Deal Structuring
(Term Sheets)

The purpose of this module is to learn how to get from the valuation of a company to the actual deal (e.g., acquisition, financing round). This is the topic of financial deal making. The module shows how to use relatively simple finance tools to bridge valuation gaps and bring buyers and sellers together. It discusses the basic principles of financial deal making and shows the main elements of a typical deal structure.

 

The terms of financial deals are usually summarized in the term sheet. We learn how to read or draft such term sheets, what the individual clauses actually mean, and how these clauses determine the allocation of returns, control, and liquidity among the parties of the deal.

Course picture financial analysis

Useful Tools

The module "Deal Structuring (Term Sheets)" proceeds in 6 steps:

  1. An introductory chapter motivates the topic and shows why deal structuring is so important. It also provides a comprehensive overview of the course and its logic.
     

  2. Second, we look at Staged Capital Contributions, a typical form of financing in new ventures.
     

  3. Third, we discuss the economic principles of financial deal making.
     

  4. Fourth, we show how these principles are reflected in the typical structure of a term sheet. Based on this knowledge, the following sections then introduce the major elements of term sheets:
     

    • Preferred Returns: How to allocate the returns of the venture between the entrepreneur and the investors? We discuss in detail the role of dividend terms, liquidation preference, participation, and conversion rights.
       

    • Valuing Financing Alternatives: How to value the various financing alternatives? We show how to roughly assess the value of typical venture financing instruments such as preferred stock, convertible preferred stock, participating preferred stock, and convertible participating preferred stock. These tools help us to understand how the financial value of a venture is allocated between the founders and the investors.
       

    • Protection and Participation: How do investors protect their valuation and make sure they participate in future rounds of financing? We get to know the most important anti-dilution provisions and learn how investors can use terms such as right of first refusal, co-sale right, and preemptive rights to manage the odds of their investments.
       

    • Corporate Governance Provisions: How is control over the firm allocated between the entrepreneur and the investors? And how are employees motivated to fully commit themselves to the venture? The key elements in this section deal with the allocation of voting rights, the composition of the board of directors, the definition of meaningful employment terms, and the vesting schedule of founder and employee options. 
       

    • Exit: And how do investors make sure that they can exit from their investment in due time? We discuss the advantages and disadvantages of redemption rights, registration rights, and drag-along clauses. We see that these clauses can and often do have a far-reaching impact on the strategic alternatives of the entrepreneurs.
       

  5. We introduce the Simple Agreement for Equity (SAFE), an innovative and increasingly popular financing contract for seed financing rounds. We discuss it's key terms (including Valuation Cap and Discount Rate) and take a close look at the mechanics of the SAFE in future financing rounds.
     

  6. We end the module with some concluding remarks.
     

For each topic, there is a short reading assignment, followed by some review questions and practice examples.