Term sheet is the primary sentences for the start-ups as they need money from investors. And not to be confused or sneaked by VCs(venture capitalists), the entrepreneurs should keep the terms fully understood. So I share the description of the terms in a series so that the beginners can get the overall terms of term sheet. Today, we’ll see the price and option pool.

Price

Price is the very basic unit of the deal as it is a measure of the valuation of the company. To get into the notion, we need to understand the terms ‘premoney’ and ‘postmoney’ because the investors’ mentioning the valuation would determine the actual value of the company. Premoney, usually called  ’pre’ in short, is the valuation before the investment whereas the postmoney is the valuation including the investment amount.

Let’s see an example. If a VC says, “I will invest $5m at a valuation of $20m,” it usually means the postmoney valuation. As a result, the investor will get 25% of equity – $5m portion of $20m. On the contrary, when the VC clarifies the valuation as premoney, then the VC gets 20% – $5m of total $25m postmoney. So do the math before talking about the price.

Option Pool

There’s one more thing to consider: option pool. Option pool is the equity reserved to compensate the employees, so it is also called as the employee pool. It is important because the entrepreneurs’ share would decrease relative to the increment of the option pool. In the above example of postmoney valuation, suppose that the entrepreneur sets the option pool to 10%. Then what if the VC requests to scale it up to 20%? The VC’s portion doesn’t change though, the founder would hold reduced portion of share, which is 65%, 10% less than the original portion if the request is accepted. Thus, the option pool should be considered if the VC tries to touch this.

There are many other economic terms like liquidation preference, warrants, pay-to-play, vesting and antidliution in term sheet. I will compact the description of the terms into the summary as if I posted here today. Next time we’ll see the term, liquidation preference.