In previous posts, I have described how certain term sheet provisions impact the Economics, Control, and Value Protection in a proposed investment. In this final post on Term Sheets, I will discuss some provisions that impact the Liquidity of the investment.
Redemption Rights: The term sheet may include a provision requiring the issuer to redeem or repurchase the preferred stock that has been issued after a certain number of years and at a specified price. This provides investors with in essence a “put” – a mechanism for obtaining a return if the Company does not go public or get acquired. Some investors will view this as a protection against an investment in a company that becomes a “lifestyle” company where the entrepreneur is not interested in an exit.
Registration Rights: This provision outlines the terms under which investors will be able to participate in the event of a public offering of the issuer’s stock. These provisions will cover how and when investors can sell their shares and who bears the expenses.
Drag-along Rights: This provision is meant to ensure that a potential exit opportunity will not be prevented by a minority shareholder. The term sheet will define what % of shareholders will be required to vote for a merger, liquidation,etc. and any dissenting minority shareholder will be required to participate.
Tag-along Rights: This provision requires that if the Founders or other major stockholders decide to sell all or a portion of their shares, then all investors will be afforded the opportunity to participate ( ie: “tag-along”) at the same percentage.
As with any investment opportunity, it is important to make sure that you not only read the term sheet but that you understand how the terms of the deal impact your potential investment return. As the Romans would say “Caveat Investor”.