A space startup's term sheet operates similarly to any venture deal, but dilution, convertible notes, SAFEs, and liquidation preferences can trip up first-time founders. These founders often lose track of dilution when raising money through multiple notes, treating valuation incorrectly, and lacking knowledge about standard vesting and liquidation terms. This guide outlines the essential mechanics for negotiating your term sheet effectively.
Dilution Explained
Dilution occurs whenever new shares are sold, reducing your ownership percentage. It's vital to understand that every financing round, including the conversion of convertible notes or SAFEs, contributes to dilution. Founders should be aware that raising more capital usually leads to increased dilution and less favorable terms if the company isn't showing progress.
Convertible Notes vs SAFE Notes
Early fundraising typically involves convertible notes or SAFE notes for simplicity. Convertible notes are debt instruments that convert into equity, while SAFEs are contracts that allow future share purchases. Both have valuation caps and discounts to reward early investors.
Cap Table Hygiene
A clean cap table is crucial, especially in early stages. Fewer pooled line items are preferable, and dead equity should be resolved before the next raise. Founders must maintain enough ownership to align incentives with investors.
Vesting and Liquidation Preferences
Vesting protects against dead equity from founders leaving early. A standard vesting schedule is four years. Liquidation preferences ensure investors are compensated first in an exit scenario, with the current norm being a 1x non-participating preference.
Key Takeaways
Track every note's cap and discount from the moment you sign. Keep your cap table clean and focus on the amount you need rather than anchoring on valuation. Expect standard liquidation preferences and understand the 3x valuation uplift rule that VCs typically use.
Originally published at vira.space.
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