the current revision dates before you rely on them, and remember that
practice differs by country and by stage.

| Term | Type | Common form (investor-friendly to company-friendly) | What to model or ask |
|---|---|---|---|
| Liquidation preference multiple | Cash flow | 2x or 1.5x, to 1x of the original issue price | Run the waterfall at three exit values |
| Participation | Cash flow | Full participation, capped participation (e.g. 3x total), non-participating | Who gets the money between the preference and the conversion point |
| Seniority | Cash flow | New series senior to all, tiered, pari passu with earlier series | Order of payment in a modest exit |
| Dividends | Cash flow | Cumulative fixed rate, non-cumulative when declared, as-converted with common | Accrued amount added to the preference at exit |
| Anti-dilution | Cash flow | Full ratchet, narrow-based weighted average, broad-based weighted average | Extra conversion shares in a down round, who bears them |
| Pay-to-play | Cash flow and control | Holders who do not invest pro rata lose preference or convert to common | Behaviour of each existing investor in a bad round |
| Redemption | Cash flow | Holder can require repurchase after a set period, or no redemption | Liquidity pressure on the company |
| Board composition | Control | Investor majority, balanced with an independent, founder majority | Who appoints the swing seat |
| Protective provisions | Control | Broad list with series votes, short list with one preferred vote | Which actions each series can block |
| Drag-along | Control | Board plus majority of preferred, plus majority of common, with price floors | Can a sale be forced below the preference stack? |
| Right of first refusal and co-sale | Control | On founder share transfers | Founder liquidity in secondaries |
| Pro rata (pre-emptive) rights | Cash flow | All investors, major investors only, none | Room for new investors in the next round |
| Information rights | Control | Monthly, quarterly, annual statements and budget | Reporting load on a small team |
| Founder vesting and acceleration | Control | Re-vesting on new money, single or double trigger | See the core card, Founder vesting |
| Option pool | Cash flow | Pre-money top-up to a set percentage | See the core card, option pool shuffle |
| No-shop and expenses | Process | Exclusivity for a period, company pays investor's legal costs up to a cap | Length of exclusivity, cap on fees |

**Weighted average versus ratchet.** The weighted average formula in many charters adjusts the conversion price by the
ratio of (shares before plus shares the new money would have bought at the old price) to (shares before plus shares
actually issued). "Broad-based" counts all common outstanding plus shares issuable on outstanding options and
convertibles in "shares before"; "narrow-based" counts fewer shares, which makes the adjustment larger. The exact
definition is in each charter.

## Formulas and notation

<!-- Guidance: Learn the weighted average formula and the three payoff forms. The rest follows from writing down who is paid first. -->

**Conversion.** Each preferred share converts into common at the ratio of its original issue price to its current
conversion price:

$$
n_{conv} = N_{pref} \times \frac{P_{orig}}{CP}
$$

**Weighted average anti-dilution:**

$$
CP_{2} = CP_{1} \times \frac{A + B}{A + C} \qquad B = \frac{\text{new money}}{CP_1} \qquad C = \text{new shares actually issued}
$$

**Full ratchet:** $CP_2 = P_{new}$ (the new, lower price).

**Cumulative dividend** (simple, non-compounding) added to the preference after $t$ years:

$$
L = m \cdot I + \delta \cdot I \cdot t
$$

**Payoffs to one preferred class** with preference $L$, as-converted share $\alpha$, exit equity $E$ after senior
claims, and cap $M$ times the investment $I$ (as in the core card):

$$
\text{Non-participating: } \max\big(\min(E, L),\ \alpha E\big) \qquad \text{Participating: } \min(E, L) + \alpha\,\max(E - L, 0)
$$

$$
\text{Capped participating: } \max\Big(\min\big(\min(E,L) + \alpha\max(E-L,0),\ M I\big),\ \alpha E\Big)
$$

| Symbol | Meaning | Unit |
|---|---|---|
| $N_{pref}$, $n_{conv}$ | Preferred shares held and common shares received on conversion | Shares |
| $P_{orig}$ | Original issue price of the series | Currency per share |
| $CP$, $CP_1$, $CP_2$ | Conversion price, before and after the adjustment | Currency per share |
| $A$ | Shares deemed outstanding before the new issue (broad or narrow definition) | Shares |
| $B$ | Shares the new money would have bought at $CP_1$ | Shares |
| $C$ | Shares actually issued in the new round | Shares |
| $P_{new}$ | Price per share of the down round | Currency per share |
| $m$, $\delta$, $t$ | Preference multiple, dividend rate, years accrued | Multiple, rate, years |
| $L$, $\alpha$, $E$, $M$, $I$ | Preference amount, as-converted share, exit proceeds, cap multiple, investment | Currency, ratio, currency, multiple, currency |

## Assumptions and limits

<!-- Guidance: Write your own assumptions next to these before you show a waterfall to anyone who will sign. -->

1. **Definitions are in the documents.** The broad-based "A", the list of exempt issues (option grants, conversions)
   and the seniority order are defined in each charter. The card uses common conventions.
2. **Equilibrium conversion.** In the waterfalls each non-participating class (and each capped participating class)
   converts when converting pays it more, given what the others do. The script searches for that stable choice.
3. **Options at exit.** As in the core card, granted options are treated as exercised common, strike prices are
   ignored and the unissued pool is cancelled.
4. **No dividends unless stated.** Worked example A has no dividends; Worked example B shows their effect.
5. **Pari passu among the earlier series.** Seed, Series A and Series B rank equally with each other in Worked example A;
   the Series C ranks senior to all of them.
6. **No management carve-out.** Companies in a low exit sometimes create a carve-out plan so that management is paid
   something; that changes the waterfall and is a negotiated, case-specific term.
7. **Taxes and law ignored.** Tax treatment and the enforceability of terms differ by country. Take qualified legal and
   tax advice before relying on any term.

## How founders, investors and boards use this

<!-- Guidance: Read the row for your role. Write down the two terms you would trade, and what you would ask for in return. -->

| Role | First thing they check | Typical trade |
|---|---|---|
| Founder and CEO | Preference stack against realistic exits; board control | Accept a lower price for a clean 1x non-participating preference and a balanced board |
| New lead investor | Seniority, anti-dilution, pro rata in later rounds | Pay a higher price for seniority or a capped participation |
| Existing investor | Whether the new terms subordinate it; pay-to-play | Support the round in exchange for pari passu treatment |
| Employees (common) | Value of common after preferences, not the headline price | Ask for a refresh grant after a down round |
| Board | Whether the round leaves the company financeable later | Avoid terms that block the next round (a full ratchet, heavy redemption rights) |

Gompers, Gornall, Kaplan and Strebulaev (2020) report from surveys that venture capitalists see the management team as
the most important factor in their investment decisions and that they negotiate many contract terms beyond
valuation. Bengtsson and Sensoy (2011) report evidence that more experienced investors tend to obtain weaker downside
cash flow protection but stronger board representation, consistent with investors substituting monitoring for
contractual protection.

## Worked example A (fully solved): Corvane Robotics raises a down round

<!-- Guidance: Build the cap table tab first, then the anti-dilution tab, then the waterfall. Check that the Series C percentage changes when the Series B gets extra conversion shares. -->

**Situation (fictional).** After the Series B in mba/mba-venture-finance-cap-table-card (USD 30m at USD 5.0501 per
share, USD 150m post-money, 29,702,624 fully diluted shares), Corvane Robotics misses its deployment plan and needs
USD 21m. A new lead investor offers USD 3.50 per share. The Series B charter contains broad-based weighted average
anti-dilution. The earlier Seed and Series A prices (USD 1.1397 average and USD 2.1560) are below USD 3.50, so only the
Series B is adjusted. There is no pool top-up in this round. All numbers are fictional.

**Step 1: the round.**

| *Example* item | Result | Excel formula |
|---|---|---|
| Series C shares | 6,000,000 | `=ROUND(21000000/3.5,0)` |
| Headline pre-money at USD 3.50 | USD 103.96m | `=3.5*29702624` |
| Headline post-money | USD 124.96m | `=3.5*29702624+21000000` |
| Discount to the Series B price | 30.69% | `=1-3.5/(30000000/5940525)` |

**Step 2: anti-dilution for the Series B.** $CP_1$ = USD 5.0501 (`=30000000/5940525`). The new money would have bought
$B$ = 4,158,367.5 shares at $CP_1$; $C$ = 6,000,000 were issued.

| *Example* method | $A$ | $CP_2$ | Series B conversion shares | Extra shares | Excel formula for $CP_2$ |
|---|---|---|---|---|---|
| No protection | | USD 5.0501 | 5,940,525 | 0 | |
| Broad-based weighted average | 26,732,362 (all shares and granted options, excluding the unissued pool) | USD 4.7659 | 6,294,685 | 354,160 | `=5.0501*(26732362+4158367.5)/(26732362+6000000)` |
| Narrow-based (preferred only, one possible definition) | 16,332,362 | USD 4.6336 | 6,474,438 | 533,913 | `=5.0501*(16332362+4158367.5)/(16332362+6000000)` |
| Full ratchet | | USD 3.5000 | 8,571,429 | 2,630,904 | `=3.5` |

Conversion shares: `=ROUND(5940525*(30000000/5940525)/CP2,0)`, which simplifies to `=ROUND(30000000/CP2,0)`. Use the
unrounded $CP_1$ in the sheet.

**Step 3: who bears the adjustment.** Fully diluted ownership after the Series C:

| *Example* holder | No protection | Broad-based | Narrow-based | Full ratchet |
|---|---|---|---|---|
| Founders (8,000,000) | 22.41% | 22.19% | 22.08% | 20.87% |
| Seed (4,825,974) | 13.52% | 13.38% | 13.32% | 12.59% |
| Series A (5,565,863) | 15.59% | 15.44% | 15.36% | 14.52% |
| Series B (as converted) | 16.64% | 17.46% | 17.87% | 22.36% |
| Series C (6,000,000) | 16.81% | 16.64% | 16.56% | 15.65% |
| Total fully diluted shares | 35,702,624 | 36,056,784 | 36,236,537 | 38,333,528 |

Options and the unissued pool make up the rest of each column. The extra Series B shares are worth USD 1.24m at the
Series C price under the broad-based formula (`=354160*3.5`) and USD 9.21m under a full ratchet (`=2630904*3.5`).
Every other holder, including the new Series C, bears that transfer pro rata unless the Series C insists on a fixed
percentage, in which case it is pushed onto the others. This is why sophisticated new investors price the anti-dilution
of earlier series into their offer, and why full ratchets make down rounds harder to close.

**Step 4: two Series C term sheets.** With the broad-based adjustment applied, the new investor offers two structures
at the same USD 3.50 price:

- **Term sheet X:** 1x non-participating, senior to all earlier series.
- **Term sheet Y:** 1.5x participating, capped at 3x the investment (USD 63m total), senior to all earlier series.

At exit the unissued pool is cancelled: 33,086,522 shares, of which the Series C holds 18.13%. The founders hold
76.92% of common. Preferences total USD 68.5m under X and USD 79.0m under Y.

| *Example* exit (USD m) | Series C under X | Founders under X | Series C under Y | Founders under Y | Cost of Y to founders |
|---|---|---|---|---|---|
| 50 | 21.000 | 0.00 | 31.500 | 0.00 | 0.00 |
| 100 | 21.000 | 18.85 | 38.991 | 9.99 | 8.87 |
| 150 | 26.874 (converts) | 35.83 | 51.319 | 26.43 | 9.41 |
| 250 | 45.336 (converts) | 60.45 | 63.000 (cap) | 55.23 | 5.22 |
| 400 | 72.537 (converts) | 96.72 | 72.537 (converts) | 96.72 | 0.00 |

**Excel at USD 100m, term sheet Y:** the Series C takes 31.5 first; the Series B keeps its USD 30m preference and the
Series A its USD 12m, the Seed converts; the remaining USD 26.5m is shared by common (10,400,000), Seed (4,825,974) and
Series C (6,000,000), so the Series C receives `=31.5+26.5*6000000/(10400000+4825974+6000000)` = 38.991 and common
`=26.5*10400000/21225974` = 12.984, of which founders `=12.984*8/10.4` = 9.99.

**Reading.** At a USD 50m exit both term sheets leave the founders with nothing: the preference stack is the whole
story. Between about USD 100m and USD 250m, term sheet Y costs the founders USD 5m to USD 9.4m. Above about USD 347m
the Series C converts under both (18.13% of the exit exceeds the USD 63m cap) and the terms stop mattering. A founder
who believes the realistic range is USD 100m to USD 200m should prefer X; a higher price offered with Y would have to
recover USD 7.6m to USD 9.4m of founders' proceeds in that range before Y is better.

```vega-lite
{
  "$schema": "https://vega.github.io/schema/vega-lite/v5.json",
  "description": "Founders' proceeds by exit value under two Series C term sheets, Corvane Robotics (fictional, USD m)",
  "width": 420,
  "height": 240,
  "data": {"values": [
    {"exit": 25, "terms": "X: 1x non-participating senior", "founders": 0.0},
    {"exit": 50, "terms": "X: 1x non-participating senior", "founders": 0.0},
    {"exit": 75, "terms": "X: 1x non-participating senior", "founders": 5.0},
    {"exit": 100, "terms": "X: 1x non-participating senior", "founders": 18.85},
    {"exit": 125, "terms": "X: 1x non-participating senior", "founders": 28.37},
    {"exit": 150, "terms": "X: 1x non-participating senior", "founders": 35.83},
    {"exit": 200, "terms": "X: 1x non-participating senior", "founders": 48.36},
    {"exit": 250, "terms": "X: 1x non-participating senior", "founders": 60.45},
    {"exit": 300, "terms": "X: 1x non-participating senior", "founders": 72.54},
    {"exit": 400, "terms": "X: 1x non-participating senior", "founders": 96.72},
    {"exit": 25, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 0.0},
    {"exit": 50, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 0.0},
    {"exit": 75, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 0.0},
    {"exit": 100, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 9.99},
    {"exit": 125, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 18.96},
    {"exit": 150, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 26.43},
    {"exit": 200, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 40.74},
    {"exit": 250, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 55.23},
    {"exit": 300, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 70.0},
    {"exit": 400, "terms": "Y: 1.5x participating, 3x cap, senior", "founders": 96.72}
  ]},
  "mark": {"type": "line", "point": true},
  "encoding": {
    "x": {"field": "exit", "type": "quantitative", "title": "Exit proceeds (USD m)"},
    "y": {"field": "founders", "type": "quantitative", "title": "Founders' proceeds (USD m)"},
    "color": {"field": "terms", "type": "nominal", "title": "Series C terms"}
  }
}
```

## Worked example B (half solved): dividends, participation and a ratchet at Start-up Q

<!-- Guidance: Fill every [ ] before looking at the answer key. Write the Excel formula next to each number you compute. -->

**Situation (fictional).** Start-up Q has 12,000,000 common shares (founders and employees) and one Series A: USD 6m at
USD 1.50 per share, with an 8% cumulative, non-compounding dividend and a 1x preference. The class terms are being
negotiated: non-participating, or participating capped at 3x.

**Part (a): a sale after four years with no further rounds.**

| *Example* item | Result | Excel formula |
|---|---|---|
| (1) Series A shares | 4,000,000 | `=ROUND(6000000/1.5,0)` |
| (2) Accrued dividend after four years | [ ] | [ ] |
| (3) Preference including dividends $L$ | USD 7.92m | `=6000000*(1+8%*4)` |
| (4) As-converted share $\alpha$ | 25.00% | `=4000000/16000000` |
| (5) Non-participating payoff at USD 20m, USD 60m, USD 120m | USD 7.92m, [ ], USD 30.0m | [ ] |
| (6) Capped participating (3x = USD 18m) payoff at the same exits | [ ], USD 18.0m, [ ] | [ ] |
| (7) Exit at which the cap is reached, and above which the capped class converts | [ ], USD 72.0m | [ ] |

**Part (b): instead of a sale, a down round.** New investors put in USD 3m at USD 1.00 per share. The Series A has
broad-based weighted average anti-dilution with $A$ = 16,000,000.

| *Example* item | Result | Excel formula |
|---|---|---|
| (8) $B$ and $C$ | 2,000,000 and 3,000,000 | `=3000000/1.5`, `=3000000/1` |
| (9) New conversion price $CP_2$ | [ ] | [ ] |
| (10) Series A conversion shares and extra shares | [ ] | [ ] |
| (11) Series A conversion shares under a full ratchet | 6,000,000 | `=ROUND(6000000/1,0)` |

(12) In one sentence each: why does the capped participating class sometimes prefer to convert, and why does the
cumulative dividend matter most in a low exit?

## Exercise C (unsolved): pay-to-play at Company R

<!-- Guidance: Work on paper first. Then write down which existing investor you would rather be, and why. -->

Company R has 10,000,000 common shares and 4,000,000 Series A shares bought at USD 1.60 (USD 6.4m), held by Fund I
(2,400,000) and Fund J (1,600,000). The Series A has a 1x non-participating preference and broad-based weighted average
anti-dilution. A new lead offers a USD 8m Series B at USD 1.00 per share with a **pay-to-play** term: Series A holders
must buy their pro rata share of half the round (USD 4m in total), or their Series A shares convert to common one for
one and lose the preference and the anti-dilution adjustment. Fund I takes up its share; Fund J does not; the new lead
buys the rest. Use $A$ = 14,000,000.

1. How much must Fund I and Fund J each invest to keep their rights?
2. Compute the Series A conversion price after the adjustment and Fund I's Series A conversion shares.
3. Compute fully diluted ownership after the round for the founders (common), Fund I (Series A as converted plus its
   Series B shares) and Fund J.
4. Compute the total preference held by Fund I and by Fund J after the round.
5. Explain why a lead investor asks for pay-to-play in a down round, and one risk it creates for the company.
6. Draft two questions the founders should ask their counsel before accepting the term.

## Process diagram

<!-- Guidance: Use the diagram as the order of work when a term sheet arrives. Most mistakes come from negotiating price before modelling terms. -->

```mermaid
flowchart TD
    A["Term sheet received"] --> B["Sort terms: cash flow, control, process"]
    B --> C["Update cap table: new shares, pool, anti-dilution of earlier series"]
    C --> D["Run waterfall at low, middle and high exits"]
    D --> E{"Founders and employees acceptable in the realistic exit range?"}
    E -->|No| F["Trade terms: price for preference, participation cap, seniority"]
    F --> C
    E -->|Yes| G["Review control: board, protective provisions, drag-along"]
    G --> H{"Company financeable in the next round?"}
    H -->|No| F
    H -->|Yes| I["Sign term sheet, counsel drafts definitive documents"]
```

The loop back from the two decisions to the cap table is the point of the diagram: every trade changes the share
counts or the waterfall, so the model is rerun after each concession. Worked example A follows the left branch once:
it updates the cap table for the down round and the Series B adjustment, runs the waterfall for X and Y, and finds that
X protects the founders in the realistic exit range.

## Connections to other cards

<!-- Guidance: For each connection, write one sentence on what you would carry from this card into the other one. -->

| Card or template | Connection |
|---|---|
| mba/mba-venture-finance-cap-table-card | The core card: cap table, pool shuffle, 1x preferences and the waterfall this card extends |
| mba/mba-vc-method-card | Sets the price; this card sets the terms that change what the price is worth |
| mba/mba-venture-capital-guide | The elective course, with a mini-case where two offers differ on price and terms |
| mba/mba-vc-portfolio-construction-card | Pro rata rights and reserves for follow-on rounds |
| mba/mba-negotiation-planner | Plan a term negotiation: interests, BATNA, tradeable issues |
| mba/mba-options-real-options-card | A preferred share is common plus a put-like protection; participation is an extra claim |
| mba/mba-deal-structuring-card | Earn-outs, rollovers and consideration in acquisitions use the same payoff thinking |
| mba/mba-corporate-governance-card | Board composition and vetoes in the wider governance frame |
| finance/due-diligence-request-list | Documents to request before signing |
| startup/board-deck | How board control shows up in practice |

## Common mistakes and misconceptions

<!-- Guidance: Tick the mistakes you have made. Revisit them before negotiating or interviewing. -->

1. **Comparing headline valuations only.** At the same price, a 1.5x participating preference costs the founders
   USD 5m to USD 9.4m across the USD 75m to USD 250m exits in Worked example A; a somewhat higher price must make up
   that gap before the participating offer is better.
2. **Forgetting earlier series' anti-dilution.** A down round triggers adjustments that dilute everyone, including the
   new investor; model them before agreeing the new price.
3. **Assuming broad-based is the same everywhere.** The definition of $A$ varies; read it.
4. **Ignoring accrued dividends.** A cumulative 8% dividend adds 32% of the investment to the preference after four
   years.
5. **Treating "1x" as harmless.** Even a clean 1x preference stack leaves common with nothing when the exit is below
   total invested capital.
6. **Overlooking control.** Protective provisions and drag-along decide whether a sale or a new round can happen at
   all; a minority investor with a veto can block a deal the majority wants.
7. **Believing the post-money is fair value.** Gornall and Strebulaev (2020) show it overstates value when terms differ
   across series.
8. **Signing a no-shop without a plan.** Exclusivity weakens the company's alternatives; agree its length and the
   conditions for ending it.

## Self-test questions

<!-- Guidance: Answer from memory, then check the answer key. Repeat the misses after two days. -->

1. Name three cash flow terms and three control terms.
2. Explain the difference between participating and non-participating preferred in two sentences.
3. Why does a narrow-based weighted average favour the protected investor more than a broad-based one?
4. A Series A bought at USD 2.00 has broad-based protection with $A$ = 10,000,000. The company raises USD 2m at USD 1.00.
   Compute the new conversion price and the common shares per Series A share.
5. What does a 6% cumulative dividend add to the preference of a USD 10m investment after five years?
6. Under a full ratchet, a series bought at USD 1.20 is adjusted after a round at USD 0.80. What is the new conversion
   ratio?
7. In Worked example A, why does term sheet Y cost founders nothing at a USD 400m exit?
8. What is pay-to-play, and whom does it protect?
9. Why might an experienced investor accept weaker downside protection in exchange for a board seat?
10. Name two terms that can make the company hard to finance in the next round.

## My notes and next steps

<!-- Guidance: Write down the terms you would trade and the evidence you need to do it confidently. -->

| Item | My entry |
|---|---|
| Terms I consider standard in my market | [ ] |
| Terms I would negotiate first, and what I would offer in return | [ ] |
| Realistic exit range for my company or case | [ ] |
| Questions for counsel | [ ] |
| Next card | mba/mba-vc-portfolio-construction-card |

## Sources and further reading

<!-- Guidance: Primary and official sources are listed for attribution and depth. Practitioner books and textbooks are named only. -->

- National Venture Capital Association. Model Legal Documents (Certificate of Incorporation, Stock Purchase Agreement,
  Investors' Rights Agreement updated October 2025; Voting Agreement updated June 2026; Right of First Refusal and
  Co-Sale Agreement updated April 2026). nvca.org/model-legal-documents, checked 2026-10-28.
- Kaplan, S. N., and Stromberg, P. (2003). Financial contracting theory meets the real world: an empirical analysis of
  venture capital contracts. *The Review of Economic Studies*, 70(2), 281-315.
- Hellmann, T. (1998). The allocation of control rights in venture capital contracts. *The RAND Journal of Economics*,
  29(1), 57-76.
- Gornall, W., and Strebulaev, I. A. (2020). Squaring venture capital valuations with reality. *Journal of Financial
  Economics*, 135(1), 120-143.
- Gompers, P. A., Gornall, W., Kaplan, S. N., and Strebulaev, I. A. (2020). How do venture capitalists make decisions?
  *Journal of Financial Economics*, 135(1), 169-190.
- Bengtsson, O., and Sensoy, B. A. (2011). Investor abilities and financial contracting: evidence from venture capital.
  *Journal of Financial Intermediation*, 20(4), 477-502.
- Practitioner books and textbooks (by name only): Feld, B., and Mendelson, J., *Venture Deals*; Metrick, A., and
  Yasuda, A., *Venture Capital and the Finance of Innovation*; Gompers, P., and Lerner, J., *The Venture Capital Cycle*.
- Open resource: OpenStax, *Entrepreneurship* (CC BY-NC-SA 4.0), chapters on funding and financing.

## Answer key

<!-- Guidance: Check only after you have written your own answers. For each miss, write down why your first answer was wrong. -->

**Worked example B.** (2) USD 1.92m (`=6000000*8%*4`). (5) At USD 60m: USD 15.0m (the class converts, because 25% of
USD 60m exceeds USD 7.92m); formula `=MAX(MIN(E,7920000),0.25*E)`. (6) At USD 20m: USD 10.94m
(`=7920000+0.25*(20000000-7920000)`); at USD 120m: USD 30.0m (converts, because 25% of USD 120m exceeds the USD 18m
cap). (7) The cap is reached at USD 48.24m (`=(18000000-7920000)/0.25+7920000`); the class converts above USD 72.0m
(`=18000000/0.25`). (9) USD 1.4211 (`=1.5*(16000000+2000000)/(16000000+3000000)`). (10) 4,222,222 shares
(`=ROUND(6000000/1.4211,0)` with the unrounded price), 222,222 extra. (12) Above the cap, the as-converted share grows
with the exit while the capped payoff does not, so converting pays more; in a low exit the preference, including
accrued dividends, is most or all of what the class receives, so each year of accrual moves money from common.

**Exercise C.** (1) Fund I USD 2.4m, Fund J USD 1.6m (60% and 40% of USD 4m). (2) $CP_2$ = USD 1.3818
(`=1.6*(14000000+5000000)/(14000000+8000000)`); Fund I converts into 2,778,947 shares (`=ROUND(2400000*1.6/1.3818,0)`
with the unrounded price). (3) Total 22,378,947 shares: founders 44.68%, Fund I 23.14% (2,778,947 plus 2,400,000
Series B shares), Fund J 7.15% (1,600,000 common). (4) Fund I USD 6.24m (USD 3.84m Series A plus USD 2.4m Series B);
Fund J none. (5) It makes existing investors support the company in a bad round or give up their protection, so the
new lead does not fund the company while non-participating holders keep senior rights; the risk is that an investor
who cannot or will not invest becomes a disgruntled common holder, and that the recapitalisation affects
relationships and signalling to future investors. (6) Examples: which shares count toward the pro rata requirement and
whether affiliates can take it up; whether the conversion to common needs a class vote and whether the charter
amendment can be approved without the non-participating holder.

**Self-test.**

1. Cash flow: liquidation preference, participation, dividends, anti-dilution, redemption. Control: board seats,
   protective provisions, drag-along, information rights.
2. Non-participating preferred takes the larger of its preference and its as-converted share. Participating preferred
   takes its preference and then also its as-converted share of what remains.
3. A smaller $A$ makes the ratio $(A+B)/(A+C)$ further below one, so the conversion price falls more.
4. $B$ = 1,000,000, $C$ = 2,000,000; $CP_2$ = USD 1.8333 (`=2*(10000000+1000000)/(10000000+2000000)`); 1.0909 common
   shares per Series A share (`=2/1.8333`).
5. USD 3.0m (`=10000000*6%*5`).
6. 1.5 (`=1.2/0.8`).
7. At USD 400m the Series C's as-converted share (USD 72.5m) exceeds its USD 63m cap, so it converts and is treated
   like common under both term sheets.
8. Existing investors must invest their pro rata share in a new round or lose rights (often by conversion to common);
   it protects the new lead and the investors who do support the company.
9. Board representation lets it influence decisions and monitor directly, which can be worth more than contractual
   protection; Bengtsson and Sensoy (2011) find this pattern for more experienced investors.
10. Examples: a full ratchet, large cumulative dividends or redemption rights, broad series vetoes, participation
    with a high multiple.

## Revision history

<!-- Guidance: Add a row each time you change the terms, the cap table or the conclusions. -->

| Version | Date | Author | Change summary |
|---|---|---|---|
| 0.1 | YYYY-MM-DD | [Your name] | First pass through the card |
| 0.2 | YYYY-MM-DD | [Your name] | *Example:* Modelled own term sheet, added a management carve-out |

## Standard and licence note

Structure aligned with the publicly available NVCA model legal documents (revision dates checked October 2026) and the
venture contracting literature listed above (Kaplan and Stromberg 2003; Hellmann 1998; Gornall and Strebulaev 2020).
The text, examples, numbers and questions are original; no model document, practitioner book or published case is
copied or paraphrased, and Corvane Robotics, Start-up Q, Company R, Fund I and Fund J are fictional. The template is
independent and not affiliated with or endorsed by the NVCA, any business school, law firm or investor. Check the
current version of any model document and take legal and tax advice before you rely on it.
Template licence: MIT.