VENTURE

CAPITAL
101
HANDBOOK
© PLUG AND PLAY VENTURES

AUTHORS / FAN WEN, JANIS SKRIVERIS, KRISTI CHOI

CONTRIBUTORS / IVAN ZGOMBA, GEORGE DAMOUNY, NOORJIT SIDHU,
MARC STEINER, FRANK VELASQUEZ

THIS DOCUMENT IS STRICTLY FOR INTERNAL CIRCULATION ONLY

Get an electronic copy: https://pnp.plus/handbook

This page is intentionally left blank.
 TEAM

IVAN ZGOMBA GEORGE DAMOUNY

Partner, Plug and Play Ventures Partner, Plug and Play Ventures
LinkedIn: https://www.linkedin.com/ LinkedIn: https://www.linkedin.com/
in/zgombaivan/ in/georgedamouny/

FAN WEN JANIS SKRIVERIS

Sr. Asso., Plug and Play Ventures Asso., Plug and Play Ventures
LinkedIn: https://www.linkedin.com/ LinkedIn: https://www.linkedin.com/
in/fanwen/ in/janisskriveris/

KRISTI CHOI NOORJIT SIDHU

Asso., Plug and Play Ventures Sr. Asso., Plug and Play Ventures
LinkedIn: https://www.linkedin.com/ LinkedIn: https://www.linkedin.com/
in/kristichoi/ in/noorjit-sidhu-5a8976118/

MARC STEINER FRANK VELASQUEZ

General Counsel, Plug and Play Legal Operations, Plug and Play
LinkedIn: https://www.linkedin.com/ LinkedIn: https://www.linkedin.com/
in/marc-steiner-bio/ in/frank-velasquez-330013113/
 TABLE OF
CONTENTS
1. Overview 1
1.1. Who this handbook is written for 2
1.2. What this handbook covers 2

2. VC business model 3
2.1. Capital providers - who gives the money 4
2.2. Capital providers - why they allocate money to VCs to invest in 7
startups
2.2.1. Risk-return profiles of different asset classes 8
2.2.2. Portfolio allocation for return optimization 8
2.3 VC Investors - how VC firms are set up 11
2.3.1. Different roles associated with a VC firm 11
2.3.2. Different types of VCs 11
2.3.3. VC fund investment strategies 12
2.3.4. Revenue streams of a VC firm - the “2 and 20” model 13
2.3.5. Life cycle of a VC fund 14
2.4. VC Investors - how to succeed as a VC 16
2.4.1. Metrics used by VCs to measure returns 16
2.4.2. Returns of VCs - long tail market 19
2.4.3. Take the right risks 20
2.5. Setup of Plug and Play Ventures 22

3. Process of a VC deal 23
3.1. Sourcing and initial assessment 24
3.1.1. Different sourcing channels 24
3.1.2. Quick screening and initial assessment 25
3.2. Due diligence 27
3.2.1. Bottom lines 27
3.2.2. Excitement 28
3.2.3. Red flags 29
3.2.4. Financial return projections 31
 3.3. Evaluating 35
3.3.1. Raise-based method 36
3.3.2. Comparison valuation method 37
3.3.3. Multiple method 37
3.3.4. Exit-based method 39
3.3.5. Discounted cash flow method 41
3.4. Term sheet negotiations 43
3.4.1. Investment amount 44
3.4.2. Valuation 44
3.4.3. Security type 45
3.4.4. Participation rights 45
3.4.5. Liquidation preference 46
3.4.6. Option pool size 48
3.4.7. Board representation 48
3.4.8. Founder vesting provisions 49
3.4.9. Other items to negotiate 49
3.5. Alternative financing instruments 51
3.5.1. Convertible note 52
3.5.2. SAFE 52
3.5.3. Similarities between convertible note and SAFE 52
3.5.4. Differences between convertible note and SAFE 52
3.5.5. Critical items included in convertible note and SAFE 54

4. Plug and Play best practices 59

4.1. Deal process at Plug and Play Ventures 60
4.2. Preferences 62
4.2.1. Investment type 62
4.2.2. Pre-Money valuation cap 64
4.2.3. Discount 65
4.2.4. Pro-rata rights/Information rights 65
4.2.5. Advisory shares 66
4.2.6. Exit prior to Series A 69
4.2.7. Threshold for Series A 70

5. Appendix 73
5.1. Standard Series A term sheet from Y Combinator 74
5.2. Sample term sheet from Emperor Ventures 77
5.3. Sample SAFE with valuation cap and conversion discount from 85
Y Combinator
5.4. Sample pro-rata side letter from Y Combinator 94
5.5. More examples 96
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 1
OVERVIEW

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1. Overview
First, thank you for taking the time to read this handbook. This book is designed to help people 
navigate through both the art and the science of the VC world. It is not a replication of “​Venture 
Deals​”  but  rather  a  quick  onboarding  read  for  those  who  just  joined  this  industry  or who want 
to  refresh  their  memory  and  knowledge.  By  including  the  basics  from  how  VC  works  as  a 
business model to how an investment is made at VC firms, this handbook will enable readers to 
quickly familiarize themselves with this new and exciting journey. 

1.1. Who this handbook is written for 

For  a  very  long  time,  the  Plug  and  Play  Ventures  team  has  been  thinking  about how to 
consolidate  the  team’s  knowledge  and  experience  in the VC space and share them with 
the future teammates. 

This  handbook  is  specifically  designed  for  the  new  Plug  and Play Ventures members to 
help  them  learn  the  basics  of  the  VC  industry and prepare them for the exciting journey 
at  Plug  and  Play  Ventures.  People  who  are  curious  about  how  VCs  work  can  also 
benefit from reading this handbook. 

1.2. What this handbook covers 

The  handbook  is  not  going to reinvent the wheel. Instead, it will focus on the most basic 

items  such  as  how  VC  works  and  how  to  evaluate  deals  for  VC  investors.  Many  of  the 
decisions  that  VCs  make  are  very  subjective  and  just like art. The basics included in this 
handbook  will  be  very  helpful  for  people  with  limited  knowledge  about  VCs  to 
understand the rationale behind the art. 

2 Ventures
 2
VC
BUSINESS
MODEL

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2. VC business model

VC  is  one  of  the  many  types  of  investors.  To  understand  VC  as  a  business,  it  is  necessary  to 
assets.
first understand how capital flows from the capital providers to the invested assets. 

Figure 2.1 Capital flow diagram

diagram 

Capital Providers Investors Assets

Direct Investing

High-Net-Worth
Bonds and Cash
Individuals (HNWIs) $ Capital
Asset Management
Family Offices Commodities
Firms

Companies Natural Resources

Pension Funds Public Equity Funds Domestic Stocks

(e.g. Hedge Funds/Mutual Funds)
$ Capital
University Private Equity Funds
Foreign Stocks
Endowments (PE firms)

Venture Capital Funds

Governments Real Estate
(VC firms)

Sovereign Wealth
Private Equity
Funds

Other Startups

2.1. Capital providers - who gives the money

money 

There  are  different  types  of  capital  providers,  and  they  invest  money  for  different 
purposes. These capital providers also have different asset sizes and risk profiles. 
profiles.

High-Net-Worth  Individuals  (HNWIs)​:  High-Net-Worth  Individual  (HNWI)  is  a  term 

used  by  some  segments  of  the  financial  services  industry  to  designate  people  whose 
investable  wealth  (assets  such  as  stocks  and  bonds)  exceed  a  given  amount.  Typically, 
these  individuals  are  defined  as  holding  financial  assets  (excluding  their  primary 
residence)  with  a  value  greater  than  US$1  million.  "Very-HNWI"  (VHNWI)  can  refer  to 
someone with a net worth of at least US$5 million1.. 

Family  offices​:  A  family  office  is  a  privately  held  company  that  handles  investment 
management  and  wealth  management  for  a  wealthy  family,  generally  one  with  over 

1
1High
High Net
Net Worth
Worth Individual
Individual -- HNWI.
HNWI. Investopedia.
Investopedia. Accessed
Accessed September
September 9,
9, 2020. 
2020.
https://www.investopedia.com/terms/h/hnwi.asp  
https://www.investopedia.com/terms/h/hnwi.asp

4 Ventures
 US$100  million  in investable assets, with the goal being to effectively grow and transfer 
wealth  across  generations.  The  company's  financial  capital  is  the  wealth  owned  by  the 
family2. 

Companies​:  Companies  usually  invest  out  of their balance sheet. Many large companies 

have set up their investment arms such as corporate VCs to make investments. 

Pension  Funds​:  A  pension  fund,  also  known  as  a  superannuation  fund  in  some 
countries,  is  any plan, fund, or scheme which provides retirement income. Pension funds 
typically  have  large  amounts  of  money  to  invest  and  they  are  the  major  investors  in 
listed  and  private  companies.  They  are  especially  important  to  the  stock  market  where 
large  institutional  investors  dominate.  The  largest  300  pension  funds  collectively  hold 
about US$6 trillion in assets3. 

University  Endowments​:  A  financial  endowment  is  a  legal  structure  for  managing,  and 
in  many  cases  indefinitely  perpetuating,  a  pool  of  financial,  real  estate,  or  other 
investments  for  a  specific  purpose  according  to  the  will  of  its  founders  and  donors. 
Endowments  are  often  structured  so  that  the  principal  value  is  kept  intact,  while  the 
investment  income  or  a  small  part  of  the  principal  is  available  for  use  each  year. 
Endowments  are  often  governed  and  managed  either  as  a  nonprofit  corporation;  a 
charitable  foundation;  or  a  private  foundation  that,  while  serving  a  good  cause,  might 
not  qualify  as  a  public  charity.  In  some  jurisdictions,  it  is  common for endowed funds to 
be  established  as  a  trust  independent  of  the  organizations  or  causes the endowment is 
meant  to  serve.  Institutions  that  commonly  manage  endowments  include  academic 
institutions  (e.g.,  colleges,  universities,  and  private  schools);  cultural  institutions  (e.g., 
museums,  libraries,  and  theaters);  service  organizations  (e.g.,  hospitals,  retirement 
homes;  ​the  Red  Cross​,  ​the  SPCA​);  and  religious  organizations  (e.g.,  churches, 
synagogues, mosques)4. 

Governments​:  Governments  can make investments directly by setting up and managing 

a  government  strategic  investment  fund  or  through  professional  institutional  investors. 
By  definition,  a  government  strategic  investment  fund  makes  equity  investments  in 
companies,  often  start-ups,  engaged  in  activities  of  particular  interest  to  the 
government.  The  government  may  use  a  strategic  investment  fund  to  support  the 
development  of  industries  to  achieve  policy  goals  such  as  improving  the  environment, 
fostering  regional  development,  or  creating  new  technologies.  In  addition  to  the  main 
goal,  the  government  may  also  use  strategic  investment  funds  to:  (1)  identify  and 

2
Family Offices. Investopedia. Accessed September 9, 2020. 
https://www.investopedia.com/terms/f/family-offices.asp. 
3
How Do Pension Funds Work? Investopedia. Accessed September 9, 2020. 
https://www.investopedia.com/articles/investing-strategy/090916/how-do-pension-funds-work.asp.
4
Endowment. Investopedia. Accessed September 9, 2020. 
https://www.investopedia.com/terms/e/endowment.asp.

Ventures 5
 understand  emerging  and  new  technologies  and  companies;  (2)  move  technologies  of 
interest  to  the  government  from  the  research  and  development  (R&D)  stage  to  a  final 
product  more  quickly;  and  (3)  induce  companies  to  develop  products  to  address  the 
needs of and contract with the government5. 

Sovereign  Wealth  Fund​:  A  sovereign  wealth  fund  (SWF)  is  a  state-owned  investment 
fund  comprised  of  money  generated  by  the  government,  often derived from a country's 
surplus  reserves.  SWFs  provide  a  benefit  for  a  country's  economy  and  its  citizens.  The 
funding  for  a  SWF  can  come  from  a  variety  of  sources.  Popular  sources  are  surplus 
reserves  from  state-owned  natural  resource  revenues,  trade  surpluses,  bank  reserves 
that may accumulate from budgeting excesses, foreign currency operations, money from 
privatizations, and governmental transfer payments6. 

Table 2.1 Comparison of different types of capital providers 

Capital  Investment  Risk Tolerance  Common  Common 
Provider  Size  Level  Investment Goals  Invested Assets7 

High Net  Thousands  Relatively high  Financial return  1. Stocks

Wealth  to millions  2. Real Estate
Individuals  3. Private
(HNWIs)  Equity (PE)
4. Startups
(VC)

Family Offices  Millions  Medium - High  Financial return  1. Stocks

2. Real Estate
3. Private
Equity (PE)
4. Startups
(VC)

Companies  Millions  Medium - High  1. Financial return 1. Stocks

2. Strategic value 2. Private
Equity (PE)
3. Startups

5
Carioscia, Sara A., Evan Linck, Keith Crane, and Bhavya Lal. "Assessment of the Utility of a Government 
Strategic Investment Fund for Space." Mary Ann Liebert, Inc., Publishers. December 16, 2019. Accessed 
August 28, 2020. ​https://www.liebertpub.com/doi/full/10.1089/space.2019.0006​. 
6
"A Sovereign Wealth Fund (SWF) Is Used to Benefit a Country's Economy." Investopedia. August 28, 
2020. Accessed September 29, 2020. 
https://www.investopedia.com/terms/s/sovereign_wealth_fund.asp​. 
7
This is a list of assets that are the common investment targets for each of the capital providers. The 
capital providers and their investors can also invest into other categories of assets depending on the 
capital providers/investors’ investment strategies. 

6 Ventures
 (VC) 

Pension  Millions to  Low - Medium  1. Financial return 1. Bonds and

Funds  billions  2. Protection Cash
against inflation 2. Commodities
3. Stocks
4. Real Estate
5. Private
Equity (PE)

University  Millions to  Low - Medium  1. Financial return 1. Bonds and

Endowments  billions  2. Protection Cash
against inflation 2. Commodities
3. Stocks
4. Real Estate
5. Private
Equity (PE)
6. Startups
(VC)

Governments  Millions to  Low - Medium  1. Financial return 1. Real Estate

billions  2. Strategic value 2. Private
3. Protection Equity (PE)
against inflation

Sovereign  Millions to  Low - Medium  1. Financial return 1. Real Estate

Wealth Fund  billions  2. Strategic value 2. Private
3. Protection Equity (PE)
against inflation 3. Startups
(VC)

2.2. Capital providers - why they allocate money to VCs to invest in startups 

When  allocating  assets,  capital  providers need to consider the risk and return profiles of 

different  asset  classes.  The  common  goal  for  all  capital  providers  and  investors  is  to 
maximize  return  while  minimizing  risks.  The  higher  return  people  are  seeking,  the  high 
risks they need to take. 

Ventures 7
 2.2.1. Risk-return profiles of different asset classes 
classes

Different  asset  classes  have  different  risk  and  return  profiles.  Based  on  their  own  risk 
profiles  (risk  required,  risk  capacity,  and  risk  tolerance),  capital providers and their asset 
managers will determine the allocation of their investment portfolio. portfolio. 

The  returns  of  different  asset  classes  are  usually  measured  based  on  the  expected 
return  data  from  the  asset’s  past  performance.  The  risks  of  different  asset  classes  are 
usually  measured  based  on  their  price  volatility  in  a  certain  period.  Volatility  is  often 
measured  as  either  the  standard  deviation  or  variance  between  returns  from  that same 
index. 
security or market index.

Because  of  the  lack  of liquidity and transparency, it is difficult to measure the return and 

risk  profile  of  startups. However, it is widely believed that startups are a high risk & high 
return asset class8.. 

Figure  2.2  Expected  Risk  &  Return  of  various  asset  classes  (5  to  10  years  investment/time 
horizon) (Source: ​BNP PARIBAS​) 
12%
Equities Emerging
Markets - Asia
US LBO
Private Equity
10%

US High Yield Listed Real Estate -

Corporate Hong Kong
8% Emerging Bonds
Market Bonds
Expected return 2018

Developed
6%
Alternatives Markets Equities
Hedge Funds
Commodities

4% US Investment
Grade Corporate Emerging Markets Gold
Bonds Bonds - Asia
US Treasuries
2%
10-year

Cash & Deposits

0% - USD
0% 5% 10% 15% 20% 25% 30% 35%

Annualized volatility Dec 2018

2.2.2. Portfolio allocation for return optimization 

optimization

With  the  risk-return-profiles  of  different  asset  classes,  asset  managers  who  work  for 
the  capital  providers  can  then  determine  the  allocation  of  capital  to  each  asset  class 

8
8"VC
"VC 101:
101: The
The Angel
Angel Investor's
Investor's Guide
Guide to
to Startup
Startup Investing."
Investing." FundersClub.
FundersClub. Accessed
Accessed August
August 28,
28, 2020. 
2020.
https://fundersclub.com/learn/guides/vc-101/the-risks-and-rewards-of-startup-investing​
https://fundersclub.com/learn/guides/vc-101/the-risks-and-rewards-of-startup-investing​..  

8 Ventures
based  on  the  capital  providers’  own  risk  profile  such  as  risk  required,  risk  capacity,  and 
risk tolerance level. 

Portfolio  allocation  is  a  mix  of  science  and  art.  Different  asset  managers  will  have 
different  portfolio  allocation  strategies.  However,  in  general,  those relatively risk-averse 
capital  providers  such  as  the  pension  funds  and  the university endowments will tend to 
allocate  more  capital  to  low-risk-low-return  assets  such  as  bonds,  fixed  income,  and 
public equities. Those relatively risk-seeking capital providers such as HNWIs and family 
offices  will  tend  to  allocate  more  capital  to  high-risk-high-return  assets  such  as  real 
estate and private equity. 

However,  in  order  to  find  the  best risk-adjusted return, even those relatively risk-averse 

capital  providers  such  as  university  endowments  will  allocate  some portion of capital to 
high-risk-high-return  assets  such  as  startups  (venture  capital).  For  example,  Yale 
Endowment allocates 15-20% of its capital to venture capital. 

For  people  who  are  interested  in  learning  more  about  how  to  calculate  the  exact 
allocation  based  on  the  risk-return-profiles  of  different  asset  classes,  feel  free  to  ​read 
more about “sharpe ratio” here​. 

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Figure 2.3 Yale endowment portfolio allocation 2019 (Source: ​Yale 2019 Endowment Update​) 

Figure 2.3 Yale endowment portfolio allocation 2019 (Source: ​Yale 2019 Endowment Update​)

Figure 2.4 Yale endowment portfolio allocation 2015 - 2019 (Source: ​Yale 2019 Endowment
Update​)
Figure  2.4  Yale  endowment  portfolio  allocation  2015  -  2019  (Source:  ​Yale  2019  Endowment
Update​) 

10 Ventures
2.3. VC Investors - how VC firms are set up
up 
2.3.1. firm
Different roles associated with a VC firm 

VCs  raise  money  from  different  capital  providers  from  HNWIs  to  governments.  In  the 
world  of  venture  capital,  the  capital  providers  are  called  Limited  Partners  or  LPs,  while 
the  VC  firms are called General Partners or GPs. In some situations, people also use GPs 
to refer to partners managing VC firms.firms. 

Within  a  VC  firm,  besides  the  partners,  there  will  be  a  group  of  principals,  associates, 
and analysts who will help to source and evaluate deals. 
deals.

Figure 2.5 Capital flow diagram for VCs

VCs 

Limited Partners (LPs) General Partners (GPs) Assets

Direct Investing

High-Net-Worth
Bonds and Cash
Individuals (HNWIs)

Asset Management
Family Offices Commodities
Firms

Companies Natural Resources

Pension Funds Public Equity Funds Domestic Stocks

(e.g. Hedge Funds/Mutual Funds)
$ Capital
University Private Equity Funds
Foreign Stocks
Endowments (PE firms)

Venture Capital Funds

Governments Real Estate
(VC firms)

Fund of Funds Private Equity

Partners

Other Startups
Principals, Associates,
Analysts $ Capital

2.3.2. Different types of VCs 

VCs

Depending  on  the  investment  goals,  there  are  different  types  of VCs. They differentiate 
from  each  other  in  many  ways  such  as  investment  goals,  investment  strategies,  and 
comparison. 
competitive advantages. Here is a quick comparison.

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 Table 2.2 Comparison of different types of VCs 
Type of VC  Capital  Primary  Targeted  Competitive 
Source  Investment Goal  Startups  Advantages 

Corporate VC  Corporate  Securing  Relatively  Resources and 

(CVC)  balance  companies with  late-stage  opportunities 
(e.g.  sheet  strategic value  companies with  from the 
Qualcomm  strategic value  corporate  
Ventures​) 

Accelerator  All sources  Seeking financial  All types of  Mentor 

/ Incubator  return  early-stage  network, alumni 
(e.g. ​Y  startups  network, 
Combinator​)  industry 
connections 

Regular VC  All sources  Seeking financial  All types of  Knowledge and 
(e.g. ​Sequoia  return  startups (stage,  experience in a 
Capital​)  vertical, location  certain domain, 
depending on  good brand, 
fund strategy)  industry 
connections 

Impact VC  Corporate  Making social or  Startups that  Dedication to 
(e.g. ​tin shed  initiatives,  environmental  generate social  impact-making 
ventures​)  Governmen impacts through  or environmental  startups and 
t initiatives  investing  impacts  flexibility in 
financial return 
requirements 

Family Office  Family  Seeking financial  All types of  Flexibility in 
VC (e.g.  office  return  startups (stage,  check size, 
Omidyar  funding  vertical, location  location, 
Network​)  depending on  industry, etc. 
fund strategy) 

2.3.3. VC fund investment strategies 

VC firms or GPs need to have a clear investment strategy when going out to raise a new 
fund.  A  VC  firm  can  raise  and  manage  multiple  VC  funds.  Each  fund  can  have different 
investment  strategies  and  LPs.  For  each  fund,  GPs  need  to  determine  the  basic 
investment  strategies  such  as  geographical  focus,  industry  focus,  stage  focus,  average 
check size, and other investment criteria. 

12 Ventures
 GPs  will  usually  determine  the  strategies  based  on  their  past  experience  and  their 
competitive  advantages.  The  fund  strategies  will  also  affect  where  GPs  can  get  money 
from  because  LPs  -  the  capital  providers  -  will  need  to  see  if  the  strategies  of  the  VC 
strategy. 
fund align with LPs’ own investment strategy.

funds 
Figure 2.6 Investment strategies of VC funds

Location Focus Domain Focus Stage Focus Check Size Lead Preference Other Criteria

U.S. FinTech Pre-Seed < $500K Prefer Lead Minority Founder

Europe InsurTech Seed $0.5 - 1M Do Not Lead Impact Investing

Israel Hardware Series A $1 - 5M No preference Strategic Value

APAC BioTech Series B $5 - 10M Others

China Mobility Series C $10 - 20M

LatAm Consumer Series D+ > $20M

Africa SaaS

Agnostic Agnostic

2.3.4. Revenue streams of a VC firm - the “2 and 20” model 

model

carry.
A typical VC firm will have two major revenue streams: management fee and carry. 

The  typical  fee  structure  of  VC  funds  is  known  as  2-and-20.  Most  VC  funds  will  keep 
2%  of  the  fund’s  total  amount  each  year  (called  a  management  fee)  and  use  it to cover 
operating  expenses  and  pay  salaries.  In  addition  to management fees, VC funds usually 
keep  20%  of  the  profits  for  their own investors, known as carried interest or a carry fee. 
Some  VC  funds  take  up  to  30  percent  based  on  what  they  specialize  in  and  their  track 
record. 
record.

It  is  important  to  note  how  management  fees  and  carried  interest  work  together  in  the 
fee  structure.  The  biggest  point  to  note  is  that  the  fund’s  return  is  calculated  as  net 
against  the  management  fees.  This  means  VC  firms  charging  higher  management  fees 
must  generate  a  larger  return  for  their  investors  in  order  to  receive  carried  interest 

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 payments.  In  fact,  a  VC  firm  generating  a  return  less  than  the  amount  of  management 
fees would not receive any carried interest payments9.. 

Some funds may also have a “hurdle” rate, which is a rate of return that must be realized 
by  the  LPs  before  the  GP  will  earn  a  carry.  In  other  words, the LPs must first receive all 
of  their  invested  capital  back  plus  an  annual  percentage  return  (e.g.  8%)  before  the GP 
will receive their 20% of any remaining distributions10. .

model 
Figure 2.7 VC business model
Carry - 20-30% upside
GP (VC firm)

2-3% Management Fee

Capital Investment
LPs VC Fund I Startups Exit

70-80% upside

2.3.5. Life cycle of a VC fund 

fund

A  VC  firm  can  raise  and  manage  multiple  funds.  These  funds  can be at different stages 
cycle.  
of their life cycle.

fund 
Lifetime of a fund
The  lifetime  of  a  fund,  or  the  period  commencing  the  day  it  begins  operations  and 
ending  when  it  is  dissolved,  is  generally  between  8-10  years.  Smaller  or  newer  funds 
may  have  a shorter term, as they have less capital to deploy. Most funds permit the term 
to  be  extended  by  two  additional  one-year  periods  to  maximize  value  of  the  remaining 
investments at the end of the term.term. 

The  first couple years is spent raising the capital that will create the fund. As fundraising 
wraps  up,  GPs  work  with  their  deal  sources  to  find  companies  they  are  interested  in 
investing  in.  After  closing those transactions, they will manage and grow the companies 
in  their  portfolio.  When  the  GP  sees that an exit can produce a rate of return that would 
meet or exceed the LPs expectations, they will sell the business.
business. 

9
9 Clark, Bill. "Invest in Startups: Equity Crowdfunding: MicroVentures." MicroVentures Blog. January 15,  15,
2015.
2015. Accessed
Accessed August
August 29,
29, 2020.
2020. ​h
​https://microventures.com/demystifying-vc-fund-fee-structures​
ttps://microventures.com/demystifying-vc-fund-fee-structures​.. 
10
10
"Management Fees & Carry." Crowdmatrix. Accessed August 29, 2020.  2020.
https://crowdmatrix.co/management-fees-and-carry-explained​. 

14 Ventures
 Many  funds  have  a  10-year  life  cycle.  Although,  that  has been changing in recent years 
with some funds choosing life cycles closer to 15 or 20 years11.. 

period
Fundraising period 
Fundraising  period is the period during which the general partner can admit investors as 
limited  partners  to  the  fund.  The fundraising period typically starts with the fund’s initial 
closing  and  ends  with  its  final  closing.  A  fund  may  have  several  closings in between. In 
most cases, the final closing occurs within 12 months of the initial closing. closing.

Investors  at  each  subsequent  closing  will  generally  contribute  capital—and  be 
treated—as  though  they  came  in  at  the  initial  closing  and  participate  in  all of the fund’s 
investments  that  haven’t  been  previously  disposed  of.  Accordingly,  the  existing 
investors’  proportionate  share  of  the  fund  is  diluted  each  time  new  investors  are 
fund. 
admitted to the fund.

In  order  to  make  this  more  fair  for  the  fund’s  existing  investors,  the  subsequent  close 
investors  typically  pay  a  subsequent  closing  fee  to  the  existing  investors,  which  is 
calculated  like  interest  (e.g.,  at  5-7%  per  annum)  on  the  subsequent  close  investors’ 
capital  contributions  from  the  date  of  the  initial  closing  to  the  date  of  the  applicable 
closing. 
subsequent closing.

period 
Investment period
A  fund  can  typically  only  call  capital  to  make  new  investments  during  its  investment 
period.  The  investment  period  normally  starts  at  the  initial  closing  and  ends  on  the 
3rd-5th  anniversary  of  the  initial  closing  or  the  date  on  which  70-75%  of  the  fund’s 
capital  is  deployed—whichever  occurs  first.  After  the  investment  period  is  over, 
generally  only  follow-on  investments  or  investments  actively  considered before the end 
of the investment period can be made. made.

cycle 
Figure 2.8 Typical VC fund life cycle
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11+

Fundraising (1 - 2+ years)

Sourcing and closing deals (2 - 5+ years)

Managing portfolio companies (3 - 7+ years)

Divestiture / exit

11
11 Winkelman, Karina, and Karina Winkelman. "The Ultimate Guide to Private Equity." The DVS Group. 
Group.
May
May 30,
30, 2019.
2019. Accessed
Accessed August
August 29,
29, 2020. 
2020.
https://thedvsgroup.com/the-ultimate-guide-to-private-equity/​. 

Ventures 15
Figure 2.9 How a VC firm manages multiple funds
funds 
VC firm

VC Fund I

VC Fund II

VC Fund III

2.4. VC Investors - how to succeed as a VC 

VC
2.4.1. Metrics used by VCs to measure returns 
returns

VC  investors  often  use  two  metrics  to  measure  or  project  the  returns  of  their 
investments. The two metrics are called multiples and Internal Rate of Return (IRR). 
(IRR).

Multiples  are  calculated  by  the  total return by the cost of the investment. For example, a 

VC  invested  $10M  into  a  startup  and  sold  all  the  shares  for  $100M  when  the  startup 
went IPO. The VC firm will claim that they made a 10X return on this investment. 
investment.

However,  the  problem  of  using  multiples  to  measure  VC  returns  is  that  it  does  not 
consider  the  time factor. For example, making a 10X return in 30 years means an annual 
compound  return  of  7.97%,  while  the  average  annual  return  for  the  S&P  500  index 
since  its  inception  in 1926 through 2018 is approximately 10%–11%12, meaning the VC 
investment is not beating the market. 
market.

Internal  Rate  of  Return  (IRR)  is  more  complicated  than  multiples,  and  it  has  taken  the 
time  factor  into  consideration.  Therefore,  IRR  is  commonly  used  in  the  VC  industry  to 
accurately  measure  the  returns  of  VC  funds  and  a  single  VC  investment.  By  definition, 
IRR  is  a  discount  rate  that  makes  the  net  present  value  (NPV) of all cash flows equal to 
zero in a discounted cash flow analysis13.. 

12
Maverick, J.B. "What Is the Average Annual Return for the S&P 500?" Investopedia. August 26, 2020. 
2020.
Accessed
Accessed October
October 06,
06, 2020. 
2020.
https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp​
https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp​.. 
13
13 2020,
Hayes, Adam. “Internal Rate of Return (IRR).” Investopedia, 28 July 2020, 
https://www.investopedia.com/terms/i/irr.asp​
www.investopedia.com/terms/i/irr.asp​. . 

16 Ventures
  
The IRR formula is as follows: 
 

 
 
Here is an example illustrating the rationale behind IRR and how to calculate it. 
 
As  mentioned  above,  IRR  is  the discount rate that makes the net present value (NPV) of 
a project zero. In other words, it is the expected compound annual rate of return that will 
be  earned  on  a  project or investment. In the example below, an initial investment of $50 
has a 22% IRR. That is equal to earning a 22% compound annual growth rate. 
 
In this example, the 22% IRR means that: 
 
0  =  NPV  =  (-50)  +  20  / (1+22%) + 15 / (1+22%)​2 + 8 / (1+22%)​3 + 18 / (1+22%)​4 + 10 / 
(1+22%)​5​ + 25 / (1+22%)​6 
 
Figure 2.10 An example showing an investment with an IRR of 22% in 6 years (Source: ​CFI​) 
Positive cash flow
(from stock dividends, etc.)

$25
$20
$15 $18
$8 $10

Initial investment
($50) ( negative cash flow)

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6  

 
For  an  VC  investment  into  a  startup,  it  is  most  likely  that  the  investors  will  not  get  any 
positive  cash  flow,  such  as  dividends,  before  they  exit  from  this  investment  by  selling 
their shares. 
 
In this scenario, the cash flow for a VC investment into a startup would look as follows. 
 

  Ventures 17
Figure 2.11 An example showing the cash flow of a VC investment 
Positive cash flow
(from selling shares, etc.)

$30

($5) Initial investment

( negative cash flow)

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6  

 
In this case, the IRR of this investment can be calculated as follows. 
 
0 = NPV = (-5) + 30 / (1+IRR)​6​, and therefore, IRR = 34.76% 
 
The return of this investment in multiples in 6 years is 6X (30/5 = 6X). 
 
Since  it  is  easier  to  calculate  multiples  than  to  calculate  the  IRRs,  VC  investors  still  use 
multiples  to  measure  returns.  But  please  always  try  to  mention  the  investment  period 
when using multiples. Below is a list of multiples and its equivalent IRRs. 
 
Table 2.3 Comparison of multiples and IRRs 
Investment Period (years)  Multiple  IRR 

5  5X  37.92% 
5  10X  58.41% 
5  20X  81.94% 
5  30X  97.29% 
8  5X  22.27% 
8  10X  33.33% 
8  20X  45.38% 
8  30X  52.94% 
10  5X  17.45% 
10  10X  25.87% 
10  20X  34.90% 
10  30X  40.47% 
 

18
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 2.4.2. Returns of VCs - long tail market 

By  nature,  VC  investing  is  highly  risky  and  also  comes  with  a  high  potential  return. 
However,  the  performances  of  VC  firms  vary  a  lot.  Only  the  top  VC  funds  tend  to 
outperform  the  market.  PME  (Public  Market  Equivalent)  percentile  is  commonly  used  to 
measure  how  VC  funds  perform  compared  to  the  public  market  (e.g.  S&P 500 returns). 
If  the  PME  percentile  is  larger  than  1,  it  means  the  VC  funds  are  outperforming  the 
public  market.  If  it  is  smaller  than  1,  it  means  the  VC  funds  are  underperforming.  For 
people  who  are  interested  in  learning  more  about  how  KS-PME  is  calculated,  please 
read more here​. 
 
Figure  2.12  VC  KS-PME  percentiles by vintage year - only the top VC funds tend to outperform 
(S&P 500 Total Return Index is used to calculate the KS-PME percentiles) (Source: ​PitchBook​) 

 
 
   

  Ventures 19
Figure 2.13 VC IRRs by vintage year (Source: ​PitchBook​) 

 
From  the  charts  above,  it  is  not  difficult  to  see  that  only  the  top  quartile  VC  funds 
outperform  the  S&P  500  Total  Return  Index  with  a  KS-PME  percentile  larger  than  1. 
However, most of the VC funds are underperforming the market. 

2.4.3. Take the right risks 

Given  the  nature  of  VC  investing,  it  is  important  for  VC  investors  to  take  the  right  risks 
but not to minimize risks. 
 
LPs  allocate  their  capital  to  VCs  for  certain  purposes.  LPs  expect  VCs  to  invest  in 
high-risk  and  high-return  assets  based  on  LPs’  portfolio  allocation  strategy.  The  high 
expected  returns  and  the  high  volatilities  of  startups  will  help  LPs  to  achieve  an 
optimized return. LPs will not want to see VC funds taking minimal risks to generate low 
returns. 
 
Here are three examples to show what kind of investments VCs are supposed to make.  
 
In  the  first  example,  a  VC  investor  makes  10  investments  into  low-risk  and  low-return 
assets.  In  the  end,  7  of  the  invested  companies  succeed,  and  each  of  them  brings  the 
fund  10%  IRR  return.  The  fund  generates  7%  IRR  with  a  4.84%  volatility.  The 
performance  of  this  VC  fund  is  not  too  bad.  However,  this  is  not  what  LPs  want  VC 
investors to do as this risk-return profile will screw up LPs’ portfolio risk-return profile. 
 
In  the  second  example,  a  VC investor invests into 10 high-risk and high-return startups. 
After  10 years, two companies achieve huge successes and bring 80% IRR, and another 

20
  Ventures
 company also succeeds with 60% IRR. The rest 7 startups have failed. The VC fund has 
achieved 22% IRR with a volatility of 35.84%. This is a typical VC investment strategy. 

In  the  third  example, a VC investor uses a mixed strategy by investing into 3 high-risk 

high-return  startups  and  7  low-risk  low-return companies. In the end, none of those 
three  high-risk  high-return  investments  succeeds.  5  of  the  7  low-risk  low-return 
investments succeed with each bringing in 10% IRR return. The VC fund achieves a 5% 
IRR return with a 5.27% volatility. 

VC  investors  should  avoid  using  the first or the third strategy. Particularly, it will be very 

dangerous  to  use  a  mixed  strategy.  When  a  VC  investor  makes  a  few  high-risk 
high-return  investments  while  deploying  the  other  capital  to  low-risk  low-return 
investments,  this  investor  is  wasting  the  fund’s  capital,  and  the  fund  is  going  to 
underperform. The reason is that when the VC investor invests into low-risk low-return 
assets,  the  investor  is  also  losing  the  opportunities  to  cover  the  potential  huge losses 
from those high-risk high-return investments that the investor has already made. 

Figure  2.14  Comparison  of  VC  investment  strategies  (IRRs  measured  in  a  10-year  time  frame, 
all investments with the same check size) 
Strategy 1 - Minimize risks Strategy 2 - High-risk High-return Strategy 3 - Mixed Strategy

Investment 1 10% IRR Investment 1 60% IRR Investment 1 0% IRR

Investment 2 10% IRR Investment 2 60% IRR Investment 2 0% IRR

Investment 3 10% IRR Investment 3 0% IRR Investment 3 0% IRR

Investment 4 10% IRR Investment 4 0% IRR Investment 4 0% IRR

Investment 5 10% IRR Investment 5 0% IRR Investment 5 10% IRR

Investment 6 10% IRR Investment 6 0% IRR Investment 6 10% IRR

Investment 7 10% IRR Investment 7 0% IRR Investment 7 10% IRR

Investment 8 0% IRR Investment 8 0% IRR Investment 8 10% IRR

Investment 9 0% IRR Investment 9 0% IRR Investment 9 10% IRR

Investment 10 0% IRR Investment 10 0% IRR Investment 10 0% IRR

Timeframe: 10 years Timeframe: 10 years Timeframe: 10 years

Fund return: 6.14% IRR / 1.82X Fund return: 36.18% IRR / 21.99X Fund return: 2.63% IRR / 1.30X
Volatility: 4.22% Volatility: 25.30% Volatility: 5.27%
Comment: This is not what LPs want Comment: This is a typical VC Comment: Losing the opportunities to
VCs to do investment strategy cover the potential huge losses

Wrong Right Extremely wrong

Ventures 21
2.5. Setup of Plug and Play Ventures 

Plug  and  Play  Ventures  is  not  a  typical  VC  firm.  It  differs  from  traditional  VC  firms  in  many 
aspects  and  has  different  investment  vehicles.  Below  is  a  table  that  helps  to  understand  the 
unique setup of Plug and Play Ventures. 
 
Table 2.4 Comparison between Plug and Play Ventures and a typical VC firm 
Item  Plug and Play  Plug and Play Vertical  Typical VC firm 
Ventures  Funds14 

Capital providers  Plug and Play  Plug and Play  All different types of 
Corporate partners  capital providers 

Investment  Plug and Play  Fund GPs (Investment  Fund GPs (Investment 
decision makers  Investment Committee  Committee)  Committee)15 

Fund size  N/A  Yes - $20-50M  Yes - from micro fund 

with $10M to mega 
fund with $500+M 

Fund life cycle  N/A  Yes - 8 to 10 years  Yes - 8 to 10 years 

(from fundraising 
to liquidation) 

Limitations on  Check size,  Industry, Location,  Industry, Location, 

investments  occasionally industry  Stage, Check size  Stage, Check size 

# of investments  200+  5-15  1 - 3016 

per year 
   

14
Plug and Play has set up several separate industry-focused funds such as the Future of Commerce 
Fund and the Smart Cities Fund. 
15
Fund LPs normally do not get involved in the investment decision-making process. 
16
The number of investments made at VC firms vary a lot. 1 - 30 is an estimate from the writers. 

22
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 3
PROCESS
OF A VC DEAL

Ventures 23
3. Process of a VC deal 

The  process  of  making  a  VC  investment  is  almost  the  same  across  different  VC  firms.  It  starts 
from  sourcing,  goes  through  a  lot  of  due  diligence,  internal  discussion,  and  negotiation,  and 
ends at an Investment Committee (IC) meeting that gives a red or green light to the deal. 
 
Figure 3.1 Diagram of the typical process of making a VC investment 

Sourcing Initial Assessment Due Diligence Deal Negotiation IC Approval Legal Process Money Transfer

Dropped Dropped Dropped Dropped Dropped Dropped

Reasons: Reasons: Reasons: Reasons: Reasons: Reasons:

Not raising, too Not meeting Lack of Poor terms, LP or IC Not meeting
early/late, too the basic excitement, big lack of lead, preferences, legal
expensive, not requirements red flags, etc. long time new red flags requirements
within investment such as TAM to close, found, etc. such as entity
focus, etc. size, etc. etc. setup, etc.

1 - 2 weeks 2 - 8 weeks 1 - 4 weeks 1 - 2 weeks 1 - 2 weeks 1 week  

 

3.1. Sourcing and initial assessment 

Sourcing  is  one  the  most  important  skill  sets  VC  investors  need  to  build. In the end, VC 
investing  is  a  competition  of  information  access,  relationship  building,  and  analytical 
capabilities. VC investors can only succeed with a strong pipeline of high-quality deals. 

3.1.1. Different sourcing channels 

Here  is  a  list of different sourcing channels. VC investors should never rely on any single 

one  of  them  but  leverage  as  many  as  possible  channels  to  get access to the best deals. 
Each  of  these  channels  has  its  own  pros  and  cons.  VC  investors  can  choose  a 
combination of these approaches based on their investment strategies and preferences. 
 
Table 3.1 Comparison of different sourcing channels 
Sourcing  Pros  Cons  Examples 
channel 

Database  1. Large quantity  1. Low quality  1. PitchBook 

2. Wide coverage  2. Not exclusive  2. Crunchbase 
3. Easy access  3. High cost  3. CBInsights 
4. Tracxn 
5. Contxto 
6. Start-up Nation 

News/Search  1. Time consuming  1. Time consuming  1. TechCrunch 

24
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 2. Unique and  2. Random  2. GeekWire 
interesting  opportunity  3. Inc. 
companies  3. Not exclusive  4. The Information 
4. Already late for  5. LatamList 
early-stage  6. Wired 
investors  7. Tech in Asia 
8. VentureBeat 
9. Inside Venture 
Capital 

VC peer  1. High-quality deals  1. Opportunistic  1. Classmates 

referrals  2. Exclusive  2. Low volume  working at VCs 
3. In-person  3. Tier-1 VCs tend  2. Alumni at VCs 
assessment  to not share deals  3. VC peers met at 
events 

Networking  1. In-person  1. Opportunistic  1. CES 

at events  assessment  2. Low volume  2. TechCrunch 
2. Semi-exclusive  3. Quality varies  Disrupt 
3. Annual J.P. 
Morgan 
Healthcare 
Conference 

Founder  1. High-quality  1. Opportunistic  1. Friends at 

network  2. Exclusive  2. Low volume  startups 
3. In-person  2. Founders of 
assessment  portfolio comps 

3.1.2. Quick screening and initial assessment 

To  make  the  best  use  of  their  time,  VC  inventors  often  need  to  prioritize  some 
opportunities  over  the  others  and  drop  some  opportunities  through  a  quick  initial 
assessment.  At  this  stage,  VC  investors  have  probably  had one call or meeting with the 
startup founding team and received some basic information about the startup company. 
 
Below  is  a  list  of  common  criteria  that  VC  investors  would  use to conduct a quick initial 
assessment.  The  purpose  of  this  process  is  to  determine  if  this  opportunity  meets  the 
baseline criteria of the fund investment strategies. 
 

  Ventures 25
 If  a  company  is  (1)  targeting  a  small  problem/opportunity,  or  (2)  not  within  the  target 
stage/valuation  based  on  the  fund  investment strategy, or (3) not raising now, or (4) not 
having  any  excitement,  VC  investors  can  then  either  pass  this  opportunity  or  prioritize 
other opportunities. 
 
Table 3.2 Comparison of different sourcing channels 
Item  Information source  Why this matters  Type 

Opportunity  1. Google  To validate if the potential  Gatekeeper 

size  2. Market reports  return is big enough to cover 
3. Quick market sizing  the potential risks 

Stage /  1. Founder call  To validate if the stage and  Gatekeeper 

Valuation  2. Investor deck  valuation aligns with fund 
3. Startup databases  investment strategies 

Fundraising  1. Founder call  To validate if the company is  Gatekeeper 

status  2. Investor deck  raising now or planning to 
raise in the near future. To 
determine if the deal is aligned 
with the investment strategy 
and thesis 

Founder  1. Google  To find excitement. A strong  Excitement 

background  2. LinkedIn  team means a higher chance of 
3. Founder call  success  
4. Investor deck 

Existing  1. Founder call  To see who has invested  Excitement 

investors  2. Investor deck  before and who is joining this 
3. Startup databases  round. Having support from 
strong investors indicates a 
higher chance of success 

Traction  1. Founder call  To find excitement. Strong  Excitement 

2. Investor deck  traction means validation from 
the market and a higher 
chance of success 

Competitive  1. Founder call  To find excitement. Strong  Excitement 

advantages  2. Investor deck  competitive advantages (e.g. 
IPs, exclusive partnerships, 
first mover advantage) means 
a higher chance of success 

26
  Ventures
3.2. Due diligence 

Once  VC  investors  finish  the  initial  assessment  and  decide  to  move  forward,  they  will 
start  working  on  a  proper  due  diligence  (DD)  report/investment  memorandum  (IM), 
which will be later presented to the team and the investment committee (IC). 

The  purpose  of  this  proper  DD/IM  is  to  conduct  an  in-depth  analysis  to  understand  the 
investment  opportunity  -  estimate  the  size  of  the  opportunity  and  projected  return, 
determine  the  excitement  and  assess  if  there  are  any  red  flags  that  investors  have  not 
found during the initial assessment. 

The  aspects  that  a  proper  DD/IM  is  trying  to  inspect  are  similar  to  what  VC  investors 
have  looked  into  during  the  initial  assessment.  However,  the  analysis in a formal DD/IM 
will be more detailed, granular, and thorough. 

3.2.1. Bottom lines 

There  are  a  collection  of  bottom  lines  that  VC  investors  would  like  to  assess.  If  the 
startup  does  not  meet  the  bottom  lines,  it  will  be  hard  for  investors  to  move  forward. 
These  bottom  lines  usually  include  market  size,  business  model,  competition,  and 
valuation/projected return, etc. 

Table 3.3 Bottom lines of deal assessment 

Bottom line  Data source  Why this matters  Example conclusions 

Market size  1. Market Determines the  1. < $1B - ​Pass

reports ceiling of the  2. $1.5B - ​Good
2. Bottom-up return of this deal  3. $5.2B - ​Excellent
market sizing

Business  1. Customer Determines if the  1. No pilot validation yet -

model17  interviews business model  Pass
2. Startup works or not  2. Many previous failed
databases examples - ​Pass
3. Investor deck 3. Validated by pilot
customers - ​Good
4. Validated by many paid
pilot customers - ​Excellent

17
Business Models (vs. Pricing Models). Medium. September 2, 2020. Accessed September 2, 2020. 
https://medium.com/@janisskriveris/business-models-vs-pricing-models-a523fc8994b2. 

Ventures 27
 Competition  1. Startup Determines how  1. Many existing strong
databases much market  competitors - ​Pass
2. Investor deck share the startup  2. Many similar companies
3. Customer can potentially  died before - ​Pass
interviews acquire and  3. First-mover - ​Good
essentially the  4. First-mover with high
return of the deal  barrier - ​Excellent

Valuation /  1. Startup Determines the  1. Highly overvalued

Projected  databases ceiling of the  compared to similar
return  2. Investor deck return of this deal  startups - ​Pass
2. Undervalued compared to
similar startups - ​Good
3. 5% IRR (10 years)
projected return - ​Pass
4. 80% IRR (10 years)
projected return - ​Excellent

3.2.2. Excitement 

After  assessing  the  investment  opportunities  against the bottom lines, VC investors will 

also  look  into  another  set  of  aspects  to  find  excitement  of  the  deal.  By  finding  this 
excitement,  VC  investors  are  actually  trying  to evaluate the probability of success of the 
startup.  The  excitement  will  usually  include  solid  founding  team  background,  tier-1 
existing  or  new  investors,  strong  traction,  good  fit  with  the  fund,  and  terms  of  the  deal 
(for non-lead investors), etc. 

Table 3.4 Excitement of VC deals 

Excitement  Data source  Why this matters  Excitement examples 

Team  1. Investor deck A team a strong  1. Previous startup exits

background  2. LinkedIn background will  2. Solid experience in
3. Google increase the  relevant companies or
Scholar chance of success  industries
4. References 3. Strong academic record
with many patents
4. Strong positive feedback
from references

Investors  1. Investor deck Support from  1. Tier-1 global investors

2. Startup strong investors  such as Sequoia leading

28 Ventures
 databases  will increase the  the new round 
chance of success  2. Backed by tier-1 investors
3. Strong local investors
leading the new round
4. Strong investors in a
specific domain leading the
new round

Traction  1. Investor deck Strong traction  1. Many paid pilots

2. Customer from customers  2. Strong revenue growth
interviews validates the value  3. Strong user base growth
of the ​product ​and  4. Strong GMV or TPV
reduce the risks of  growth
the deal 

Fund fit  1. Investor deck A good fit with the  1. Strong synergy with GP’s
fund means the  network or LP’s network
fund can offer a  2. Strong insider validation
lot of help and  from GPs and/or LPs
reduce the risks of  3. Strong synergy with
the deal  portfolio

Deal terms  1. Founder call Favorable terms  1. Low valuation

2. Investor deck will reduce the  2. Low valuation cap on
risks of the deal  SAFE18 or convertible
for investors  notes19
3. High discount rate on
SAFE or convertible notes

3.2.3. Red flags 

Last  but  not  least,  VC  investors  will  also  be  looking  for  red  flags  when  working  on  the 
DD/IM.  These  red  flags  are  based  on  VC  inventors’  past  experience  and  are  very 

18
A SAFE (simple agreement for future equity) is an agreement between an investor and a company that 
provides rights to the investor for future equity in the company similar to a warrant, except without 
determining a specific price per share at the time of the initial investment. 
Carolyn Levy. “Safe Financing Documents.” Y Combinator. Accessed September 8, 2020. 
https://www.ycombinator.com/documents/. 
19
A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a 
future financing round; in effect, the investor would be loaning money to a startup and instead of a return 
in the form of principal plus interest, the investor would receive equity in the company. 
"Convertible Note: Examples and How It Works." SeedInvest. October 27, 2017. Accessed August 29, 
2020. ​https://www.seedinvest.com/blog/startup-investing/how-convertible-notes-work​. 

Ventures 29
 subjective.  None  of  the  red  flags  will  be  an  absolute  deal-breaker.  However,  VC 
investors do not want to move forward with a deal that has a lot of apparent red flags. 

Below  is  a  list  of  red  flags  summarized  by  investors  at  Plug  and  Play  Ventures  and 
agreed  by  many  investors from the other VC firms. If you are interested in learning more 
about the rationale behind these red flags, please ​read more here​. 

Table 3.5 Red flags of VC deals 

Excitement  Excitement examples 

Founding  1. Being emotional or irrational under pressure

team  2. Lack of empathy
3. Looking for a quick exit
4. Unable to pitch the idea/business well
5. Not responding to the key questions
6. Overconfident or arrogant
7. Lack of necessary experience or knowledge
8. Not knowing each other for long/well
9. Not sharing data room after multiple conversations
10. Not being transparent or honest
11. An all-star team
12. Not fully committed
13. Being highly diluted at an early stage

Business  1. Low traction after a long period of time

2. Lack of paid customers/pilots
3. All the traction coming from one customer
4. User growth heavily relying on marketing (or compensation)
5. High GMV with a low/negative margin
6. Being a traditional business (low risk, low return) instead of a
high-growth business (high risk, high return)
7. Unclear business model
8. Failed/bad precedents in the same space
9. Limited exit opportunity

Fundraising  1. Not closed for a long time

2. Not being transparent
3. Too aggressive for funding and valuation
4. A long gap between two rounds
5. Having been founded for too long

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 6. TAM20 being too big or too small
7. Spending too much effort on the deck
8. Not spending enough effort on the deck

Deal  1. Previous investors not following on

2. The same lead investor for the new round
3. Lack of reputable co-investor
4. Taking corporate money at an early stage

3.2.4. Financial return projections 

For  VC  investors,  it  is  critical  to  project  the  financial  returns  that  an  investment  can 
bring.  This  process  offers  investors  a  different  lens  to  evaluate  if  a  deal  is  attractive  or 
not. 

There  are  many  different  ways  to  project  financial  returns.  For  all  these  methods,  the 
most  important  metrics to estimate include (1) the value of the company at an exit event 
for  investors  (e.g.  IPO,  M&A, etc.), (2) potential dilution in future financing rounds before 
the exit event happens, and (3) the time it will take the startup to that ​“exit”​ point. 

Here  are  two  examples  showing  how  VC  investors  can  roughly  estimate  the  financial 
returns. 

Example 1: 

Startup  A  is  offering  a  digitization  solution  to  SMEs  in  Brazil.  The  company  will  charge 
their  customers  a  monthly subscription fee for the software. Moreover, the company will 
also generate revenue from offering working capital loans to SMEs. 

Startup A is raising a seed round at a $3.67M post-money valuation now. 

Here  are  the  steps  a  VC  investor  takes  to  estimate  the  potential  financial  return  from 
this investment opportunity: 

1) Estimate  total  addressable  market  size  (TAM)  based  on  the  number  of
SMEs, an estimated SaaS fee, and the revenue from working capital loans
for SMEs.

20
Total addressable market (TAM), also called total available market, is a term that is typically used to 
reference the revenue opportunity available for a product or service. TAM helps to prioritize business 
opportunities by serving as a quick metric of the underlying potential of a given opportunity. 
TAM SAM SOM - what it means and why it matters. The Business Plan. Accessed September 8, 2020. 
https://www.thebusinessplanshop.com/blog/en/entry/tam_sam_som.

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 2) Estimate  the  market  share  and  ARR  that  Startup  A  can  achieve  in
different scenarios at the projected exit time (e.g. 5 years).
3) Use  the  multiple  valuation  method  to  estimate  the  valuation of Startup A
at  the  exit  event.  For  example,  investors  can use an industry average P/S
ratio  to  estimate  the  valuation at exit. Please navigate to the next chapter
to read more about different valuation methods.
4) Estimate  the  dilution  that  will  happen  in  the  future  financing  rounds
before  the  exit  event  happens.  For  example,  since  this  is  a  very  early
stage  company,  VC  investors  estimate  that  60%  of  Startup  A  will  be
diluted in the future rounds during the projected time frame.
5) Calculate  the  potential  return  based  on  the  estimated  valuation  at  exit
and the time Startup A takes to get to that exit point.
6) Estimate  the  success  rate  of  this  company  to  compensate  for  the  high
risks  associated  with  Startup  A.  The  earlier  stage  the  company  is  at,  the
lower  the  success  rate  will  be.  By  taking  the  risks  into account, investors
can calculate the expected valuation at exit.
7) Based on the above estimations, calculate the risk-adjusted returns.

Table  3.6  Financial  return  analysis  for  Company  A  using  industry  multiple  (Price/Sales 
ratio) to estimate valuation at exit 
All numbers are in millions of USD 
Market share scenarios 
Bear case  Base case  Bull case  Excellent 
Metric  TAM 
case 
1%  2%  3%  5% 
SMB working  $ 7,360.00  $ 73.60  $ 147.20  $ 220.80  $ 368.00 
capital financing 
SMB SaaS  $ 1,760.00  $ 17.60  $ 35.20  $ 52.80  $ 88.00 
Micro-businesses  $ 1,100.00  $ 11.00  $ 22.00  $ 33.00  $ 55.00 
working capital 
financing 
Micro-businesses  $ 550.00  $ 5.50  $ 11.00  $ 16.50  $ 27.50 
SaaS 
Total ARR  $ 10,770.00  $ 107.70  $ 215.40  $ 323.10  $ 538.50 

Valuation today  $3.67 

Scenario 1 - Industry-average P/S ratio and success rate 

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P/S ratio  11.83 
Valuation  -  $ 1,274.09  $ 2,548.18  $ 3,822.27  $ 6,370.46 
Dilution in 5 years  60% 
Return (multiple)  -  138.87  277.73  416.60  694.33 
Return (IRR)  -  168.09%  207.93%  233.93%  269.83% 
Success rate  30% 
Expected  -  $ 382.23  $ 764.45  $ 1,146.68  $ 1,911.14 
valuation 
Risk-adjusted  -  41.66  83.32  124.98  208.30 
Return (multiple) 
Risk-adjusted  -  110.75%  142.07%  162.51%  190.73% 
Return (IRR) 

Scenario 2 - Low P/S ratio and low success rate 

P/S ratio  5 
Valuation  -  $ 538.50  $ 1,077.00  $ 1,615.50  $ 2,692.50 
Dilution in 5 years  60% 
Return (multiple)  -  58.69  117.38  176.08  293.46 
Return (IRR)  -  125.70%  159.24%  181.12%  211.34% 
Success rate  10% 
Expected  -  $ 53.85  $ 107.70  $ 161.55  $ 269.25 
valuation 
Risk-adjusted  -  5.87  11.74  17.61  29.35 
Return (multiple) 
Risk-adjusted  -  42.44%  63.61%  77.42%  96.49% 
Return (IRR) 

Scenario 3 - Invest in next round at $15M post-money valuation 

Valuation today  $15.00 
P/S ratio  5 
Valuation  -  $ 538.50  $ 1,077.00  $ 1,615.50  $ 2,692.50 
Dilution in 5 years  50% 
Return (multiple)  -  17.95  35.90  53.85  89.75 

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 Return (IRR)  -  78.10%  104.57%  121.84%  145.69% 
Success rate  30% 
Expected  -  $ 161.55  $ 323.10  $ 484.65  $ 807.75 
valuation 
Risk-adjusted  -  5.39  10.77  16.16  26.93 
Return (multiple) 
Risk-adjusted  -  40.01%  60.82%  74.39%  93.14% 
Return (IRR) 

Example 2: 

Startup  B  is  offering  a  POS  payment  solution  to  SMEs  in  Colombia.  The  company  will 
make  money  by  charging  transaction  fees  from  all  the  payments  processed  by  the 
company.  The  company  will  also  potentially  make  money  by  lending  working  capital  to 
SMEs. 

Startup B is raising a Series A round at a $16M post-money valuation now. 

Here  are  the  steps  a  VC  investor  takes  to  estimate  the  potential  financial  return  from 
this investment opportunity: 

1) Estimate  the  Total  Payment  Volume  (TPV)  of  the  Colombian  market
based on public data.
2) Estimate  the  market  share  that  Startup  B  can  acquire  in  different
scenarios at the projected exit time (e.g. 5 years).
3) Estimate  the  probabilities  of  different  scenarios  to  take  into  account  the
high  risks  associated  with  Startup  B.  Calculate  the  expected  TPV  based
on those probability assumptions.
4) Use  the  multiple  valuation  method  to  estimate  the  valuation of Startup B
at  the  exit  event.  For  example,  investors  can  use  an  industry  average
Total  Payment  Volume/Enterprise  Value  (TPV/EV)  ratio  to  estimate  the
valuation  at  exit.  Investors  can  estimate  the  industry  ratio  based  on  the
data  from many similar companies. Please navigate to the next chapter to
read more about different valuation methods.
5) Estimate  the  dilution  that  will  happen  in  the  future  financing  rounds
before  the  exit  event  happens.  For  example,  since  this  is  a  very  early
stage  company,  VC  investors  estimate  that  40%  of  Startup  B  will  be
diluted in the future rounds during the projected time frame.
6) Calculate  the  value of the owned equities at the end of the projected time
frame after taking into account potential dilutions.
7) Based on the above estimations, calculate the risk-adjusted returns.

34 Ventures
 Table  3.7  Financial  return  analysis  for  Company  B  using  industry  multiple  (Total 
Payment Volume/Enterprise Value ratio) to estimate valuation at exit 
All numbers are in millions of USD 
TPV Market size  $34,000.00 
Years of projection  5 
Scenario  Bear  Base  Bull 
Market share  3%  10%  20% 
TPV processed annually  $1,020.00  $3,400.00  $6,800.00 
Probability  45%  50%  5% 
Expected TPV  $2,499.00 

TPV/EV ratio from competitors  4.539 

Valuation at the end of projection period  $550.56 

Valuation today  $16.00 

Estimated dilution during projection  40% 
period 
Valuation of equity owned at the end of  $330.34 
projection period 
IRR  83.10% 

3.3. Evaluating 

There  are  different  methods  to  value  a  startup.  Given  the  opacity  of  the private market, 
there  is  really  no  right  or  wrong  price  for  a  startup.  What VC investors can do is to pick 
the  best approach based on their own experience and update their data points based on 
the market situation. 

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 Table 3.8 Different startup valuation methods and their best use cases 
Valuation  Pre-seed  Seed  Series A  Series B  Series C  Series D+ 
methods 

Raise-based  X  X  X 
Method 

Comparison  X  X  X 
Valuation 
Method 

Competitor’s  X  X  X  X 
Multiple 
Method 

Exit-based  X  X  X  X 
Method 

Discounted  X  X  X 
Cash Flow 
Method 

3.3.1. Raise-based method 

For  very  early-stage  startups,  it  is  hard  to  get  an  accurate  valuation.  For  pre-seed  and 
seed  rounds,  investors  will  usually  desire  something  in  the  neighborhood  of  20  to  25 
percent  of  a  company’s  equity. Therefore, the valuation will be around 5X of the funding 
being  raised.  For  example,  if  a  company is raising $1M for its seed round, it is very likely 
that investors will agree to invest at a valuation of about $5M. 

On  top  of  this,  investors  will  also  pay  some  premium  for  strong  teams,  strong 
co-investors,  and/or  strong  traction.  This  is  because  these  competitive  advantages  will 
reduce  the  risks  associated  with  the  startup  and  therefore  increase  the  chance  of 
success and the expected return. 

Table  3.9  VC  investors  pay  premium  for  the  reduced  risks  and  increased  expected 
return 
Case  Round  Team  Lead investor /  Startup product  Valuation 
size  background  co-investor 

1  $1M  Two  Sequoia - Lead  Autonomous  $12M 

Seed  co-founders  Bessemer  driving system 

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 round  graduated from  Ventures -  = ​$5M + $2M 
HBS and both  co-investor  (team) + $1M 
worked at  (investor) + 
Google for 7  $4M (return 
years  potential)  

2  $1M  Two fresh  Tier-2 VC fund  Computer  $5M 

Seed  graduates  - Lead vision solution 
round  Angel investors for identifying 
- co-investors counterfeit 
semiconductor 
component 

3.3.2. Comparison valuation method 

Anchoring  valuation  in  recent  and  comparable  venture  investments  or  M&A  deals  is 
often the most common way both founders and investors look at startup valuation. 

For  example,  a  VC  investor  recently  met  the  CEO  from  Company  A  that  is  building  a 
virtual  online  conference  system  for  organizations  that  wanted  to  move  their 
conferences  from  offline  to  online.  The  team  is  not  stellar,  and  the  company  is  raising 
$2M. 

On  the  other  hand,  this  VC  investor  also  learned  that  Company  B  was  building  a  very 
similar  product targeting the same market. The investor also figured out that the team of 
Company  B  was  not  that  impressive  either.  The  valuation  of  Company  B’s  last  round, 
which happened 2 months ago, was $12M, and that round was led by a tier-2 VC firm. 

Therefore,  the  VC  investor  can estimate that the valuation of Company A should also be 

around $12M. 

This  approach  works  best  for  early-stage companies since investors can easily compare 

the  teams,  the  products,  the  targeted  markets,  and  the  other  relevant  information. 
However,  when  startups  get  into  their  later  stages  as  they  grow,  it  will  be  difficult  for 
investors  to  find  a  very  similar  company  in  terms  of  team,  traction,  market,  and 
everything  else.  As  late-stage  startups  will  have  more  operational  data,  a 
multiple-based valuation method would make more sense. 

3.3.3. Multiple method 

This  is  a  method  that  is  commonly  used  not  only  in  the  private  market  but  also  in  the 
public  market.  Investors  can  use  multiples  such  as  Valuation/Sales,  Valuation/Gross 

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 Profits,  Valuation/Monthly  Active  Users  (MAU),  Valuation/Gross  Merchandise  Value 
(GMV),  Valuation/Total  Payment  Volume  (TPV),  and  many  others  to  value  a  company 
based on the market data. 

Here are some examples illustrating how to use the multiple method to price startups. 

Table 3.10 Use market multiples to price a startup 

Multiple  Example  Good for 

Valuation  Known​: Company A, a Series C startup  Relatively late-stage 

/ Sales  selling accounting tools to SMEs and  companies 
charging monthly fees, raised at a 
post-money valuation of $120M two  Companies that are not 
months ago. Company A has an ARR of  profitable 
$15M. 
Examples: SaaS, B2C, etc. 
Valuation target​: Company B, which is 
offering a similar product to the same 
market and has a $6M ARR. 

Multiple​: 
Valuation / Sales = $120M/$15M = 8 

Pre-money Valuation of Company B​: 

8 * $6M = $48M 

Valuation  Known​: Company A, a Series D startup  Relatively late-stage 

/ Gross  providing last-mile delivery services in the  companies 
Profit  US, raised at a post-money valuation of 
$350M three months ago. Company A has  Companies that have 
an annual gross profit of $7M.  passed the break-even 
point 
Valuation target​: Company B, which is 
offering a similar service to the same  Examples: SaaS, B2C, etc. 
market and has an annual gross profit of 
$2M. 

Multiple​: 
Valuation / Gross profit = $350M/$7M = 50 

Pre-money Valuation of Company B​: 

50 * $2M = $100M 

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 Valuation  Known​: Company A, a Series C startup  Companies directly 
/ MAU  offering a B2C digital banking app in the  targeting consumers (B2C 
US, raised at a post-money valuation of  companies) 
$210M three months ago. Company A has 
an MAU of 3M.  Companies offering 
products that have stable 
Valuation target​: Company B, which is  customer lifetime value 
offering a similar product to the same  (CLV) 
market and had an MAU of 1M users at the 
time of raising.  Examples: B2C 

Multiple​: 
Valuation / MAU = $210M/$3M = 70 

Pre-money Valuation of Company B​: 

70 * 1M = $70M 

Valuation  Known​: Company A, a Series D startup in  Companies whose profits 

/ TPV or  Brazil offering payment systems to SMEs to  are highly correlated to 
GMV  enable their customers to pay in credit  processed transaction 
cards. Company A makes money by  volume (stable margin 
charging transaction fees. Company A  rate) 
raised at a post-money valuation of $800M 
three months ago and had an annual TPV  Examples: E-commerce, 
of $600M at the point of raising.  payment, fintech 
companies, etc. 
Valuation target​: Company B, which is 
offering a similar product in Colombia and 
processes $100M annually. 

Multiple​: 
Valuation / TPV = $800M/$600M = 1.33 

Pre-money Valuation of Company B​: 

1.33 * $100M = $133M 

3.3.4. Exit-based method 

Investors can also value a startup based on the projected exit value of the company. 

Ventures 39
 For  example,  a  Series-B  Startup  A  is  developing  a  digital  banking  solution  for  SMEs  in 
Mexico,  and  it  aims  at  going  public  on  NASDAQ  in 8 years. Based on some comparable 
companies,  VC  investors  believe  the  IPO  price  of  this  company  will  be  about  $4B  to 
$5B.  VC  investors  also  estimate  a  40%  dilution  will  happen  in  the  future  financing 
rounds before an IPO happens. 

However,  VC  investors  are not sure how much chance Startup A has to achieve its goal. 

To  compensate  for  this  risk,  VC  investors  will  use  a  high  discount  rate  to  calculate  the 
present  valuation  of  Startup  A.  The  discount  rate  also  represents  the  return  from  the 
investment  on  Startup  A. The rationale of using a high discount rate is that VC investors 
need  to  get  a  higher  potential  return  to  compensate  for  the high risks that VC investors 
are taking. 

A  discount  rate  commonly  used  in  the  VC  industry  is  40%,  which  is  the  typical  IRR 
requirement that many VC investors are seeking for21. 

Here is a table illustrating how to value Startup A based on the above information. 

Table 3.11 Valuation based on exit value 

Item  Value 
Estimated IPO price ($M)  $5,000.00 
Years to IPO  8 
Estimated dilution  40% 
Discount rate  40% 
Valuation today ($M)  $203.28 

The formula used to calculate the above valuation is as follows: 

Valuation today = p * (1 - d) / (1 + r)​n 

In  the  above  formula,  ​p  is  the  estimated  exit  value,  ​d  is  the  estimated  dilution  after this 
financing  round  and  before  exit,  ​r  is  the  discount  rate,  and  ​n  is  the  number  of  years 
between now and the exit. 

An alternative way to value a company is based on different exit scenarios. The rationale 
behind  this  approach  is  similar  to  that  of  the  above  approach.  However,  instead  of 
compensating  for  the  risks  by  using  a high discount rate, VC investors count in the risks 
by giving probabilities to different results of the startup. 

21
Bhagat, Sanjai. "Why Do Venture Capitalists Use Such High Discount Rates?" The Journal of Risk 
Finance 15, no. 1 (2014): 94-98. doi:10.1108/jrf-08-2013-0055. 

40 Ventures
Here is an example of how this alternative approach works. 

Table 3.12 An alternative to estimate valuation based on exit value 

Scenario  IPO  Strategic  Downside case  Liquidation / 
acquisition  Dissolution 
Exit value ($M)  $5,000.00  $3,500.00  $1,500.00  $200.00 
Probability  15%  10%  50%  25% 
Expected value  $750.00  $350.00  $750.00  $50.00 
Expected exit value  $1,900.00 
Years to exit  8 
Estimated dilution  40% 
Discount rate  15% 
Valuation today ($M)  $372.67 

The formula used to calculate the above valuation is as follows: 

Valuation today = p * (1 - d) / (1 + r)​n 

In  the  above  formula,  ​p  is  the  probability-based  expected  exit  value,  ​d  is  the  estimated 
dilution  after  this  financing  round  and  before  exit,  ​r  is  the  discount  rate,  and  ​n  is  the 
number of years between now and the exit. 

3.3.5. Discounted cash flow method 

Discounted  cash  flow  method  is  commonly  used  in  both  the  private  market  and  the 
public  market.  The  simple  idea  behind  this  method is to value a company based on how 
much money the company can make in the future. 

For  example,  assuming  Company  A  can  generate  a  net  profit  of  $100  per  year and it is 
going  to  generate  the  same  amount  of  profit  in  all  future  years,  the  valuation  of  the 
Company A can be roughly calculated as follows: 

Valuation of Company A now = Profit (year 1) + Profit (year 2) + Profit (year 3) + … + 

Profit (year N) (N = the number of years that investors believe the company can last) 

However,  there  are  two  small  flaws  in  this formula. First, not all profit could be returned 

to  investors.  For  example,  Company  A  may  need to reserve more working capital in any 
of the future years, and the extra reserve will be deducted from the net income from that 
year.  For  example,  Company  A  may  need  to  purchase  some  properties  or  machinery  in 
any  of  the  future  years,  and  that  expense  will  also  be  deducted  from  the  net  income of 
that  year.  Therefore,  investors  use  “Free  Cash  Flow”  to  replace  “Profit”  in  the  last 

Ventures 41
 formula  to  represent  the  real  return that Company A can distribute to investors in future 
years. 

By  definition,  Free  cash  flow  (FCF)  represents  the  cash  a  company  generates  after 
accounting  for  cash  outflows  to  support  operations  and  maintain  its capital assets. ​Feel 
free to read more here about how to calculate FCFs​. 

Therefore the above formula should be updated to: 

Valuation of Company A now = FCF​1​ (FCF from year 1) + FCF​2​ (FCF from year 2) + FCF​3 
(FCF from year 3) + … + FCF​n​ (FCF from year N) 

Second,  the  formula has not taken into account the value of time. It is widely known that 

$100  received  today  is  more  valuable  than  $100  received  next  year  since  people  can 
use  this  $100  to  make  more  money  in  one  year,  for  example  generating  interest  by 
saving  this  $100  in  a  bank  account.  Therefore,  assuming  an  annual  interest  rate  (r)  of 
2%,  $100 today should be equal to $102 next year. Alternatively, the present value (PV) 
of $100 from next year will be $100/(1+2%) = $98.04 today. 

The formula of Present Value (PV) is fairly straightforward: 

PV = FCF​n​/(1+r)​n​, 

Where  r  is  called  discount  rate, and ​n is the number of years between now and the time 

when the FCF​n​ is generated. 

Specifically,  discount  rate  ​r  will  heavily  depend  on  the  cost  of  capital  of  each  investor. 
For  example,  for  VC  investors,  assuming  they  promise  to  give  at  least  15%  return  to 
their  LPs,  the  cost  of  capital  will  be  15%,  and  the  discount rate ​r ​will therefore be 15%. 
The  rationale  is  that  if  VC  investors  do  not  invest  in  Company  A,  they  can  allocate  the 
capital  to  some  other  projects  and  make  15%  return,  and  therefore  15%  is  just  like the 
2% interest rate used in the very first example to calculate present value. 

Therefore, the above formula should be further updated to: 

Valuation of Company A now = FCF​1​/(1+r)​1​ + FCF​2​/(1+r)​2​ + FCF​3​/(1+r)​3​ + … + FCF​n​/(1+r)​n 

When  ​n  gets  larger,  FCFn/(1+r)​n  gets  smaller  and  smaller.  To  simplify  the  calculation, 
investors give a terminal valuation to sum up the FCFs after a certain number of years. 

The formula of Terminal Value (TV) is: 

TV = FCF​n​*(1 + g)/(r-g), 

42 Ventures
 Where  ​r  is  the  discount  rate,  FCF​n  is  the  last  projected  FCF,  and  ​g  is  the  estimated 
growth  rate  of  Company  A  after  many  years.  For  example,  investors  can  estimate 
Company A’s revenue (or profit) will always grow at a 2% ​(g)​ speed after year 30. 

Assuming  investors  sum  up  the  FCFs  after  year  30,  the  valuation  formula  will  be 
finalized as: 

Valuation of Company A now = FCF​1​/(1+r)​1​ + FCF​2​/(1+r)​2​ + FCF​3​/(1+r)​3​ + … + 

FCF​30​/(1+r)​30​ + FCF​30​*(1+g)/(r-g) 

Here  is  a  simplified  example  of  how  the  discounted  cash  flow  valuation  method works. 
Feel  free  to  read  more  about  how  the  discounted  cash  flow  valuation  method  works 
here​.  

Table 3.13 Simple valuation model using discounted cash flow method (g = 2%) 
Item  Value 
Discount  15% 
rate (​r​) 
Year  1  2  3  4  5  6  7  8  9  10  ...  20  Terminal 
Value 
Projected  $100  $110  $101  $111  $102  $112  $103  $113  $104  $114  ...  $120  $120 
FCF 
Present  $87  $83  $66  $64  $51  $49  $39  $37  $30  $28  ...  $7  $941 
Value of 
FCF 
Valuation  $ 1,612 ​(Sum of present value of all future FCFs) 

3.4. Term sheet negotiations 

In  the  context  of  startups,  a  term  sheet  (TS)  is  the  first  formal  (but  non-binding) 
document  between  a  startup  founder  and  an  investor.  A  term  sheet  lays  out  the  terms 
and  conditions  for  investment.  It’s  used  to  negotiate  the  final  terms,  which  are  then 
written  up  in  a  contract.  A  good  term  sheet  aligns  the interests of the investors and the 
founders,  because  that’s  better  for  everyone  involved  (and  the  startup  company)  in  the 
long run. A bad term sheet pits investors and founders against each other22. 

22
McGowan, Emma. "Term Sheets: What You Need To Know." Term Sheets: What You Need To Know | 
Startups.com. April 27, 2018. Accessed August 30, 2020. 
https://www.startups.com/library/expert-advice/term-sheets​. 

Ventures 43
 In  most  cases,  VC  investors  will  set  up  the  terms.  However,  startup  founders  can  also 
set  the  terms  from  their  end.  No  matter  who  sets  the  initial  terms,  both  sides  will  need 
to sit down and negotiate around each component included in the term sheet. 

There  is  a  list  of  critical  items  that  will  be  usually  included  in  a  term  sheet  -  the 
investment  amount,  valuation,  the  type  of  the  security,  participation  rights,  liquidation 
preference, option pool, board representation, vesting provisions, and other items.  

3.4.1. Investment amount 

Investment  amount  refers  to  the  amount  of  capital  that  an  investor  will  invest  in  this 
startup  in  this  round.  In  some  term  sheets,  it  can  also  be  defined  by  “number  of  shares 
purchased” and “price per share”.  

To  simplify  the deal negotiation process, it is most likely only the lead investor, who puts 

the  biggest  check  in  this  round,  will  write  the  TS.  While  the  other investors will join the 
same  round  using  the  same  TS.  Therefore,  the lead investor will take the majority of the 
round. 

3.4.2. Valuation 

Pre-money  valuation  refers  to  the  agreed  value  of  the  company  before  the  new 
investment.  Post-money  valuation  is  the  mathematical  value  of  the  company  after  the 
investment has been made. 

Formula: Post-money valuation = Pre-money valuation + New investment 

Startup  founders  will  want  to  get  a  higher  valuation,  while  investors  will  want  to lower 
down the “price”. However, a higher valuation might not always be good for startups.  

For  example,  if  a  startup  raises  its  seed  round  at  $20M  post-money  valuation,  which  is 
very  high,  the  startup  will  face  a  big challenge when raising the next round. The startup 
will  need  to  either  work  extremely  hard  to  prove  the  value  and  raise  at  an  even  higher 
valuation  for Series A or raise a down round - a round valued at a price that’s lower than 
$20M. A down round is a very bad indicator of a startup to other potential investors as it 
indicates  that  the  founder  is  not sophisticated when raising the previous round and that 
the startup has not made enough progress. 

With  almost  no  doubt,  VC  investors  always  want  to  invest  in  a  company  at  a  lower 
valuation.  A  small  change  in  valuation  in  early-stage  deals  will  result  in a big difference 
in returns for investors. 

44 Ventures
 Table 3.14 A small valuation change will result in big difference in returns 
Case  Investment  Post-money  Post-money  Valuation at  Exit  Value of  Return  Return - 
($M)  Valuation  Valuation  Exit ($M)  Year  Purchased  - IRR Multiple 
(Before  (After  Equity at 
negotiation)  negotiation)  Exit ($M) 
($M)  ($M) 
A  $ 0.50  $ 10.00  $ 10.00  $ 1,000.00  8  $ 50.00  77.76%  100.00 
B  $ 0.50  $ 10.00  $ 9.00  $ 1,000.00  8  $ 55.56  80.11%  111.11 
C  $ 0.50  $ 10.00  $ 8.50  $ 1,000.00  8  $ 58.82  81.40%  117.65 

3.4.3. Security type 

Different  types  of  equity  are  available  to  various  stakeholders  within  a  startup;  equity 
generally breaks down into common stock and preferred stock.  

Common  stock  is the most common type of stock that is issued by companies. Preferred 

stock  affords  additional  benefits  to  the  investors  including  rights  over  common 
shareholders.  Preferred  stockholders  are  first  in  line  to  collect  a  payout  if  a  solvency 
event  lower  than  the  company’s  valuation  occurs  (e.g.  bankruptcy,  mergers, 
acquisitions).  Companies  will  sometimes  divide  common  stock/equity  into  two  classes, 
Common  A  stock,  and  Common  B  stock;  Common  A  stockholders  taking  priority  over 
Common  B  stockholders.  Startup  investors  typically  hold  Preferred  Stock/Equity, 
whereas  founders  generally  hold  Common  Stock/Equity.  Employees  often  hold  options 
that  grant  them  the  right  to  purchase  shares  of  Common  Stock/Equity,  subject  to 
vesting schedules23. 

Startup  founders  might  want  to  negotiate  with  investors  and  issue  common  stock 
shares  instead  of  preferred  stock  shares.  While  investors  will  try  to  get  preferred  stock 
shares to protect their investments. 

3.4.4. Participation rights 

There  are  two  types  of  preferred  stock  shares:  participating  preferred  shares  and 
non-participating preferred shares. 

Participation  rights  give  investors  two  benefits:  A  return  on their investment before any 

other  investors  and  a  percentage  of  whatever  is  left.  Generally,  upon  the  sale  of  a 
company,  a  holder  of  either  participating  or  non-participating  preferred  stock is entitled 
to  a  preferential  return  (typically  the  investor’s  initial investment amount, and often plus 

23
"Understanding Startup Investments." FundersClub. Accessed August 29, 2020. 
https://fundersclub.com/learn/guides/understanding-startup-investments/common-vs-preferred-stock/​. 

Ventures 45
 an  accruing  dividend),  before any payment is made to the holders of common stock (e.g. 
management)24. 

The  difference  between  the  two  types  of  preferred  stock  is  that  participating  preferred 
stock,  after  receipt  of  its  preferential  return,  also  shares  with  the  common  stock  (on  an 
as-converted  to  common  stock  basis)  in  any  remaining  available  deal  proceeds,  while 
non-participating  preferred  stock  does  not.  To  put  it  in  another  way,  participating 
preferred  stock  entitles  the  holder  to  its  investment  amount  back  (plus  an  accrued 
dividend,  if  applicable)  first  AND  its  pro  rata  “common  upside”  in  the  company,  while 
nonparticipating  preferred  stock  entitles  the  holder  to  the  GREATER  OF  its  investment 
amount  back  (plus  an  accrued  dividend,  if  applicable)  OR  its  pro  rata  “common upside” 
in  the  company.  In  a  poor  outcome where a company is sold or liquidated at a price that 
less  than  the  aggregate  investment amount of the preferred, the distinction is irrelevant, 
as  both  securities  give  the  investors  “downside  protection”  with  no  proceeds  being 
available  for distribution to the common. However, in a moderate or successful outcome, 
the  distinction  can  have  a  significant  impact  on the allocation of deal proceeds between 
the investors and management25. 

For  example,  Company  A  has  one  series  of  non-participating  preferred  stock  with  a 
liquidation preference of $6 million representing 50% of the capital stock of Company A. 
If  Company  A  were  to  be  sold for $10 million, the investors would receive $6 million (as 
the  $6  million  investment  amount  is  greater  than  the  preferred’s  50%  share  of the $10 
million  sale  proceeds)  and  the  remaining  $4  million  of  proceeds would be distributed to 
management.  Company  B  also  has  one  series  of  preferred  stock  with  a  liquidation 
preference  of  $6  million  representing  50%  of  the  capital  stock  of  Company  B,  but  its 
preferred  stock  is  participating.  Upon  the  same  $10  million  sale  event,  the  investors 
would  receive $8 million (the $6 million liquidation preference plus 50% of remaining $4 
million  of  sale  proceeds)  and  the  remaining  $2  million  of  the  proceeds  would  be 
distributed  management.  Thus,  in  the  same  $10  million  sale,  the  difference  between 
participating  vs.  non-participating  preferred  resulted  in  a  $2  million  shift  in  economics 
away  from  management  to  the  investors,  which  represents  one-half  of  the  return  that 
management  would  have  received  had  the  preferred  stock  been  structured  as 
non-participating26. 

3.4.5. Liquidation preference 

A  liquidation  preference  is  one  of  the  primary  economic  terms  of  a  venture  finance 
investment  in  a  private  company.  The  term  describes  how  various  investors'  claims  on 
dividends  or  on  other  distributions  are  queued  and  covered.  Liquidation  preference 

24
"Participating vs. Non-Participating Preferred Stock." Founders Workbench. Accessed August 29,
2020. https://www.foundersworkbench.com/participating-vs-non-participating-preferred-stock.
25
Ibid. 
26
Ibid. 

46 Ventures
 establishes  that  certain  investors  receive  their  investment money back first before other 
company  owners  in the event the company is sold, has a public offering, pays dividends, 
or has another liquidation (payout) event27. 

Liquidation  preferences  are  typically  implemented  by  making  them  an  attribute  that 
attaches  to  preferred  stock  that  investors  purchase  in  exchange  for  their  investment. 
This  means  that  the preference is senior to common shares (and possibly other series of 
preferred stock), but junior to a company's debts and secured obligations.28 

Liquidation  preferences  can  be  partial  (they  apply  to  less  than  100%  of  investment 
funds),  full  (100%),  or  at  a  multiple  of  original  investment  funds.  Further,  interest  or 
guaranteed  dividends  may  or  may  not  be  added  to  the  preference  amount  over  time. 
Occasionally the multiple shifts over time as well29. 

Another  distinction  is  that  preferences  may  be  "participating",  which  has  been 
introduced  in  the  last  section,  meaning  investors  receive  their  preference  first  and  are 
then  entitled  to  a  share  of  any  remaining  funds  based  on  their  ownership,  or  they  may 
be  "non-participating",  in  which  case  they  receive  either  their  preference  amount  only 
with  no  further  right  to  distributions,  or  else  their  proportionate  share  of  distributions 
but without the preference, whichever is greater30. 

Here  are  two  examples  showing  how  participating  liquidation  preference  and 
non-participating liquidation preference work. 

Participating  liquidation  preference:  As  an  example,  an  investor  invested  $1M  in  a $6M 
pre-money  valuation  ($7M  post)  with  a  2x  participating  liquidation  preference.  They 
would  then  own  14.4%  ($1M/$7M)  of  the  company  and  would  get  upside  on  any 
change  of  control.  If  the  company  then  sold  for $15M the investor would get back 2x of 
their  investment  first for $2M (2 × $1M) and then the rest of the remaining $13M ($15M 
– $2M)  would  be  distributed  among  all  shareholders.  The  investor  would  then  get  an
additional $1.9M (14.4% × $13M) for a total of $3.9M ($2M + $1.9M)31.

Non-Participating  liquidation  preference:  As  another  example  using  the  same  numbers 
as  above,  the  investor  has  a  2x  non-participating  liquidation  preference  and  a  14.4% 
ownership  of  a  $7M  post-money  valuation.  If  the  company  again  sold  for  $15M,  the 
investor  would  have  a  choice  of  either  receiving  $2M  (2  ×  $1M)  for  their  liquidation 

27
Liquidation Preference. Investopedia. Accessed September 8, 2020.
https://www.investopedia.com/terms/l/liquidation-preference.asp.  
28
Ibid. 
29
Ibid. 
30
Ibid. 
31
Ibid. 

Ventures 47
 preference  or  $2.2M  (14.4%  ×  $15M)  for  their  participation.  Thus  the  investor  would 
then receive $2.2M32. 

3.4.6. Option pool size 

Option  pool  refers  to  the  shares  of  a  startup  that  are  set  aside by the company in order 
to  hire  and  retain  employees  when  the  company  is  growing  up.  A  typical  size  for  the 
option  pool  is  20%  of  the  stock  of  the  company,  but,  especially  for  earlier  stage 
companies, the option pool can be 10%, 15%, or other sizes33. 

For  early  stage  startup  founders,  they  will  have  the  incentive  to  lower  down  the  option 
pool  determined  in the term sheet so that they can have the current investors and future 
investors  to  share  the  dilution  when  the  company  needs  to  expand  the  option  pool  in 
the  future.  However,  for  VC  investors,  “refreshing”  or  expanding  the  option  pool  in  the 
future will dilute the equity that VC investors hold in the startup. Therefore, VC investors 
would like to set the option pool right - at around 20% - to avoid future dilution. 

Table 3.15 Expanding option pool after investment will dilute existing investors’ equity 
Equity Purchased  Option Pool  New Option Pool  Equity Owned after  Dilution 
Expansion 
10%  15%  20%  9.41%  5.88% 
10%  20%  20%  10.00%  0.00% 

3.4.7. Board representation 

Startups  will  plan  to  set  up a board as it grows. Investors might also ask a startup to set 

up  a  Board  of  Directors  after  a  financing  round  and  include  the  board  details  in  a  term 
sheet.  For  example,  these  details  will  include  the  number  of  board  seats  and  who  will 
serve as board directors. 

If  the startup has set up a board or plans to set up a board, VC investors will want to get 
a  board  seat. The benefits of having a board seat include decision-making power on any 
big  decision  that  the  startup  will  make,  interaction  with  other  investors  on  the  board, 
and  access  to  the  startup's  confidential  information.  These  benefits  will  enable  VC 
investors to monitor the invested startups and make sure they are on the right track. 

If  a  startup  already  has  a  board  while  giving  out  a  board  seat  is  not  an  option,  VC 
investors  -  particularly  those  non-lead/follow-on  investors  -  can  try  to  negotiate  for  a 

32
Ibid. 
33
"The Option Pool - The Holloway Guide to Equity Compensation." Holloway. Accessed August 29, 
2020. ​https://www.holloway.com/g/equity-compensation/sections/the-option-pool​. 

48 Ventures
 board  observer  seat  instead.  A  board observer can also join the regular board meetings, 
but a board observer will not have voting rights. 

3.4.8. Founder vesting provisions 

There  is  always  a  risk  that  startup  founders  might  leave  to  develop the “next big thing” 
at  another  new  company. To mitigate this risk, VCs usually create a vesting schedule for 
its  portfolio  companies’  founders.  This ensures that the key team members will have the 
incentive  to  stay  with  their  companies  for  a  number  of years. While options represent a 
right  to  purchase  stock  and  vest  over  time,  founders  actually  “reverse-vest”  -  that right 
goes away over time. 

It  is  normal  to  give  founders  some  credit  for  the amount of time they have already been 
working  at  the  startup.  However,  the  longer  VCs  can  make  the  vesting  provision,  the 
more  the  founder  will  feel  locked  in.  VCs  would  like  the  founders’  vesting  schedule  to 
match  the  employee  option  vesting, which is usually four years with a one year cliff, and 
1/48th vesting monthly thereafter. 

However,  startup  founders  might  be  against  the  idea  of  any founder vesting at all since 
they do not want to be locked in. 

3.4.9. Other items to negotiate 

3.4.9.1. Pro-rata right 
Pro-rata  investment  rights  give  an  investor  in  a  company  the right to participate 
in a subsequent round of funding to maintain their level of percentage ownership 
in  the  company.  This  becomes  a  way  for  investors  to  continue  to  invest  in 
companies  that  they  want  to put more into34. Having pro-rata rights will help VC 
investors  to  maintain  their  ownership  and  increase  the  return  from  the 
investment by participating in future rounds. 

Pro-rata  rights  are  not  always granted to investors. In practice, typically pro-rata 

rights  are  given  to  larger  investors  in  rounds.  Depending  on  their  strategy, 
investors  may  or  may  not  take  up  their  pro-rata  rights  in  subsequent  rounds  of 
financing35. Investors are not obligated to exercise their pro-rata rights. 

Here  is  an  example  showing how pro-rata rights works. See “Plug and Play best 

practices” for more explanation and examples. 

34
"What Are Pro-rata Investment Rights?" FundersClub. Accessed August 29, 2020. 
https://fundersclub.com/learn/startup-equity/preferred-equity-rights-and-terms/pro-rata-investment-righ
ts​. 
35
Ibid. 

Ventures 49
 Table 3.16 How pro-rata rights works 
Scenario  With pro-rata rights  No pro-rata rights 

Invested Capital  $ 500,000  $ 500,000 

Post-money Valuation  $ 10,000,000  $ 10,000,000 
at Investment 
Equity Purchased  5.00%  5.00% 
Pre-money Valuation of  $ 30,000,000  $ 30,000,000 
Next Round 
Capital Raised for Next  $ 12,000,000  $ 12,000,000 
Round 
Post-money Valuation  $ 42,000,000  $ 42,000,000 
of Next Round 
Capital Required to  $ 600,000  $ - 
Exercise Pro-rata 
Rights 
Equity Owned after  5.00%  3.57% 
Next Round 
Valuation at Exit  $ 200,000,000  $ 200,000,000 
Value of Equity Hold at  $ 10,000,000  $ 7,142,857 
Exit 
 
3.4.9.2. Advisory shares 
Advisory  shares  are  typically issued as common stock options (which can lead to 
equity  in  the  company)  to  business  advisors  in  exchange  for  their  involvement 
within the company. 
 
VC  investors  sometimes  negotiate  for  advisory  shares  if  they  believe  they  can 
bring  tremendous  value  to  the  invested  company.  Getting  advisory  shares  will 
help  VC  investors  to  increase  their  owned  equity  stake  in  a  company  and  lower 
the effective valuation for the investment. 
 
In  certain  circumstances,  VC  investors  and  startup  founders  can  negotiate  and 
set up a vesting plan that typically vests monthly over 1-2 years. 
 
In  the  US,  Plug  and  Play  can  either  purchase  the  advisory  shares  for  $5K  or 
under  (409A  permitting)  or  Plug  and  Play  would  exchange  the  value  of  its 
services  for  the  shares  if  they  cost  over  $5K  to  obtain  (i.e.  purchase  the  shares 
via services rendered). 

50
  Ventures
 For  very  early-stage  startups  in  the  US,  Plug  and  Play  typically  purchases  the 
shares  at  a  nominal  price  per  share  (e.g.  $0.01  per  share).  But  for  startups  that 
have  been  operating  for  a  year  or  longer  it's  typically  more  complicated  for  tax 
and  other  reasons.  For  example,  once  startups  have  raised  money  of  $750K  or 
greater,  they  likely  need  to  file  a  409A  valuation  to  price  their  common  stock 
shares  that  they  issue  to  employees,  advisors,  etc.  which  is  done  for  tax 
purposes.  Once  that  valuation  is  in  place,  Plug  and  Play  cannot  go  below  that 
PPS,  and  the  company  can  only  pay  that  higher price (if total cost to purchase is 
less  than  $5K)  or  exchange  the  value  of  Plug  and  Play’s  services  for  the shares, 
which  allows  Plug  and  Play  to  pay  $0  for  the  shares,  but  results  in  a  taxable 
event for Plug and Play equal to the total purchase price of the advisory shares36. 

See “Plug and Play best practices” for more explanation and examples. 

Table 3.17 Getting advisory shares will lower the effective valuation 
Item  Value 
Post-money Valuation (in  $ 5.00 
millions) 
Investment (in millions)  $ 0.10 
Equity Stake  2.00% 
Advisory Share  1.00%  0.50%  0.00% 
Total Equity Stake  3.00%  2.50%  2.00% 
Effective Valuation (in  $ 3.33  $ 4.00  $ 5.00 
millions) 

3.5. Alternative financing instruments 

A  startup  can raise a round of funding in different formats. A startup can raise the round 
as  a  priced  equity  round  that  is  properly  priced  by  investors  in  a  term  sheet,  and  a 
startup  can  also get the funding through some alternative financing instruments such as 
convertible note or SAFE. 

Raising  funding  in  a  convertible  note  or  SAFE  sometimes  can  be  very  helpful  for 
startups.  For  early-stage  startups,  these  instruments  are  much  simpler  than  a  formal 
term  sheet  in  a  proper  priced  round  and  can  therefore  save  founders  a  lot  of  time  in 
negotiating  terms.  For  later-stage  companies,  they  will  often  use  convertible  notes  to 

36
Shared by Marc Steiner, General Counsel of Plug and Play. 

Ventures 51
 raise  a  round,  mostly  a  bridge  round,  because  the  founders  and  the  investors  cannot 
agree on terms such as valuation while the startup still needs the funding. 

3.5.1. Convertible note 

A  convertible note is a type of debt that has the right to convert into equity when you hit 
an  agreed  upon  milestone.  FundersClub  explains  convertible  notes  as  an  investment 
vehicle  that  is  structured  similarly  to  a loan37. However, as TechCrunch points out38, this 
type  of  debt  automatically  converts  into  shares  of  preferred  stock  upon  the  closing of a 
Series  A  round  of  financing.  The  overall  consensus  about  convertible  notes  is  that  they 
are known to be complex and therefore, finicky or glitchy. 

3.5.2. SAFE 

SAFE  is  an  acronym  that  stands  for  “simple  agreement  for  future  equity”  and  was 
created  by  the  Silicon  Valley  accelerator  Y  Combinator  as  a  new  financial instrument to 
simplify  seed  investment.  At  its  core,  a  SAFE  is  a  warrant  to  purchase  stock  in  a future 
priced round. 

3.5.3. Similarities between convertible note and SAFE 

There  are  some  similarities  between  SAFE  and  convertible  notes  investments.  Both act 
as  a  viable  way  to  help  startups  overcome  their current big hurdle in growing or scaling 
to  reach  the milestones that warrant a Series A round. Also, both SAFEs and convertible 
notes  convert  into  equity  in  a  future  priced  equity  round;  a  convertible  note  may  have 
more  complexity to when/if/how it converts. Both SAFEs and convertible notes can have 
valuation  caps,  discounts,  and  “most-favoured-nations”  clauses  (an  agreement  to  offer 
the  SAFE  note  investor  the  same  terms  as  future  investors  on  subsequent  investment 
rounds  and/or  the  opportunity  to  pull  their  proceeds  out  first  in  the  event  of  a  sale  or 
winding-up of the company). 

3.5.4. Differences between convertible note and SAFE 

In  short,  a  convertible  note  is  debt,  while  a  SAFE  is  a  convertible  security  that  is  not 
debt.  As  a  result,  a  convertible  note  includes  an  interest  rate  and  maturity date, while a 
SAFE  does  not. SAFE is a warrant to purchase a stock at a later priced round, and hence 
is  basically  a  contract.  The  main  difference  SAFE  differs  from  convertible  notes  are 
maturity date, interest rate, and conversion to equity. 

37
"How Does a SAFE Compare to a Convertible Note?" FundersClub. Accessed August 30, 2020.
https://fundersclub.com/learn/safe-primer/safe-primer/safe-vs-convertible-note/​. 
38
Levensohn, Pascal, and Andrew Krowne. "Why SAFE Notes Are Not Safe for Entrepreneurs." 
TechCrunch. July 08, 2017. Accessed August 30, 2020. 
https://techcrunch.com/2017/07/08/why-safe-notes-are-not-safe-for-entrepreneurs/​. 

52 Ventures
 Table 3.18 Differences between convertible note and SAFE39 
Item  Convertible note  SAFE 

Simplicity  Relatively complex  Very simple and straightforward 

Maturity  Convertible  notes  do  have  a  SAFE  is  not  a  debt and hence does 

date  maturity  date.  Upon  reaching  the  not have a maturity date 
maturity  date,  entrepreneurs  face 
tough  decisions  on  whether  to  pay 
back  the  principal  of  the 
convertible  note,  with  interest  or 
convert  the  debt  into  equity  for the 
investors.  Most founders would opt 
for  the  latter  option  as  paying back 
the  principal  amount  with  interest 
could  be  difficult  for  startups, 
especially at an early stage. 

Points of  A convertible note can allow for the  SAFE  only  allows  for  a  conversion 

conversion  conversion  into  the  current  round  into the next round of financing. 
to equity  of stock or a future financing event. 
SAFE  can  convert  when  a  startup 
Convertible  notes  typically  trigger  raises  any  amount  of  equity 
only  when  a “qualifying transaction  investment. 
takes  place” (more than a minimum 
amount  dictated on the agreement)  Raising  common  stock  doesn’t 
or  when  both  parties  agree  on  the  trigger  a  conversion  for  a  SAFE 
conversion.  investor40. 

Interest  Convertible  notes  carry  an  interest  Since  SAFE  is  not  a  debt,  but  a 
rate  rate,  which  can  be  simple  or  warrant/contract,  it  does  not  carry 
compounded, between 5–8%.  an  interest  rate  hence  keeping 
things simple and founder friendly. 

39
VenturX. "Differences between SAFE and Convertible Notes." Medium. August 06, 2019. Accessed 
August 30, 2020. https://medium.com/@VenturX_team/differences-between-safe-and-convertible-
notes-c0cca5f09796​. 
40
Hollis, Melissa. "Seed Investment: Comparing SAFE and Convertible Notes." Seed Investment: 
Comparing SAFE and Convertible Notes. June 22, 2018. Accessed August 30, 2020. 
https://www.indinero.com/blog/safe-convertible-notes-comparison​. 

Ventures 53
 3.5.5. Critical items included in convertible note and SAFE 

There  are  several  critical  items  that  will  be  included  in  a  convertible  note  or  a  SAFE. 
Among  all  the  items,  the  most  important  items  are  “Conversion  Discount”  and 
“Valuation  Cap”,  both  of  which  are  mechanisms  by  which  investors  can  convert  their 
positions into equity at a lower company valuation than the latest funding round. 

Since  valuation  cap  and  conversion  discount  offer  complementary  protections  to 
investors,  many  convertible  notes  and  SAFE  will  include  both  features.  In  such 
scenarios, investors can use whichever option provides the best deal at conversion.  

However,  valuation  cap  and  conversion  discount  will  not  be  put  into  effect  at  the same 
time.  Investors  will  determine  the  lowest  valuation  among:  1)  the  subsequent  funding 
round’s  price  per  share,  2)  the  valuation  cap  conversion  price,  and  3)  the  conversion 
discount price. 

Specifically,  valuation  cap  can  be  set  as  either  pre-money  valuation  cap  or  post-money 
valuation cap.  

Here’s an example illustrating how valuation cap and conversion discount will work. 

Table 3.19 How valuation cap and conversion discount work 

Scenario  Scenario 1: Valuation  Scenario 2:  Scenario 3: Valuation 
cap only  Conversion discount  cap + Conversion 
only  discount 

Investment  $1M  $1M  $1M 

Post-money $10M  -  $10M 

Valuation 
cap 

Conversion  -  20%  20% 

discount 

Case 1:  $15M  $15M  $15M 

Next round 
post-money 
valuation 

Case 1:  $10M  $12M  $10M 

Conversion 
price 

54 Ventures
 Case 2:  $8M  $8M  $8M 
Next round 
post-money 
valuation 

Case 2:  $8M  $6.4M  $6.4M 

Conversion 
price 

Table 3.20 Critical items applied to convertible note and SAFE41 

Application  Items 

Both  Principal:  The  amount  of  cash  that  the  stakeholder  paid  for  the 
Convertible  note.  For  example,  if  the  stakeholder  invested  $10,000,  then 
note and SAFE  $10,000 is the principal amount. 

Conversion  Discount:  The  discount  applied  to  the  price  per  share 
when  the  note  holder  will  purchase  shares  in  the  next  fundraising 
round. 

For  example,  imagine  an  investor  who  is  owed  $10,000  for 
their  convertible  investment  with  a  20%  conversion 
discount.  The  new  equity  round  is  set  at  a  $2.00  price  per 
share.  The  price  per  share  is  discounted  by  20%.,  which 
calculates  to  $2.00  x  (1  -  0.20)  =  $1.60.  The  principal 
amount is converted using the discounted price per share for 
a total of 6,250 shares ($10,000 / $1.60). 

Valuation  Cap  (optional):  The  valuation  cap  sets  a  maximum value 

at  which  a  convertible  security  will  convert  into  equity  in  the 
financing  round.  This  valuation  cap  stands  regardless  of  the 
valuation of the financing round. 

For  example,  imagine  a  stakeholder  invests  $10,000  in  a 

company  valued at around $1,000,000 (Note the convertible 
owner  does  not  own  equity  at  this  point).  The  convertible 
includes  a  valuation  cap  of  $5,000,000.  Two years later, the 

41
"Convertible Notes and SAFE Terms and Definitions." Carta Support Center. January 7, 2020. 
Accessed August 30, 2020. ​https://support.carta.com/s/article/convertible-terms-and-definitions​. 

Ventures 55
 company  raises  a  round  of  financing  at  a  $50,000,000 
valuation  after  experiencing  rapid  growth.  The  price  per 
share  of  the  round  is  $2.00,  implying  25,000,000  fully 
diluted  shares  ($50,000,000  /  $2.00).  Had  there  been  no 
valuation  cap  (and  assuming  a  0%  discount),  the  investor 
would  receive  5,000  shares  ($10,000  /  $2.00)  and  own 
0.02%  of  the  company.  With  the  valuation  cap,  the investor 
is  protected  from  a  rapid  increase  in  the  company’s 
valuation.  Rather  than  converting  at  $2.00  /  share,  the 
convertible  will  convert  at $0.40 ($5,000,000 / $25,000,000 
x  $2.00)  and  the  shareholder  will  receive  25,000  shares 
($10,000 / $0.40) for 0.10% ownership of the company. 

Convertible  Conversion  Trigger​:  For  convertibles to convert into the next equity 

note ONLY  round,  terms  may  be  included  that  specify  that  the  round  be  of  a 
certain  size  for  the  convertible  to  convert.  For  example,  imagine  a 
convertible  note  has  a  $5,000,000  conversion  trigger.  In  this  case, 
the  equity  round  must be for at least $5,000,000 for the convertible 
securities to be able to convert into equity. 

Federal Exemption:​ ​Choosing Federal Exemptions 

Interest Rate: ​The annual interest rate that the note accrues. 

For  example,  a  $10,000  with  a  5.00%  interest  rate  will 

accrue  $500  in  interest  ($10,000  x  5.00%)  over  the  course 
of the year. 

Interest  Type:   Choose  if  the interest on the convertible is simple or 

compounded. 

Interest  Accrual  Period:   The  length of time over which the interest 

due  to  the  lender  is  calculated.  For  the interest to be reflected more 
often, choose "Daily" or "Weekly". 

Interest  Compounding  Period:  ​Simple  interest is calculated only on 

the  principal  amount  of  the  loan,  while  compound  interest  is 
calculated  on  the  principal  amount  and  also  on  the  accumulated 
interest  of  the  previous  period.  Must  be  one  of:  Annually, 
Semi-annually, Quarterly, Monthly, or Daily. 

56 Ventures
  
Interest  Payout:  ​A  deferred  interest  payout  allows  interest  on  the 
convertible  to  be  in  the  form  of  additional  shares  (rather than cash) 
upon  conversion  of  the  note  in  the  next  financing  round.  Carta 
supports  either  “Cash”  or  “Deferred”  payouts  if  these  terms  are 
included for your notes. 
 
Maturity  Date:  The  date on which the convertible note matures. For 
example,  if  a  note  was  issued  on  1/1/2019 and has a 10-year term, 
the  maturity  date  will  be  1/1/2029.  At  maturity,  the note’s principal 
and  interest  must  be  paid  back  if  the  note  hasn’t  converted  into 
equity. 
 
Change  of  Control  Percent  (optional):  ​Use  this  field  if  there’s  any 
premium  or  multiplier  applied  to  the  principal  in  the  event  of  a 
change in control prior to the maturity date.  
   

  Ventures 57
This page is intentionally left blank.
 4
PLUG & PLAY
BEST
PRACTICES

Ventures 59
4. Plug and Play best practices

Based  on  the  unique  setting  of  Plug  and  Play  Ventures,  here  are  some  best  practices  and 
preferences that the firm holds when making investments.
investments. 

4.1. Ventures
Deal process at Plug and Play Ventures 

The  deal  process  at  Plug  and  Play Ventures is similar to that in the other VC firms. Here 

is a list of steps and common practices that the team has been using. using. 

Figure 4.1 Diagram of a typical deal process at Plug and Play Ventures 
Ventures
Process People Tool

Sourcing Analyst Associate Sr. Asso. Principal Partner IC Varies

If interesting

Screening Call Analyst Associate Sr. Asso. Principal Partner IC Affinity

If still interesting

Profiling Analyst Associate Sr. Asso. Principal Partner IC Playbook

Collect into Playbook and Affinity

Initial Assessment Analyst Associate Sr. Asso. Principal Partner IC ESOA

Get more people onboard

Follow-up Calls Analyst Associate Sr. Asso. Principal Partner IC Varies

If very promising and investable

Due Diligence Analyst Associate Sr. Asso. Principal Partner IC Google Doc

If everything still looks good

DD Presentation Analyst Associate Sr. Asso. Principal Partner IC Google Doc

If the team feels strong about the deal

IC Presentation Analyst Associate Sr. Asso. Principal Partner IC Google Doc

If IC approves to invest
Legal Process Legal N/A

If no legal issue found

Money Transfer Accounting N/A

 
Table 4.1 Best practices of deal process at Plug and Play Ventures 
Ventures
Process
Process  Best practice 
practice Purpose 
Purpose Tools
Tools 

Sourcing 
Sourcing Source deals from different 
different Get access to the 
the See “Different 
“Different
channels and find a good 
good best deals 
deals sourcing channels” 
channels”
balance between quantity 
quantity
and quality 
quality

Screening call 
call Set up a 30-min screening 
screening Learn about the basic  Affinity 
basic Affinity

60 Ventures
 call to learn about the  information  Phone calls 
basics of a startup and  Build the relationship  Zoom/Hangouts 
share with the team how  Take notes to help  Zoom/Hangouts 
Plug and Play can help  other team members  Phone call 
Take notes on Affinity  understand the 
company 

Profiling  Create a profile or invite the  Make the company  Playbook 

company to create a profile  visible to Plug and 
on Playbook  Play teams and 
corporate partners 

Initial  Complete an ESOA (Early  Make sure the  Google Doc 

assessment  Stage Opportunity  startup meets the  PNP Plus - ESOA 
Assessment) to evaluate  basic investment 
the company  requirements so that 
the team can 
prioritize resources 

Follow-up calls  Set up follow-up calls for  Invite more people to  Affinity 
other team members such  make a further  Phone calls 
as principals and partners to  assessment of the  Zoom/Hangouts 
get more people buy in  company before 
putting a lot of 
resources into the 
company 

Due diligence  Work on an in-depth due  Make sure the  Google Doc 
(DD/IM)  diligence report to analyze if  startup meets Plug 
the deal is attractive.  and Play Ventures’ 
Analyze company's success  investment thesis 
and traction through Plug  and does not have 
and Play programs and  many apparent red 
dealflow sessions  flags 
(preferred). 

DD/IM  Present the DD/IM to the  Get more feedback  Google Doc 
Presentation  entire ventures team  from other team 
An additional follow-up call  members 
might be needed to answer  Make sure there are 
questions collected from the  no major red flags or 
DD/IM presentation  unclear but critical 
items 

Ventures 61
 IC  Present the deal in a very  Explain to the  Google Doc 
Presentation  precise manner to the  investment 
investment committee (IC)  committee (IC) why 
to get their approval  the deal is attractive 

Legal Process  Connect startup team with  Enable legal team to  Email 
the Plug and Play legal  ask for legal 
team  documents and 
assess if there is any 
legal issues 

Money  Connect startup team with  Make sure the  Email 

Transfer  the Plug and Play  accounting team 
accounting team  receives the money 
This will usually be done by  transfer instructions 
the legal team  from the legal team 

4.2. Preferences 
4.2.1. Investment type 

Plug  and  Play  prefers  to  use  its  revised  version  of  the  YC  SAFE  instead  of  convertible 
notes  when  investing  in  early  stage  startups.  There  are  a  few  reasons  Plug  and  Play 
prefers SAFEs rather than convertible notes: 

● How convertible notes are bad for startups:

○ Convertible  notes  are  debt  instruments  (e.g.,  loans)  and,  therefore,  have
maturity  date,  interest  rates,  and  repayment  obligation.  The  repayment
obligation  allows  investors  to  call  back  their  investment  with  interest  at
the  maturity  date;  a  time  when  the  startup  may  not  have  the  money  to
pay them back.

○ Additionally,  interest  is  included  in  the  investor’s  conversion  amount

when  a  priced  round  occurs  i.e.  both  the  initial  principal  investment  plus
accrued  interest  will  convert  into  shares  leading  to  more  dilution  to  the
existing cap table.

○ Having  a  lot  of  debt  in  the  balance  sheet  might make the life of a startup

harder.  Legally  speaking,  the  company  might  be  virtually  insolvent  after
raising investment through convertible notes.

62 Ventures
 ○ Some  jurisdictions  impose  legal  limitations  on  interest  rates and maturity
dates.  Raising  money  from  investors  based  in  different  states  (or
countries)  might  require  legal  advice  to  confirm  compliance  with  local
regulations concerning debt instruments.

● How Convertible Notes are bad for investors:

○ Unlike  SAFEs,  convertible  notes  usually  don’t  include  a  pro  rata  right  to
invest  in  future  financings,  which  allows  Plug  and  Play  to  maintain  its
equity  position  in  the  company  and  expresses  continued  interest  in  the
startup.

○ By  holding  a  bunch  of  convertible  notes, the investor needs to keep track

of  multiple  maturity  dates,  which  is not free of cost. Moreover, more legal
costs  are  incurred  everytime  a  note  needs  to  be  amended  to  extend  the
maturity  date.  And  most  importantly:  it  is  not  Plug  and  Play’s  goal  to  be
repaid  upon  maturity.  The  investor’s  goal  is  to  invest  early  and  quickly
through  a  convertible  note, and then eventually convert into shares of the
startup’s  preferred  stock.  A  SAFE  is  more  appropriate  for  such  purposes
since it is not repayable such as a convertible note.

○ Convertible  notes  may  also  convert  the  investor  into  a  mix  of  common
and  preferred  stock.  Plug  and  Play  expects  to  convert  to solely preferred
stock  that  enjoys  market  liquidation  preferences,  conversion  rights,  and
protective provisions.

○ Some  convertible  notes  allow  the  startup  to  pay  off  the note or a portion
of  it,  again,  because  it  is  a  debt  instrument,  which  provides  a  meager
return  (principal plus interest). Plug and Play is investing at an early stage
and  taking  on  substantial  risk  with  the  expectation  of  receiving  a  return
that is substantially higher than what interest provides.

○ Finally,  convertible  notes  have  traditionally  not  included  the  existing

employee  pool  or  the  creation  of  a  pool  in  the  conversion  calculations,
resulting thus in less shares for the investor.

Plug  and  Play  has  made  a  few  edits  to  the  standard  YC  SAFE  to  better  fit  its  own 
business model. 

Ventures 63
 4.2.2. Pre-Money valuation cap 

When  Plug  and  Play  invests,  the  startup  should  know  that  all  convertible  notes/SAFEs 
issued  at  lower  valuation  caps  will  be  included  in  Plug  and Play’s investment as well as 
its advisory share percentage. 

● Why is this fair for Plug and Play? How to ask for this term?

○ Plug  and  Play  considers  convertibles  issued  at  lower  valuation  caps  as
previous  investments.  So,  even  though  these  prior  convertibles  may  not
have  converted  into  shares yet, Plug and Play treats them as though they
have  i.e.  they  are,  for  all  intents  and  purposes,  essentially  shares  on  the
cap table before Plug and Play’s investment comes in.

○ When top VC firms (or blue chip VC firms) invest through a Series A, they
first  convert  all  of  the  SAFEs/Notes  in  order  to  achieve  the  actual
valuation  that  was  agreed  on  between  the  two  parties.  Although  Plug
and  Play  invests  earlier  than  a  blue  chip  VC,  Plug  and  Play  still structure
its investments as any institutional/sophisticated investor would.

○ Because  this  money  came  in  before  Plug  and  Play,  the team can assume
that  the  startup  has  used  the  investment  to  increase  the  value  of  their
company,  which  Plug  and  Play  acknowledges  by  investing  in  a  higher
valuation cap than previous investors.

● Why is this important?

○ Convertible  notes/SAFEs  issued  at  lower  valuation  caps  will  be  adding
shares  to the cap table in the future. If Plug and Play does not account for
these  shares  being  added,  the  firm  will  be investing in a higher “effective
valuation”  than  the  valuation  cap  agreed  on  (i.e.  the  percentage  of  the
company  that  you  thought  you  were  getting  is  actually  lower).  To  avoid
this,  the  team  needs  to  make  sure  that  the  terms  in  the  SAFE/Note  are
written correctly. (See Appendix 5 - Example 1)

● What if the startup still doesn’t budge?

○ Oftentimes,  the  startup  has  already  raised a significant amount of money

on a specific document and, as a result, are reluctant to change the terms.
To  avoid  doing  this,  Plug  and  Play  can  increase  the  advisory  shares  it  is
getting  to  make  up  for  dilution  -  or  if  advisory  shares  weren’t  part of the
initial discussion, Plug and Play can add it. (See Appendix 5 - Example 2)

64 Ventures
 4.2.3. Discount 
Plug  and  Play usually has the option to receive a 15-20% discount off the Series A price 
per  share  -  only  if  this  discount  results in a lower price per share than the valuation cap. 
Discounts  lower  than  20% are not usually a dealbreaker, but Plug and Play still consider 
them as a red flag. 

● Why is this important?

○ The  discount  is  only  triggered  if  the  pre-money  valuation of the startup’s

Series  A  is  equal  or  lower  (down  round)  than  Plug  and  Play’s  valuation
cap  -  this  is  a  type  of  “down-side”  protection  term.  The  discount
essentially  ensures  that  Plug  and  Play  receives  a  lower  price  per  share
than  the  Series  A  investors  no  matter  what.  (See  Appendix  5  -  Example
3)

○ If  there’s  no  discount  at all, that’s a definite red flag. If the SAFE/Note has

no  discount  and  the  startup  went on to raise a Series A round with an $8
million  pre-money  valuation after Plug and Play signed a SAFE/Note with
a  $10  million  valuation  cap,  the  best  price  per  share  Plug  and Play could
get  would  be  exactly  the  same  as  the  Series  A  price  per  share,  because
the pre-money is lower than Plug and Play’s $10 million valuation cap.

● Why is this fair for Plug and Play? How to ask for this term?

○ Plug  and  Play  is  investing  at  an  earlier  stage  and  the  risk  that  Plug  and
Play  is  taking  should  be  reflected  by  a  lower  price  per  share  than  later
investors.

● What if a startup doesn’t budge?

○ Plug  and  Play  should  ask  the  startup  to  grant  the  company  advisory
shares to drop the effective valuation of Plug and Play’s investment.

4.2.4. Pro-rata rights/Information rights 

As  discussed  in  the  last  chapter,  pro-rata  rights  give  an  investor in a company the right 
to  participate  in  a  subsequent  round  of  funding  to  maintain  their  level  of  percentage 
ownership in the company42. 

42
See Chapter 3.4.9 for more details. 

Ventures 65
 ● Why is this important?

○ Pro-rata  Rights:  Allows  Plug  and  Play  to  maintain  a  certain  equity
position  in the company by investing more money in future rounds, which
can  be  as  lucrative  as  the  original  round.  For  example,  Plug  and  Play’s
pro-rata  in  Lending  Club  Series  A  returned  far  more  than  the  original
investment (due to scale and price).

○ Info  Rights:  Allows Plug and Play to track the ROI of the company’s initial

investment as the startup raises more money.

● Why is this fair for Plug and Play? How to ask for this term?

○ Pro-rata  rights  are  an  essential  part  of  Plug  and  Play’s  investment
philosophy  as  it  would  allow  Plug  and  Play  to  contribute  more  capital  in
the  future  and  continue  Plug  and  Play’s  relationship with the startup and
its founders.

○ Warning​:  Plug  and  Play  advises  startups  to  avoid  providing  pro-rata
rights  to  a  large  portion  of  their  investors  because  it  could  cause
problems  in their future Series A (they’d be raising more money than they
intended  i.e.  giving  away  more  equity).  ​They  should  only  give  these
rights  to  investors  that  bring  a  lot  of  extra value outside of just capital
contributions.

○ Information  Rights:  Ensures  that Plug and Play keeps in touch and is able

to  track  the  health  of  the  startup  so  that  Plug  and  Play  can  contribute
more meaningfully in the future.

● What if a startup doesn’t budge?

○ Try to limit Plug and Play’s pro rata right to just Series A and B for now.

○ Try  to  limit  information  rights  to  just  a  cap table, Amended and Restated

Certificate of Incorporation (A&R COI), and pitch deck.

4.2.5. Advisory shares 

To  receive  the  equity  ownership  negotiated  with  the  startup  in  consideration  for  Plug 
and  Play’s  cash  investment  without  having  to  drop  their  valuation  cap  substantially, 
Plug  and  Play  usually  negotiates  to  receive  “advisory  shares”  through  a stock purchase 
agreement.  Advisory  shares  are  actually  common  shares,  the  same  type  of  shares 

66 Ventures
owned  by  founders,  employees,  and  other  company’s  advisors.  The  startup  should 
know  that  Plug  and  Play’s  advisory  share  percentage  will  include  at  least  a  10% 
employee  pool  ​and  previous  convertibles  -  for  an  explanation  on  building  in  previous 
convertibles, refer to the “Pre-Money Valuation Cap” section above. 

● Why is this important?

○ Plug  and  Play  tries  to  include  a  10%  pool  to avoid dilution of its advisory

shares and SAFE shares in the future (See Appendix 5 - Example 4).

○ It  is  important  for  a  startup  at  such  an  early  stage  -  with  a small amount
of  money  to  work  with  -  to  incentivize  employees  through  an  employee
stock  option  plan  (employee  pool),  since  they  can’t  pay  these  talented
individuals  the  salary  that  they  could  easily  get  working  for  other
companies.  Therefore,  an  employee  pool  will  help  the  startup  keep  their
burn rate low.

○ Advisory  shares  can  drop  the  startup’s  effective  valuation, which may be

necessary  if  their  valuation  doesn’t  match  the  valuations  Plug  and  Play
typically invests at, and/or the startup’s valuation is inflated due to market
conditions (See Appendix 5 - Example 5).

● Why is this fair for Plug and Play? How to ask for this term?

○ Experienced  institutional investors would all prefer for the startup to have
an  employee  pool  to  keep  the  company’s  burn  rate  low  (rationale
mentioned  above)  so  that  they  can  spend  responsibly  and  have  enough
money to last them until their next financing round.

○ If they already have a pool, it makes their Series A raise simpler.

○ Plug  and  Play  is  an  international  open  innovation  platform  with  over  30
locations,  400  employees,  and  over  300  corporate  partners,  all  of  which
contribute  to  helping  startups  on  Plug  and Play’s platform. Plug and Play
can  essentially  serve  as  a  business  development  arm  for  the  startup  at a
point  where  they  can’t  afford  to  develop  one  themselves.  For all the help
that  Plug  and  Play  is  in  position  to  provide to the startups, Plug and Play
asks for advisory shares as part of the firm’s investment model.

● What if a startup doesn’t budge?

○ Plug and Play can ask to create a hypothetical pool that the founder plans
on  creating  in  the  future.  After  Plug  and  Play  knows  how  many  shares

Ventures 67
 this  would  add,  Plug  and  Play can base its advisory share calculations on 
this figure. 

4.2.5.1. Advisory Shares (Cost and Fully Vested) 

Plug and Play does not pay more than $5K to obtain the advisory share portion 
of an investment and Plug and Play tries to avoid a vesting schedule. 

● Why is this important?

○ Cost:  Advisory  shares  (common  stock)  are  meant  to  compensate

Plug  and  Play  for  the  extra  value  Plug  and  Play  brings  to  the
startup  outside  of  investing  capital.  If  Plug  and  Play  had  to  pay  a
lot  for  the  advisory  shares,  it  would  be  as  if  Plug  and  Play  was
making  an  additional  investment  for  common  stock,  which  is
significantly less valuable than preferred stock.

○ Fully  Vested:  Plug  and  Play  prefers  to  receive  all  advisory  shares
upfront  and  free  of  any  restrictions  on  resale.  Founders  usually
seek  to  put  a  vesting  schedule  in  place  to  ensure  that  Plug  and
Play  continues  to  bring  value  to  the  startup  as  promised  during
negotiations.  Fully  vested  shares  are  worth  more  than  unvested
shares,  so  as much as practical Plug and Play should push back to
receive the shares fully vested or at least partially vested upfront.

● Why is this fair for Plug and Play? How to ask for this term?

○ Cost:  Since  it  is  essentially  a  supplement  and compensation, Plug

and  Play  does  not  want  to  pay  more  than  $5K;  otherwise,  it  is
essentially another investment.

○ Fully  Vested:  Vesting  schedules  are  placed  on  founders  and

employees  to  keep  them  incentivized  to  stay  with  the  company.
Plug  and Play is usually making an investment alongside receiving
advisory  shares  so  Plug  and  Play  is  already  incentivized  to  help
the  company  as  much  as  possible to increase the ROI of Plug and
Play’s  investment.  As  a  result,  Plug  and  Play  shouldn’t be treated
like founders and employees.

● What if a startup doesn’t budge?

68 Ventures
 ○ Cost:  If  the  price  is  too  high  for  any  reason  and  the  startup
won’t/can’t  bring  the  price  down, Plug and Play will exchange the
value of its services for the advisory shares.

○ Vesting  schedule:  If  Plug  and  Play  must  agree  to  a  vesting
schedule,  its  typical  vesting  schedule  is  50%  upfront  and  the
remaining  50%  in  equal  monthly  instalments  over  the  next  12
months.  Alternatively,  Plug  and  Play  can  agree  to  a  vesting
schedule  of  equal  monthly  installments  of  24  months  and  no
upfront  payment.  If  there  is  a  change  of  control  (startup  is
acquired  prior to the conversion of Plug and Play’s investment), all
of  the  shares  will  accelerate  i.e.  all  of  the  unvested  shares  shall
immediately vest.

4.2.5.2. Advisory Shares (409A valuations) 

In  addition  to  negotiating  the  total  amount  of  advisory  shares,  if  the  company 
has  raised  more  than  $750K,  Plug  and  Play  requires  the  company  to  either 
conduct  a  409A  valuation  or  have  the  board  of  directors  determine  (in  good 
faith)  a  price  per  share  of  the  company’s  common  stock.  The  IRS  requires 
companies  to  issue  or  sell  their  common  stock  at  or  above  the  fair  market  value 
(FMV).  If  common  stock  is  issued  or  purchased  at  a  price  that  is  not  at  least  at 
the  FMV  of  the  common  stock,  investors  and/or  employees  (not  the  company) 
might  be  subject  to  tax  penalties.The  cost  of  a  409A  valuation  might  range 
between  $1K  to  $7K,  but  this  is  a  must-have  to  startups  planning  to  have  a  EE 
or  issue  options  or  warranties.  If  the  startup  doesn’t  have  the  funds  or  the  time 
to  conduct  a  409A  valuation,  the  board  of  directors  must  determine  a  price  per 
share  -  Plug  and Play will not execute the investment without the advisory share 
paperwork being finalized in conjunction. 

4.2.6. Exit prior to Series A 

If  the  startup  is  acquired  prior  to  the  conversion  of Plug and Play’s SAFE, Plug and Play 
will  elect  to  receive  either  1X  its  investment  back  or  convert  to  common  stock  at  the 
valuation cap. 

● Why is this important?

○ Plug  and  Play  is  investing  to  receive a return on its investment. This term

ensures  that  Plug  and  Play  receives  the  highest  return  possible  (See
Appendix 5 - Example 6).

● Why is it fair? How to ask for this term?

Ventures 69
 ○ Plug  and  Play  is  founder  friendly  and  prefers  not  to  have  any  approval
rights  over  acquisitions  or  future  funding  rounds.  All  that  Plug  and  Play
asks  is  to  have  its  investment  treated  fairly  and  Plug  and  Play  believes
that  this  term  most  fairly  protects  its  investment  in  the  event  of  an  early
exit.

○ However,  if  there  aren’t  enough  funds  to  pay  Plug and Play back at least

1X,  as  long  as  the  startup  allows  Plug  and  Play  to  review  the  exit
documents, Plug and Play won’t make any unreasonable demands.

● What if a startup doesn’t budge?

○ This  is  a  boilerplate  clause,  and  Plug  and  Play  has  not  had  much  trouble
negotiating  it.  It  is  a  fair  protection  for  investors  such  as  Plug  and  Play
since  it  does  not  have  veto  rights  over  CofC  or  liquidation  events.  The
founders  have  the  power  and  discretionary  to  decide  upon  selling  the
company  earlier  than  expected,  whereby  the  early  investors  might  elect
to  be  paid  back  or  keep  their  investment  in  the  company  with  the  new
controlling shareholders.

4.2.7. Threshold for Series A 

In  order  for  Plug  and  Play’s  investment  to  automatically  convert  into  shares,  Plug  and 
Play requires the amount raised to be at least $2 million. 

● Why is this important?

○ Plug  and  Play  sets  this  threshold  for  automatic  conversion  because  Plug
and  Play  wants to convert into preferred stock that is properly negotiated
by  an  institutional  VC.  The  bigger  the  round,  for  Plug  and  Play,  means
that  your  lead  has  more  skin  in  the  game  and  will  negotiate for standard
Series  A  protective  provisions,  liquidation  preferences,  etc.  Otherwise,
Plug  and  Play  runs  the  risk  of  being  automatically  converted  to  "friends
and  family"  type  Series  A  preferred  stock  where  standard  rights  are  not
in place.

● Why is it fair? How to ask for this term?

○ In  Plug  and  Play’s  experience,  the  "friends  and  family"  type  Series  A  is
pretty  rare,  and  Plug  and  Play  will  usually  convert  to  Series A even if the
total  round  is  less  than  $2  million.  The  team  just  been  burned  before  by
this and have since implemented this provision to avoid that situation.

70 Ventures
● What if a startup doesn’t budge?

○ Plug  and  Play  can  try  to  lower  the  threshold  to  $1  million  and  try  to
relieve  any  pressure  the  founder  may  feel  with  having  to  raise  a  $2
million round.

Ventures 71
This page is intentionally left blank.
 5
APPENDIX

Ventures 73
5. Appendix
5.1. Standard Series A term sheet from Y Combinator43

TERM SHEET 

Company:  [__________], a Delaware corporation. 

Securities:  Series A Preferred Stock of the Company (“​Series A​”). 

Investment  $[_] million from [__________] (“​Lead Investor​”) 

Amounts: 
$[_] million from other investors 

Convertible notes and safes (“​Convertibles​”) convert on their terms 

into shadow series of preferred stock (together with the Series A, the 
“​Preferred Stock​”). 

Valuation:  $[_]  million  ​post-money  valuation,  including  an  available  option  pool 
equal to [__]% of the post-Closing fully-diluted capitalization. 

Liquidation  1x  non-participating  preference.  A  sale  of  all  or  substantially all of the 

Preference:  Company’s  assets,  or  a merger (collectively, a “​Company Sale​”), will be 
treated as a liquidation. 

Dividends:  6%  noncumulative,  payable  if  and  when  declared  by  the  Board  of 
Directors.   

Conversion to  At  holder’s  option  and  automatically  on  (i)  IPO  or  (ii)  approval  of  a 
Common Stock:  majority  of  Preferred  Stock  (on  an  as-converted  basis)  (the  “​Preferred 
Majority​”).  Conversion  ratio  initially  1-to-1,  subject  to  standard 
adjustments. 

43
Kwon, Jason, and Aaron Harris. "A Standard and Clean Series a Term Sheet: Fundraising, Fundraising 
Docs, Series A." YC Startup Library. Accessed August 30, 2020. 
https://www.ycombinator.com/library/4P-a-standard-and-clean-series-a-term-sheet​. 

74 Ventures
Voting Rights:  Approval  of  the  Preferred  Majority  required  to  (i)  change  rights, 
preferences  or  privileges  of  the  Preferred  Stock;  (ii)  change  the 
authorized  number  of  shares;  (iii)  create  securities  senior  or  pari  passu 
to  the  existing  Preferred  Stock;  (iv)  redeem  or  repurchase  any  shares 
(except  for  purchases  at  cost  upon  termination  of services or exercises 
of  contractual  rights of first refusal); (v) declare or pay any dividend; (vi) 
change  the  authorized  number of directors; or (vii) liquidate or dissolve, 
including  a  Company Sale.  Otherwise votes with Common Stock on an 
as‑converted basis. 

Drag-Along:  Founders,  investors  and  1%  stockholders  required  to  vote  for  a 
Company  Sale  approved  by (i) the Board, (ii) the Preferred Majority and 
(iii) a  majority  of  Common  Stock  [(excluding  shares  of  Common  Stock
issuable  or  issued  upon  conversion  of  the  Preferred  Stock)]  (the
“​Common Majority​”), subject to standard exceptions.

Other Rights &  The  Preferred  Stock  will have standard broad-based weighted average 

Matters:  anti-dilution  rights,  first  refusal  and  co-sale  rights  over  founder  stock 
transfers,  registration  rights,  pro  rata  rights  and  information  rights. 
Company  counsel  drafts  documents.  Company  pays  Lead  Investor’s 
legal fees, capped at $30,000. 

Board:  [Lead  Investor  designates  1  director.  Common  Majority  designates  2 

directors.] 

Founder and  Founders: [_______________]. 

Employee Vesting: 
Employees: 4-year monthly vesting with 1-year cliff. 

No Shop:  For  30  days,  the  Company  will  not  solicit,  encourage  or  accept  any 
offers  for  the  acquisition  of  Company  capital  stock  (other  than  equity 
compensation  for  service  providers),  or  of  all  or any substantial portion 
of Company assets. 

The “No Shop” is legally binding between the parties. Everything else in this term sheet is 
non-binding and only intended to be a summary of the proposed terms of this financing. 

Ventures 75
 [COMPANY] 

By: 

Name: 

Title: 

Date: 

[LEAD INVESTOR] 

By: 

Name: 

Title: 

Date: 

76 Ventures
5.2. Sample term sheet from Emperor Ventures44 

SALE OF SERIES A PREFERRED STOCK REBEL TECHNOLOGIES 

SUMMARY OF TERMS 

THIS  TERM  SHEET  SUMMARIZES  THE  PRINCIPAL  TERMS  OF  A  PROPOSED  SERIES  A 
PREFERRED  STOCK  FINANCING  OF  EQUITY  SECURITIES  IN  REBEL  TECHNOLOGIES  (THE 
“COMPANY”).  EXCEPTING  ARTICLE  VI.A,  THIS  TERM  SHEET  IS  FOR  DISCUSSION 
PURPOSES  ONLY;  THERE  IS NO OBLIGATION ON THE PART OF ANY NEGOTIATING PARTY 
UNLESS  A  DEFINITIVE  STOCK  PURCHASE  AGREEMENT  IS  SIGNED  BY  ALL  PARTIES.  THIS 
TERM  SHEET  IS  NOT  A  COMMITMENT  TO  INVEST,  AND  IS  CONDITIONED  ON  THE 
COMPLETION  OF  DUE  DILIGENCE,  LEGAL  REVIEW  AND  DOCUMENTATION  THAT  IS 
SATISFACTORY  TO  THE  INVESTORS.  THIS  TERM  SHEET  SHALL  BE  GOVERNED  IN  ALL 
RESPECTS BY THE LAWS OF THE STATE OF DELAWARE. 

I. SECURITIES

A. AMOUNT AND INVESTORS:

Emperor  Ventures  (“EV”)  will  lead  a  transaction  in  which  EV and its Investor Group (the
“Investor Group”) will invest a total of $ ____ million.

B. TYPE OF SECURITY:
Series A Preferred Stock (the “Preferred Stock”)

C. PRICE PER SHARE:

$ ____ (the “Series A Original Purchase Price”)

D. CAPITALIZATION:
Emperor  Ventures  understands  the  capitalization  of  the Company to be 1,000,000 total
pre-  financing  fully-diluted  Common  shares  and  options  fully  owned  by  the  Founder.
This  financing  consists  of  up  to  ____  shares  of  Preferred  Stock to Emperor Ventures for
a Grand total of ____ .

The post-money valuation of the Company is $ ____ and $ ____ purchases  ​____% of the 
Company in Preferred Stock. 

44
Lenet, Scott, Laju Obasaju, and Selina Troesch. "Rebel Technologies Series Seed Negotiation: Emperor 
Information ^ SCG535." HBR Store. November 15, 2017. Accessed August 30, 2020. 
https://store.hbr.org/product/rebel-technologies-series-seed-negotiation-emperor-information/SCG535​. 

Ventures 77
 The  unallocated  employee  pool  will  be  approximately  ____%  of  the  fully  diluted 
capitalization of the Company. 

II. STOCK PURCHASE RIGHTS

A. RIGHT OF FIRST REFUSAL:

The  Preferred  Stock  Investors  shall  have  the  right,  in  the  event  the  Company  proposes
an  equity  offering  of  any  amount  to  any  person  or  entity  (other  than  for  a  strategic
corporate  partner,  employee  stock  grant,  equipment  financing,  acquisition  of  another
company,  shares  offered  to  the  public  pursuant  to  an  underwritten  public  offering,  or
other  conventional  exclusion),  to  purchase  up  to  a  pro  rata  portion  of  such  shares.  If  a
Preferred  Stock  Investor  chooses  not  to  exercise  their  right  of  first  offer,  the  other
Preferred  Stock  investors  and/or  their  affiliated  funds  have  the  right  to  expand  their
investments to fill the gap.

The  Company  has  an  obligation  to  notify  all  Preferred  Investors  of any proposed equity 
offerings of any amount. 

If  the  affiliated  groups  of  Preferred  Investors  do  not  respond  within  15  days  of  being 
notified  of such an offering or decline to purchase all of such securities, then that portion 
which  is  not purchased may be offered to other parties on terms no less favorable to the 
Company  for  a  period  of  120  days.  Such  right  of  first  offer  will  terminate  upon  an 
underwritten public offering. 

In  addition,  the  Company  will  grant  the  Preferred  shareholder  any  rights  of  first  refusal 
or  registration  rights  granted  to  subsequent  purchasers  of  the  Company’s  equity 
securities  to  the  extent  that  such subsequent rights are superior, in good faith judgment 
of the Company’s Board of Directors, to those granted connection with this transaction. 

B. COMMON STOCK:
The  Company’s  bylaws  shall  contain  a  right  of  first  refusal  on  all  transfers  of  Common
Stock,  subject  to  normal  exceptions.  If  the  Company  elects  not  to  exercise  its  right,  the
Company shall assign its right to the Investors.

C. RIGHT OF ASSIGNMENT:
Each  of  the  Investors  shall  be  entitled  to  transfer  all  or  part  of  its  shares  of  Preferred
purchased  by  it  to  one  or  more  affiliated  partnerships  or  funds  managed  by  it  or any of
their  respective  directors,  officers,  or  partners,  provided  such  transferee  agrees  in
writing  to  be  subject  to  the  terms  of  the  Stock  Purchase  Agreement  and  related
agreement as if it were a purchaser thereunder.

78 Ventures
 D. REDEMPTION:
The  Preferred  Stock  shall  be  subject  to  redemption in years ____ , ____ , and ____ at the
greater of fair market value or cost.

III. REGISTRATION RIGHTS

A. DEMAND RIGHTS:
If  investors  holding  at  least  50  percent  of  Series  A  Preferred  (or  Common  issued  upon
conversion  of  the  Preferred  or  a  combination  of  such  Common  and  Preferred)  request
that  the  Company  file  a  registration  Statement  for at least 20 percent of their shares (or
any  lesser  percentage  if  the  anticipated  gross  receipts  from  the  offering  exceed
$2,000,000),  the  Company  will  use  its  best  efforts  to  cause  such  shares  to  be
registered;  provided,  however,  that  the  Company  shall  not  be  obligated  to  effect  any
such  registration  prior  to  the  earlier  of  ____,  or  within  one  year  following  the  effective
date  of the Company’s initial public offering (“IPO”). The Company shall not be obligated
to effect more than two registrations under these demand rights and provisions.

B. PIGGYBACK RIGHTS:
The  holders  of  Registrable  Securities  will  be  entitled  to  “piggyback”  registration  rights
on  all  registration  statements  of  the  Company  or  on  demand  registrations  of  any  later
round  investor,  subject  to  the  right,  however,  of  the  Company  and  its  underwriters  to
reduce  the  number  of  shares  proposed  to  be  registered  on  a  pro  rata  basis  in  view  of
market  conditions  and  to  complete  reduction  on  an  IPO  at  the  underwriter’s  discretion.
No  shareholder  of  the  Company  shall  be  granted  piggyback  registration  rights  superior
to  those  of  the  Series  A  Preferred  without  the  consent  of  the  holders  of  at  least  50
percent  of  the  Preferred  Stock  (or  Common  issued  upon  conversion  of  the  Preferred
Stock or a combination of such Common and Preferred).

C. S-3 RIGHTS:
Investors  shall  be  entitled  to  an  unlimited  number  of  demand  registrations  on  form S-3
(if  provided,  however,  that  the  Company  shall  only  be  required  to  file  two  Form  S-3
Registration Statements on demand of the Preferred every 12 months.

D. EXPENSES:
The  Company  shall  bear  registration  expenses  (exclusive of underwriting discounts and
commissions  and  special  counsel  of  the  selling  shareholders)  of  all  demands,
piggybacks,  and  S-3  registrations.  Any  expenses  in  excess  of  $15,000  of  any  special
audit  required  in  connection  with  a  demand  registration  shall  be  borne  pro  rata  by  the
selling shareholders.

E. OTHER PROVISIONS:

Ventures 79
 The  registration  rights  may  be  transferred,  provided  that  the  Company  is  given  written 
notice  thereof  and  provided  that  the  transfer:  a)  is  in  connection  with  a  transfer  of  all 
securities  if  the  transferor;  b)  involves  a  transfer  of  at  least  100,000  shares;  or  c)  is  to 
constituent partners or shareholders who agree to act through a single representative. 
  
Other  provisions  shall  be  contained  in  the  Purchase  Agreement  with  respect  to 
registration  rights  as  are  reasonable,  including  cross-indemnification,  the  period of time 
in  which  the  Registration  Statement  shall  be  kept  effective,  standard  standoff 
provisions,  underwriting  arrangements  and  the  ability  of the Company to delay demand 
registrations for up to 90 days (S-3 Registrations for up to 60 days). 
  
F.  VOTING RIGHTS: 
Holders  of  Preferred  Stock will have a right to that number of votes equal to the number 
of shares of Common Stock on an as-if-converted basis. 
  
G.  CO-SALE AGREEMENT: 
The  shares  of  the  Company’s  securities held by the Founders shall be made subject to a 
co-  sale  agreement  (with  certain  reasonable  exceptions)  with  the  Investors,  such  that 
the  Founders  may  not  sell,  transfer,  or  exchange their stock unless each Investor has an 
opportunity  to  participate  in  the  sale  on  a  pro  rata  basis.  This  right  of  co-sale  shall  not 
apply to and shall terminate upon a qualified IPO. 
 
IV. BOARD OF DIRECTORS RIGHTS 
 
A.  COMPOSITION: 
The Board of Directors will consist of ____ seats. Emperor Ventures will have the right to 
elect ____ members to the Company’s Board of Directors (initially ____ ). The Company’s 
Chief  Executive  Officer  will  also  serve  as  a  Director.  The  additional  Directors  will  be 
representatives  mutually  agreeable  to  the  Company’s  existing  Directors  and  the 
Preferred  Stock  investors.  EV  will  also  have board visitation rights for its other partners. 
Direct  travel  costs  incurred  by  EV's  appointed  Board  members  for  the  purpose  of 
attending  the  Board  meetings  and  conducting other company business will be borne by 
the Company. 
  
B.  INDEMNIFICATION: 
The  bylaws  and  any  other charter documents of the Company shall limit the liability and 
exposure  to  damages  of  members  of  the  Board  of  Directors  to  the  broadest  extent 
permitted by applicable law, using a form of indemnification acceptable to Directors. 
  
C.  LIQUIDATED PREFERENCE: 
In  the  event  of  any  liquidation  or  winding  up  of  the  Company,  the  holders  of  Preferred 
Stock  will  be  entitled  to  receive  in  preference  to  the  holders  of  Common  Stock  an 

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 amount  equal  to  the  Original  Purchase  Price  per  share,  plus  all  declared  but  unpaid 
dividends,  if  any.  Any  remaining  proceeds  shall  be  allocated  between  the Common and 
the  Preferred  on  a  pro-rata.  A  merger,  acquisition,  or  sale  of  substantially  all  of  the 
assets of the Company in which the shareholders of the Company do not own a majority 
of the outstanding shares of the surviving corporation shall be deemed a liquidation. 

D. CONVERSION:
The  Series  A  Preferred  initially  converts  1:1  to  Common  Stock  at  any  time  at  option  of
holder,  subject  to  adjustments  for  stock  dividends,  splits,  combinations  and  similar
events and as described below under “Antidilution Provisions.”

Each  share  of  Series  A  Preferred  will  be  automatically  converted into Common Stock at 

the  then  applicable  conversion  rate  in  the  event  of:  (i)  the  closing  of  an  underwritten 
public  offering  of  shares of Common Stock of the Company at a public offering price per 
share  (prior  to  underwriting  commissions  and  expenses)  that  values  the  Company  at 
least  $100  million  in  an  offering  of  not  less  than  $30  million,  before  deduction  of 
underwriting  discounts  and  registration  expenses;  or  (ii)  approval  of  60  percent  of  the 
Preferred Stock. 

E. ANTIDILUTION:
Proportional  antidilution  protection  for  stock  splits,  stock  dividends,  combinations,  re- 
capitalizations,  etc.  The  conversion  price  of  the  Preferred  shall be subject to adjustment
to  prevent  dilution,  on  a  weighted  average  basis,  in  the  event  that  the  Company issues
additional  shares  of  Common  or  Common  equivalents  (other  than  reserved  employee
shares) at a purchase price less than the applicable conversion price.

F. DIVIDENDS:
The  holders  of  Preferred  Stock  shall  be  entitled  to  receive  dividends  at  a  rate  of  8
percent  per  annum  in  preference  to  any  dividend  on  Common  Stock,  whenever  funds
are  legally  available,  when,  if,  and as declared by the Board of Directors. Dividends shall
be non- cumulative.

V. COVENANTS

A. RESTRICTIONS & LIMITATIONS:

So  long  as  Series  A  Preferred  Stock  remains  outstanding,  the  Company  shall  not,
without  the  vote  or  written  consent  of  at  least  a  majority  of the Preferred shareholders,
take  any  action  that would: (i) alter or change the rights, preferences, or privileges of the
Series  A  Preferred;  (ii)  authorize  or  issue  any equity security senior to or on a party with
a  Series  A  Preferred  as  to  dividend  rights,  redemption  rights  or  liquidation preferences;
(iii) amend  or  waive  any  provision  of  the  Company’s  Articles of Incorporation or Bylaws
in  a  manner  that  would  alter  or  change  the  rights,  preferences  or  privileges  of  any

Ventures 81
 Preferred Stock without the approval of at least a majority of the Preferred shareholders; 
(iv)  increase  or  decrease  the  authorized  number  of  shares  of  Common  or  Preferred 
Stock;  (v)  result  in  the  redemption  or  repurchase  of any shares of Common Stock (other 
than  pursuant  to  equity  incentive  agreements  with  service  providers  giving  the 
Company  the  right  to  repurchase  shares  upon  the  termination  of  services);  (vi)  result in 
any  merger, consolidation, or other corporate reorganization, or any transaction or series 
of  transactions  in  which  excess  of  50  percent  of  the  Company’s  voting  power  is 
transferred  or  in  which  all  or  substantially all of the assets of the Company are sold; (vii) 
increase  or  decrease  the  authorized  size  of  the  Company’s  Board  of  Directors,  except 
with  approval  of  the  Board,  including  the  Series A Preferred representatives; (viii) result 
in  the  payment  or  declaration  of  any  dividend  on  any  shares  of  Common  or  Preferred 
Stock;  or  (ix)  result  in  the  issuance  of  debt  in  excess of $100,000, except with approval 
of the Board, including the Series A Preferred representatives.  
 
B.  INSURANCE: 
The  Company  will  obtain  key  person  life  insurance,  payable  to  the  Company  for  $1 
million. The Company will also maintain D&O insurance acceptable to the investors. 
  
C.  REPRESENTATIONS & WARRANTIES: 
The  investment  shall  be  made  pursuant  to  an  Investment  Agreement  reasonably 
acceptable  to  the  Company  and  the  Investors,  which  agreement  shall  contain,  among 
other  things,  appropriate  representations  and  warranties  of  the  Company  with  respect 
to  patents,  litigation,  previous  employment,  and  outside  activities,  covenants  of  the 
Company  reflecting  the  provisions  set  forth  herein,  and  appropriate  conditions  of 
closing, including an opinion of the counsel for the Company. 
  
D. VESTING: 
Unless  the  Board  determines  otherwise,  all  founders’  and  employees’  Common  Stock 
and  options  shall  vest  as  follows:  25  percent  at  the  end  of  the  first  year  of  full-time 
employment  following  the  closing  of  the  financing  contemplated by this term sheet and 
at  a  rate  of  1/36th  of  the  remaining  amount  per  month  thereafter  such  that  the  entire 
stock  option  grant  vests  in  its  entirety  over  a  period of four years. In general, there shall 
be  no  accelerated  vesting  of  Common  Stock  in  the  event  that  the  Company  is acquired 
or  merged.  All  unvested  Common  shares  shall  be  re-purchasable  at  cost  by  the 
Company upon the termination of employment for any reason. 
  
E.  COMPENSATION: 
No  Company  employee  shall  receive  annual  compensation  in  excess  of  $100,000 
(except  those  receiving  commissions  from  approved  compensation  plans)  without 
consent  of  the  Board  of  Directors  or  Compensation  Committee,  if  any,  until  the 
Company  is  merged, sold, or completes an IPO. Any and all accruals shall be forgiven by 
the founders and employees prior to this financing. 

82
  Ventures
 All  employees  are  employed  by  the  Company  “at  will”  –  no  employment  contracts  will 
be granted without the unanimous consent of the Board of Directors. 

F. PROPRIETARY INFORMATION & INVENTIONS AGREEMENT:

Each  officer,  director,  and  employee  of  the  Company  shall  have  entered  into  a
proprietary  information  and  inventions  agreement  in  a  form  reasonably  acceptable  to
the  Company  and  the  Investors.  Each  key  technical  employee  shall  have  executed  an
assignment  of  inventions  acceptable  to  the  Company  and  Investors.  Each  founder  will
have  made  appropriate  representations  and  warranties  as  to  no-conflict  with  prior
employers.

G. INFORMATION RIGHTS:
So  long  as  an  investor  continues  to  hold  at  least  100,000  shares  of  Preferred  Stock  or
Common  (a  “Major  Investor”),  the  Company  shall  deliver  to  the  Investor  the Company’s
annual  budget,  as  well  an  audited annual and unaudited quarterly and monthly financial
statements.  Furthermore,  as  soon  as  reasonably  possible,  the  Company  shall  furnish  a
report  to  each  Major  Investor  comparing  each  annual  budget  to  such  financial
statements.  Each  Major  Investor  shall  also  be  entitled  to  standard  inspection  and
visitation rights. These provisions shall terminate upon a qualified IPO.

VI. CLOSING

A. NO SHOP AGREEMENT:
For  a  period  of  forty-five  (45)  days  following  the  acceptance  of  this  term  sheet,  the
Company  shall  not  solicit  other  potential  investors  nor  disclose  the  terms  of  this  Term
Sheet  to  other  discussions or execute any agreements related to the sale or transfer of a
significant  portion  of  the  Company’s  assets  or  securities  to  any  other  party  other  than
the  Investors until after the signing of definitive documents memorializing the provisions
herein.  Should  both  parties  agree  that  definitive  documents  shall  not  be  executed
pursuant  to  this  term  sheet,  the  Company  shall  have  no  further  obligations  under  this
section.

B. CLOSING:
Subject  to  the  satisfactory  completion  of  due  diligence,  the  closing  of  this  transaction
will be on or before ____ .

C. LEGAL FEES & EXPENSES:

The  Company  shall  bear  its  own  fees  and  expenses  and  shall  pay  at  the  closing  the
reasonable  fees  and  expenses  (not  to  exceed  $15,000)  of  the  Preferred  Investors’
respective  legal  firms  if  any  transactions  contemplated  by  this  term  sheet  are  actually
consummated.  Investors’  counsel  shall  draft  the  definitive  stock  purchase  agreement

Ventures 83
 and  other  needed  legal  documentation.  In  addition,  the  legal  fees  and  expenses  of  the 
Company shall not exceed $10,000. 

The  foregoing  Summary  of  Terms  sets  forth  the good faith agreement of the parties set 

forth below. This offer expires on ____ at 5:00 p.m. EST. 

AGREED AND ACCEPTED: 

REBEL TECHNOLOGIES EMPEROR VENTURES 

By: By: 
Date: Date: 

84 Ventures
5.3. Sample SAFE with valuation cap and conversion discount from Y Combinator45 

THIS  INSTRUMENT  AND  ANY  SECURITIES  ISSUABLE  PURSUANT  HERETO  HAVE  NOT 
BEEN  REGISTERED  UNDER  THE  SECURITIES  ACT  OF  1933,  AS  AMENDED  (THE 
“SECURITIES  ACT”),  OR  UNDER  THE  SECURITIES  LAWS  OF  CERTAIN  STATES.  THESE 
SECURITIES  MAY  NOT  BE  OFFERED,  SOLD  OR  OTHERWISE  TRANSFERRED,  PLEDGED  OR 
HYPOTHECATED  EXCEPT  AS  PERMITTED  IN  THIS  SAFE  AND  UNDER  THE  ACT  AND 
APPLICABLE  STATE  SECURITIES  LAWS  PURSUANT  TO  AN  EFFECTIVE  REGISTRATION 
STATEMENT OR AN EXEMPTION THEREFROM.  

[COMPANY NAME] 

SAFE 
(Simple Agreement for Future Equity) 

THIS  CERTIFIES  THAT  in  exchange  for  the  payment  by  [Investor  Name]  (the  “Investor”)  of 
$[_____________]  (the  “Purchase  Amount”)  on  or  about  [Date  of  Safe],  [Company  Name],  a 
[State  of  Incorporation]  corporation  (the  “Company”),  issues  to  the  Investor  the  right  to certain 
shares of the Company’s Capital Stock, subject to the terms described below. 

The “Post-Money Valuation Cap” is $[___________]. 

The “Discount Rate” is [100 minus the discount]%. 
See Section 2 for certain additional defined terms. 

1. Events

(a) Equity  Financing.  If  there  is  an  Equity  Financing  before the termination of this Safe, on the
initial  closing  of  such  Equity  Financing,  this  Safe  will  automatically  convert  into  the  number  of
shares of Safe Preferred Stock equal to the Purchase Amount divided by the Conversion Price.
In  connection  with  the  automatic  conversion  of  this  Safe  into  shares  of  Safe  Preferred  Stock,
the  Investor  will execute and deliver to the Company all of the transaction documents related to
the  Equity  Financing;  provided,  that  such  documents  (i)  are  the  same documents to be entered
into  with  the  purchasers  of  Standard  Preferred  Stock,  with  appropriate  variations  for  the  Safe
Preferred  Stock  if  applicable,  and  (ii)  have  customary  exceptions  to  any  drag-along  applicable
to  the  Investor,  including  (without  limitation)  limited  representations,  warranties,  liability  and
indemnification obligations for the Investor.

(b) Liquidity  Event.  If  there  is  a  Liquidity  Event  before  the  termination  of  this  Safe,  this  Safe
will  automatically  be  entitled  (subject  to  the  liquidation  priority  set  forth  in  Section  1(d) below)
to  receive  a  portion  of  Proceeds,  due  and  payable  to  the  Investor  immediately  prior  to,  or

45
"Safe Financing Documents." Y Combinator. September 1, 2018. Accessed August 30, 2020. 
https://www.ycombinator.com/documents/​. 

Ventures 85
concurrent  with,  the  consummation  of  such  Liquidity  Event,  equal  to  the  greater  of  (i)  the 
Purchase  Amount  (the  “Cash-Out Amount”) or (ii) the amount payable on the number of shares 
of Common Stock equal to the Purchase Amount divided by the Liquidity Price (the “Conversion 
Amount”).  If  any  of  the  Company’s  securityholders  are  given  a  choice  as  to  the  form  and 
amount  of  Proceeds  to  be  received  in  a  Liquidity  Event,  the  Investor  will  be  given  the  same 
choice,  provided  that  the  Investor  may  not  choose  to  receive  a  form  of  consideration  that  the 
Investor  would  be  ineligible  to  receive  as  a  result  of  the  Investor’s  failure  to  satisfy  any 
requirement  or  limitation  generally  applicable  to  the  Company’s  securityholders,  or  under  any 
applicable laws. 

Notwithstanding  the  foregoing,  in  connection  with a Change of Control intended to qualify as a 

tax-free  reorganization,  the  Company  may  reduce  the  cash  portion  of  Proceeds  payable  to the 
Investor  by  the  amount  determined  by  its  board  of  directors  in  good  faith  for  such  Change  of 
Control  to  qualify  as  a  tax-free  reorganization  for  U.S.  federal  income  tax  purposes,  provided 
that  such  reduction  (A)  does  not  reduce  the  total  Proceeds  payable  to  such  Investor  and  (B) is 
applied  in  the  same  manner  and  on  a  pro  rata  basis  to  all  securityholders  who  have  equal 
priority to the Investor under Section 1(d). 

(c) Dissolution  Event.  If  there  is  a  Dissolution  Event  before  the  termination  of  this  Safe,  the
Investor  will  automatically  be  entitled  (subject to the liquidation priority set forth in Section 1(d)
below)  to  receive  a  portion  of  Proceeds  equal to the Cash-Out Amount, due and payable to the
Investor immediately prior to the consummation of the Dissolution Event.

(d) Liquidation  Priority.  In  a  Liquidity  Event  or  Dissolution  Event,  this  Safe  is  intended  to
operate  like  standard  non-participating  Preferred  Stock.  The  Investor’s  right  to  receive  its
Cash-Out Amount is:

(i) Junior  to  payment  of  outstanding  indebtedness  and  creditor  claims,  including
contractual  claims  for  payment  and  convertible  promissory  notes  (to  the  extent  such
convertible promissory notes are not actually or notionally converted into Capital Stock);

(ii) On  par  with  payments  for  other  Safes  and/or  Preferred  Stock,  and  if  the  applicable
Proceeds  are  insufficient  to  permit  full  payments  to  the  Investor  and  such  other  Safes
and/or  Preferred  Stock,  the  applicable  Proceeds  will  be  distributed  pro  rata  to  the
Investor  and  such  other  Safes  and/or  Preferred  Stock  in  proportion to the full payments
that would otherwise be due; and

(iii) Senior to payments for Common Stock.

The  Investor’s  right  to  receive  its  Conversion  Amount  is (A) on par with payments for Common 

Stock  and  other  Safes  and/or  Preferred  Stock  who  are  also  receiving  Conversion  Amounts  or 
Proceeds  on  a  similar  as-converted  to  Common  Stock  basis,  and  (B)  junior  to  payments 

86 Ventures
described  in  clauses  (i)  and  (ii)  above  (in  the  latter  case,  to  the  extent  such  payments  are 
Cash-Out Amounts or similar liquidation preferences). 

(e) Termination.  This  Safe  will  automatically  terminate (without relieving the Company of any

obligations  arising  from  a  prior  breach  of  or  non-compliance  with  this  Safe)  immediately
following  the earliest to occur of: (i) the issuance of Capital Stock to the Investor pursuant to the
automatic  conversion  of  this  Safe  under  Section  1(a);  or  (ii)  the  payment,  or  setting  aside  for
payment, of amounts due the Investor pursuant to Section 1(b) or Section 1(c).

2. Definitions

“Capital  Stock”  means  the  capital  stock  of  the  Company,  including,  without  limitation,  the 
“Common Stock” and the “Preferred Stock.” 

“Change  of  Control”  means  (i)  a  transaction  or  series  of  related  transactions  in  which  any 
“person”  or  “group”  (within  the  meaning  of  Section  13(d)  and 14(d) of the Securities Exchange 
Act  of  1934,  as  amended), becomes the “beneficial owner” (as defined in Rule 13d-3 under the 
Securities  Exchange  Act  of  1934,  as  amended),  directly  or  indirectly,  of  more  than  50%  of  the 
outstanding  voting  securities  of  the  Company  having  the  right  to  vote  for  the  election  of 
members  of  the  Company’s  board  of  directors,  (ii)  any  reorganization,  merger  or  consolidation 
of  the  Company,  other  than  a  transaction  or  series  of  related  transactions  in which the holders 
of  the  voting  securities  of  the  Company  outstanding  immediately  prior  to  such  transaction  or 
series  of  related  transactions  retain,  immediately  after  such  transaction  or  series  of  related 
transactions,  at  least a majority of the total voting power represented by the outstanding voting 
securities  of  the  Company  or  such other surviving or resulting entity or (iii) a sale, lease or other 
disposition of all or substantially all of the assets of the Company.  

“Company  Capitalization”  is  calculated  as  of  immediately  prior  to  the  Equity  Financing  and 
(without double-counting, in each case calculated on an as-converted to Common Stock basis): 

● Includes all shares of Capital Stock issued and outstanding;

● Includes all Converting Securities;
● Includes all (i) issued and outstanding Options and (ii) Promised Options; and
● Includes  the  Unissued  Option  Pool,  except  that  any  increase  to  the  Unissued  Option
Pool  in connection with the Equity Financing shall only be included to the extent that the
number of Promised Options exceeds the Unissued Option Pool prior to such increase.

“Conversion  Price”  means  the  either:  (1)  the  Safe  Price  or  (2)  the  Discount  Price,  whichever 
calculation results in a greater number of shares of Safe Preferred Stock. 

“Converting  Securities”  includes  this  Safe  and  other  convertible  securities  issued  by  the 
Company,  including  but  not  limited  to:  (i)  other  Safes;  (ii)  convertible  promissory  notes  and 

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other  convertible  debt  instruments;  and  (iii)  convertible  securities  that  have the right to convert 
into shares of Capital Stock. 

“Direct  Listing”  means  the  Company’s  initial  listing  of  its  Common  Stock  (other than shares of 
Common  Stock  not  eligible  for  resale  under  Rule  144  under  the  Securities  Act)  on  a  national 
securities  exchange  by  means  of  an  effective  registration  statement  on  Form  S-1  filed  by  the 
Company  with  the SEC that registers shares of existing capital stock of the Company for resale, 
as  approved  by  the  Company’s  board  of  directors.  For  the  avoidance  of  doubt,  a  Direct Listing 
shall  not  be  deemed  to  be  an  underwritten  offering  and  shall  not  involve  any  underwriting 
services. 

“Discount  Price”  means  the  price  per  share  of  the  Standard  Preferred  Stock  sold  in the Equity 
Financing multiplied by the Discount Rate. 

“Dissolution  Event”  means  (i)  a  voluntary  termination  of  operations,  (ii)  a  general  assignment 
for  the  benefit of the Company’s creditors or (iii) any other liquidation, dissolution or winding up 
of the Company (excluding a Liquidity Event), whether voluntary or involuntary. 

“Dividend  Amount”  means,  with  respect  to  any  date  on  which  the  Company  pays  a  dividend 
on  its  outstanding  Common  Stock,  the  amount  of  such  dividend  that  is  paid  per  share  of 
Common  Stock  multiplied  by  (x)  the  Purchase  Amount  divided  by  (y)  the  Liquidity  Price 
(treating  the  dividend  date  as  a  Liquidity  Event  solely for purposes of calculating such Liquidity 
Price). 

“Equity  Financing”  means  a  bona  fide  transaction  or  series  of  transactions  with  the  principal 
purpose  of  raising  capital,  pursuant to which the Company issues and sells Preferred Stock at a 
fixed valuation, including but not limited to, a pre-money or post-money valuation. 
“Initial  Public  Offering”  means  the  closing  of  the  Company’s  first  firm  commitment 
underwritten  initial  public  offering  of  Common  Stock  pursuant  to  a  registration  statement  filed 
under the Securities Act. 

“Liquidity  Capitalization”  is  calculated  as  of  immediately  prior  to  the  Liquidity  Event,  and 
(without double- counting, in each case calculated on an as-converted to Common Stock basis): 

● Includes all shares of Capital Stock issued and outstanding;

● Includes  all  (i)  issued  and  outstanding  Options  and  (ii)  to  the extent receiving Proceeds,
Promised Options;
● Includes  all  Converting  Securities,  other  than  any  Safes  and  other  convertible securities
(including  without  limitation  shares  of  Preferred  Stock)  where  the  holders  of  such
securities  are  receiving  Cash-Out Amounts or similar liquidation preference payments in
lieu of Conversion Amounts or similar “as-converted” payments; and
● Excludes the Unissued Option Pool.

88 Ventures
“Liquidity Event”​ means a Change of Control, a Direct Listing or an Initial Public Offering. 
 
“Liquidity  Price”  means  the  price  per  share  equal  to  the  Post-Money Valuation Cap divided by 
the Liquidity Capitalization. 
 
“Options”  includes  options,  restricted  stock  awards  or  purchases,  RSUs,  SARs,  warrants  or 
similar securities, vested or unvested. 
 
“Proceeds”  means  cash  and  other  assets (including without limitation stock consideration) that 
are  proceeds  from  the  Liquidity  Event  or  the  Dissolution  Event,  as  applicable,  and  legally 
available for distribution. 
 
“Promised  Options”  means  promised  but  ungranted  Options  that  are  the  greater  of  those  (i) 
promised  pursuant  to  agreements  or  understandings  made  prior  to  the  execution  of,  or  in 
connection  with,  the  term  sheet  or  letter of intent for the Equity Financing or Liquidity Event, as 
applicable  (or  the  initial  closing  of  the  Equity Financing or consummation of the Liquidity Event, 
if  there  is  no  term  sheet  or  letter  of  intent),  (ii)  in  the  case  of  an  Equity  Financing,  treated  as 
outstanding  Options  in  the  calculation  of  the  Standard  Preferred  Stock’s  price  per share, or (iii) 
in  the  case  of  a  Liquidity  Event,  treated  as  outstanding  Options  in  the  calculation  of  the 
distribution of the Proceeds. 
 
“Safe”  means  an  instrument  containing  a  future  right  to shares of Capital Stock, similar in form 
and  content  to  this  instrument,  purchased  by  investors  for  the  purpose  of  funding  the 
Company’s business operations. References to “this Safe” mean this specific instrument. 
“Safe  Preferred  Stock”  means  the  shares  of  the  series  of Preferred Stock issued to the Investor 
in  an  Equity  Financing, having the identical rights, privileges, preferences and restrictions as the 
shares  of  Standard  Preferred  Stock,  other  than  with  respect  to:  (i)  the  per  share  liquidation 
preference  and  the  initial  conversion  price  for  purposes  of  price-based  anti-dilution  protection, 
which  will  equal  the  Conversion  Price;  and  (ii)  the  basis  for  any  dividend  rights,  which  will  be 
based on the Conversion Price. 
 
“Safe  Price”  means  the  price  per  share  equal  to  the  Post-Money  Valuation  Cap  divided by the 
Company Capitalization. 
 
“Standard  Preferred  Stock”  means  the  shares  of  the  series  of  Preferred  Stock  issued  to  the 
investors  investing  new  money  in  the  Company  in  connection  with  the  initial  closing  of  the 
Equity Financing. 
 
“Unissued  Option Pool” means all shares of Capital Stock that are reserved, available for future 
grant  and  not  subject  to  any  outstanding  Options  or  Promised  Options  (but  in  the  case  of  a 
Liquidity  Event,  only  to  the  extent  Proceeds  are  payable  on  such  Promised  Options) under any 
equity incentive or similar Company plan. 
  

  Ventures 89
3. Company Representations

(a) The  Company  is  a  corporation  duly  organized,  validly  existing  and  in  good  standing  under
the  laws  of  its  state  of  incorporation,  and  has  the  power  and  authority  to  own,  lease  and
operate its properties and carry on its business as now conducted.

(b) The  execution,  delivery and performance by the Company of this Safe is within the power of

the  Company  and  has  been  duly  authorized  by  all  necessary  actions  on  the  part  of  the
Company  (subject  to  section  3(d)).  This  Safe  constitutes  a  legal, valid and binding obligation of
the  Company,  enforceable  against  the  Company  in accordance with its terms, except as limited
by  bankruptcy,  insolvency  or  other  laws  of  general  application  relating  to  or  affecting  the
enforcement  of  creditors’  rights  generally  and  general  principles  of  equity.  To  its  knowledge,
the  Company  is  not  in  violation  of  (i)  its  current  certificate  of  incorporation  or  bylaws,  (ii)  any
material  statute,  rule  or  regulation  applicable  to  the  Company  or  (iii)  any  material  debt  or
contract  to  which  the  Company  is  a  party  or  by  which  it  is  bound,  where,  in  each  case,  such
violation  or  default,  individually,  or  together  with  all  such  violations  or  defaults,  could
reasonably be expected to have a material adverse effect on the Company.

(c) The  performance  and  consummation  of  the  transactions  contemplated  by  this  Safe  do  not
and  will  not:  (i)  violate  any  material  judgment,  statute,  rule  or  regulation  applicable  to  the
Company;  (ii) result in the acceleration of any material debt or contract to which the Company is
a  party  or  by  which  it  is  bound;  or  (iii)  result  in  the  creation  or  imposition  of  any  lien  on  any
property,  asset  or  revenue  of  the  Company  or  the  suspension,  forfeiture,  or  nonrenewal of any
material permit, license or authorization applicable to the Company, its business or operations.

(d) No  consents  or  approvals  are  required  in  connection  with  the  performance  of  this  Safe,
other  than:  (i)  the  Company’s  corporate  approvals;  (ii)  any  qualifications  or  filings  under
applicable  securities  laws;  and  (iii)  necessary  corporate  approvals  for  the  authorization  of
Capital Stock issuable pursuant to Section 1.

(e) To  its  knowledge,  the  Company  owns  or  possesses  (or  can  obtain  on  commercially
reasonable  terms)  sufficient  legal  rights  to  all  patents,  trademarks,  service marks, trade names,
copyrights,  trade  secrets,  licenses,  information,  processes  and  other  intellectual property rights
necessary  for  its  business  as  now  conducted  and  as  currently  proposed  to  be  conducted,
without any conflict with, or infringement of the rights of, others.

4. Investor Representations

(a) The  Investor has full legal capacity, power and authority to execute and deliver this Safe and

to  perform  its  obligations  hereunder.  This  Safe  constitutes  a  valid and binding obligation of the
Investor,  enforceable  in  accordance  with  its  terms,  except  as  limited  by  bankruptcy, insolvency
or  other  laws  of  general  application  relating  to  or  affecting  the  enforcement  of creditors’ rights
generally and general principles of equity.

90 Ventures
 
(b)  The  Investor  is  an  accredited  investor  as  such  term  is  defined  in  Rule  501  of  Regulation  D 
under  the  Securities  Act,  and  acknowledges and agrees that if not an accredited investor at the 
time  of  an  Equity  Financing,  the  Company  may void this Safe and return the Purchase Amount. 
The  Investor  has  been  advised  that  this  Safe  and  the  underlying  securities  have  not  been 
registered  under  the Securities Act, or any state securities laws and, therefore, cannot be resold 
unless  they  are  registered  under  the  Securities  Act  and  applicable  state  securities  laws  or 
unless  an  exemption  from  such  registration  requirements  is  available.  The  Investor  is 
purchasing  this  Safe  and  the  securities  to  be  acquired  by  the  Investor  hereunder  for  its  own 
account  for  investment,  not  as  a  nominee  or  agent,  and  not  with  a  view  to,  or  for  resale  in 
connection  with,  the  distribution  thereof,  and  the  Investor  has  no  present  intention  of  selling, 
granting  any  participation  in,  or  otherwise  distributing  the  same.  The  Investor  has  such 
knowledge  and  experience  in  financial  and  business  matters  that  the  Investor  is  capable  of 
evaluating  the  merits  and  risks  of  such  investment,  is  able  to  incur  a  complete  loss  of  such 
investment  without  impairing  the  Investor’s financial condition and is able to bear the economic 
risk of such investment for an indefinite period of time. 
 
5. Miscellaneous 
(a)  Any  provision  of  this  Safe  may  be  amended,  waived  or  modified  by  written  consent  of  the 
Company  and  either  (i)  the  Investor  or  (ii)  the  majority-in-interest of all then-outstanding Safes 
with  the  same “Post-Money Valuation Cap” and “Discount Rate” as this Safe (and Safes lacking 
one  or  both  of  such  terms  will  be  considered  to  be  the  same  with  respect  to  such  term(s)), 
provided  that with respect to clause (ii): (A) the Purchase Amount may not be amended, waived 
or  modified  in  this  manner,  (B)  the  consent  of  the  Investor  and  each  holder of such Safes must 
be  solicited  (even  if  not  obtained),  and  (C)  such  amendment,  waiver  or  modification  treats  all 
such  holders  in  the  same  manner.  “Majority-in-interest”  refers  to  the  holders  of  the  applicable 
group  of  Safes  whose  Safes  have  a  total  Purchase  Amount  greater  than  50%  of  the  total 
Purchase Amount of all of such applicable groups of Safes. 
 
(b)  Any  notice  required  or  permitted  by  this  Safe  will  be  deemed  sufficient  when  delivered 
personally  or  by  overnight  courier  or  sent  by  email  to  the  relevant  address  listed  on  the 
signature  page,  or  48  hours  after  being deposited in the U.S. mail as certified or registered mail 
with  postage prepaid, addressed to the party to be notified at such party’s address listed on the 
signature page, as subsequently modified by written notice. 
 
(c)  The  Investor  is  not  entitled, as a holder of this Safe, to vote or be deemed a holder of Capital 
Stock  for  any  purpose  other  than  tax  purposes,  nor  will  anything  in  this  Safe  be  construed  to 
confer  on  the  Investor,  as  such,  any  rights  of  a  Company  stockholder  or  rights  to  vote  for  the 
election  of  directors  or  on  any  matter  submitted  to  Company  stockholders,  or  to  give  or 
withhold  consent  to  any  corporate  action  or  to  receive  notice  of  meetings,  until  shares  have 
been  issued  on  the  terms  described  in  Section  1.  However, if the Company pays a dividend on 
outstanding  shares  of  Common  Stock  (that  is  not  payable  in  shares  of  Common  Stock)  while 

  Ventures 91
this Safe is outstanding, the Company will pay the Dividend Amount to the Investor at the same 
time. 

(d) Neither  this  Safe  nor  the  rights  in  this  Safe  are  transferable  or  assignable,  by  operation  of
law  or  otherwise,  by  either  party  without  the  prior  written  consent  of  the  other;  provided,
however,  that  this  Safe  and/or  its  rights  may  be  assigned  without  the  Company’s  consent  by
the  Investor  (i)  to  the  Investor’s  estate,  heirs,  executors,  administrators,  guardians  and/or
successors  in  the  event  of Investor’s death or disability, or (ii) to any other entity who directly or
indirectly,  controls,  is  controlled  by  or  is  under  common  control  with  the  Investor,  including,
without  limitation,  any  general  partner,  managing  member, officer or director of the Investor, or
any  venture  capital  fund  now  or  hereafter  existing  which  is  controlled  by  one  or  more  general
partners  or  managing  members  of,  or  shares  the  same  management  company  with,  the
Investor;  and  provided,  further,  that  the  Company  may  assign  this  Safe  in  whole,  without  the
consent of the Investor, in connection with a reincorporation to change the Company’s domicile.

(e) In  the  event  any  one  or  more  of  the  provisions  of  this  Safe  is  for  any  reason  held  to  be
invalid,  illegal  or  unenforceable,  in  whole  or  in  part  or  in  any  respect,  or  in  the  event  that  any
one  or  more  of  the  provisions  of  this  Safe  operate  or  would  prospectively operate to invalidate
this  Safe,  then  and  in  any  such  event,  such  provision(s)  only  will  be  deemed  null  and  void  and
will  not  affect  any  other  provision  of  this  Safe  and  the  remaining  provisions  of  this  Safe  will
remain  operative  and  in  full  force  and  effect  and  will  not  be  affected,  prejudiced,  or  disturbed
thereby.

(f) All  rights  and  obligations  hereunder  will  be  governed  by the laws of the State of [Governing
Law Jurisdiction], without regard to the conflicts of law provisions of such jurisdiction.

(g) The  parties  acknowledge  and  agree  that  for  United  States  federal  and  state  income  tax
purposes this Safe is, and at all times has been, intended to be characterized as stock, and more
particularly  as  common  stock  for  purposes  of  Sections  304,  305,  306,  354,  368,  1036  and
1202  of  the  Internal  Revenue  Code  of  1986,  as  amended.  Accordingly,  the  parties  agree  to
treat  this  Safe  consistent  with  the  foregoing  intent  for  all  United  States  federal  and  state
income  tax  purposes  (including,  without  limitation,  on  their  respective  tax  returns  or  other
informational statements).

(Signature page follows) 

IN  WITNESS  WHEREOF,  the  undersigned  have  caused  this  Safe  to  be  duly  executed  and 
delivered. 

[COMPANY] 

By: _____________________________ 

92 Ventures
 [name] 
[title] 
Address: _______________________ 
________________________________ 
Email: __________________________ 
________________________________ 

INVESTOR: 

By: _____________________________ 
Name: __________________________ 
Title: ___________________________ 
Address: ________________________ 
________________________________ 
Email: __________________________ 
________________________________  

Ventures 93
5.4. Sample pro-rata side letter from Y Combinator46 

[COMPANY NAME] 
PRO RATA AGREEMENT 

This  agreement (this “​Agreement​”) is entered into on or about [Date of Safe] in connection with 
the  purchase  by  [Investor  Name]  (the  “​Investor​”)  of  that  certain  simple  agreement  for  future 
equity  with  a  “Post-Money  Valuation  Cap”  (the  “​Investor’s  ​Safe​”)  issued  by  [Company  Name] 
(the  “​Company​”)  on  or  about  the  date  of  this  Agreement.  As  a  material  inducement  to  the 
Investor’s  investment,  the  Company  agrees  to  the  provisions  set  forth  in  this  Agreement. 
Capitalized terms used herein shall have the meanings set forth in the Investor’s Safe. 

The  Investor  shall  have  the  right  to  purchase  its  pro  rata  share  of  Standard  Preferred  Stock 
being  sold  in  the  Equity  Financing  (the  “​Pro  Rata  Right​”).  Pro  rata  share  for  purposes  of  this 
Pro  Rata  Right  is  the  ratio  of  (x)  the  number  of  shares  of  Capital  Stock  issued  from  the 
conversion  of  all  of  the  Investor’s Safes with a “Post-Money Valuation Cap” to (y) the Company 
Capitalization.  The  Pro  Rata  Right  described  above  shall  automatically  terminate  upon  the 
earlier  of  (i)  the  initial  closing  of  the  Equity  Financing;  (ii)  immediately  prior  to  the  closing  of  a 
Liquidity Event; or (iii) immediately prior to the Dissolution Event.  

Neither  this  Agreement  nor the rights contained herein may be assigned, by operation of law or 

otherwise,  by  Investor  without  the  prior  written  consent  of  the  Company;  ​provided,  however​, 
that  this  Agreement  and/or  the  rights  contained  herein  may  be  assigned  without  the 
Company’s  consent  by  the  Investor  to  any  other  entity  who  directly  or  indirectly,  controls,  is 
controlled  by  or  is  under  common  control  with  the  Investor,  including,  without  limitation,  any 
general  partner,  managing  member,  officer  or  director  of  the  Investor,  or  any  venture  capital 
fund  now or hereafter existing which is controlled by one or more general partners or managing 
members of, or shares the same management company with, the Investor.  

Any  provision  of  this  Agreement  may  be  amended,  waived  or  modified  upon  the  written 
consent of the Company and either (i) the holders of a majority of shares of Capital Stock issued 
from  all  Safes  converted  in  connection  with the Equity Financing held by the Investor and other 
Safe holders with Pro Rata Rights pursuant to agreements on the same form as this Agreement 
(available  at  ​http://ycombinator.com/documents​),  provided  that  such  amendment,  waiver  or 
modification  treats  all  such  holders  in  the  same  manner,  or  (ii)  the  Investor.  The Company will 
promptly  notify  the  Investor of any amendment, waiver or modification that the Investor did not 
consent  to.  This  Agreement is the form available at ​http://ycombinator.com/documents and the 
Company  and  the  Investor  agree  that  neither  one  has modified the form, except to fill in blanks 
and  bracketed  terms.  The  choice  of  law  governing  any  dispute  or  claim  arising  out  of  or  in 
connection with this Agreement shall be consistent with that set forth in the Investor’s Safe. 

46
"Safe Financing Documents." Y Combinator. September 1, 2018. Accessed August 30, 2020. 
https://www.ycombinator.com/documents/​. 

94 Ventures
IN WITNESS WHEREOF, the undersigned have caused this Agreement to be duly executed 
and delivered. 

[COMPANY NAME] 

By:_____________________________ 
[​name​] 
[​title​] 

[INVESTOR NAME] 

By: ____________________________ 
Name: _________________________ 
Title: ​___________________________ 

Ventures 95
5.5. More examples 
5.5.1. Example 1: cap table and the importance of building in previous convertibles 

Below is a typical cap table of a startup that has not raised an equity round yet. 

Table 5.1 Typical cap table for a startup that has never raised an equity round 
Name  Shares  % Equity 

Founder 1  4,000,000  40% 

Founder 2  4,000,000  40% 

Employee pool  2,000,000  20% 

Total shares  10,000,000  100% 

However,  they  may  have  raised  money  on  convertible  instruments  (Notes/SAFEs)  that 
have not converted yet. Below is a list of what they’ve raised and at what valuation cap. 

Table 5.2 Convertible notes/SAFEs that this startup has raised 

Name  Conversion shares  Amount  Pre-money 
added  Valuation cap 

Investor 1  $500,000  $5,000,000 

Investor 2  $500,000  $5,000,000 

Total  2,000,000  $1,000,000 

Plug  and  Play  Investment:  $100,000  in  a  SAFE  with  a  $10 million pre-money valuation 

cap  and  a  20%  discount.  Please  see  the  next  section  for the conversion mechanics of 2 
situations:  

1. Convertibles are not built into Plug and Play’s investment

2. Convertibles are built into Plug and Play’s investment

The difference is substantial. 

96 Ventures
Table 5.3 Conversion mechanics under two situations 
1. Convertibles ​Not​ Built In 2. Convertibles Built In

Plug and Play Conversion  $1.00  $0.83 

PPS 

Plug and Play shares  100,000  120,481 

Plug and Play total equity  0.83%  1% 

Plug and Play effective  ~$12 million  ~$10 million 

valuation 

The  difference  between  situations  1  and  2  depends  on  whether  or  not Plug and Play is 
dividing  the  valuation  cap  ($10  million)  by  a  number  of  shares  that  includes  the 
Conversion Shares (Table 5.2) from the $1 million investment ($5 million valuation cap): 

Situation 1: 
Conversion PPS = Valuation cap / Total shares​ (Table 5.1) 
Conversion PPS = $10,000,000 / 10,000,000 
Conversion PPS = $1.00 

Situation 2: 
Conversion PPS = Valuation cap / (Total shares​ (Table 5.1) ​+ Conversion shares 
(Table 5.2)​) 
Conversion PPS = $10,000,000 / (10,000,000 + 2,000,000) 
Conversion PPS = $0.83 

See below for the calculations used to fill in the rest of the information: 

Plug and Play shares​ = Plug and Play investment / Conversion PPS 
Plug and Play total equity​ = Plug and Play shares / Fully diluted shares 
Plug and Play total equity​ = Plug and Play shares / (10M shares + 2M conversion 
shares + Plug and Play shares) 
Plug and Play effective pre-money valuation​ = Conversion PPS * (Total shares + 
Conversion shares) 

Ventures 97
 Plug and Play effective pre-money valuation​ = Conversion PPS * (10M shares + 2M 
shares) 
 
These calculations depend on how Capitalization is defined in the Note/SAFE. 
 
5.5.2. Example  2:  advisory  shares:  how  to  model  advisory  shares  to  get  target 
equity % 

Using  Table  5.1  and  Table  5.3  in  Example  1,  it  is  easy  to  calculate  the  percentage 
advisory  shares  Plug  and  Play  need  in  order  to  reach  the  agreed  upon  1%  if  Plug  and 
Play decides to not build in the previous convertibles. 
 
Table 5.4 Conversion with convertibles not built in 
  Convertibles ​Not​ Built In 

Plug and Play Conversion PPS  $1.00 

Plug and Play shares  100,000 

Plug and Play total equity  0.83% 

Plug and Play effective valuation  ~$12 million 

 
The  company  would  need  to  give  Plug  and  Play  0.17%  in  advisory  shares  for Plug and 
Play  to  truly  reach  1%  in  a  vacuum.  When  calculating  how  many  shares equals 0.17%, 
the  Fully  Diluted  Share  number  that  includes  the Conversion Shares from Table 5.2 and 
Plug and Play’s Conversion Shares in Table 5.3 is used. 
 
Advisory shares percentage​ = 1 - Plug and Play total equity 
Advisory shares percentage​ = 0.17% 
Plug and Play advisory shares​ = Advisory shares percentage * Fully diluted shares / (1 
- Advisory shares percentage) 
Plug and Play advisory shares​ = 0.0017 * (10M shares + 2M shares) / (1-0.0017) 
Plug and Play advisory shares​ = 20,434 
 
To check that Plug and Play indeed holds 1%, see below: 
 
1.00% = (Plug and Play advisory shares + Plug and Play conversion shares) / Fully 
diluted shares 

98
  Ventures
 1.00% = (20,434 shares + 100,000 shares) / (10M shares + 2M shares + 100,000 
shares + 20,434 shares) 
1.00% = 1.00% 

Note:  The  actual  percentage  won’t  be  exactly  1.00%,  but  this  is  normal;  it  is  usually 
0.99%. 

5.5.3. Example 3: converting at either discount or cap 

Assuming  that  the  company has 10 million shares at the time they raise their series A at 

a $10 million pre-money valuation. The PPS would be $1.00. Also assume that Plug and 
Play  has  a  $100k  SAFE  that  is converting at either a $10 million valuation cap or a 20% 
discount off of Series A. 

Table 5.5 Conversion mechanics under two situations 

1. $10 million Valuation cap 2. 20% discount

Plug and Play  $1.00  $0.80 

Conversion PPS 

Plug and Play  100,000  125,000 

conversion shares 

In this case, it is economically better for Plug and Play to convert at a discount. 

5.5.4. Example 4: cap table and the importance of building in employee pool 

The cap table below does not have an employee pool. 

Table 5.6 Cap table of a company without an employee pool 

Name  Stock  % Equity 

Founder 1  5,000,000  50% 

Founder 2  5,000,000  50% 

Total  10,000,000  100% 

If  Plug  and  Play  is  receiving  1%  advisory  shares  at  this  time,  the  cap  table  would  look 
like the following: 

Ventures 99
 Table 5.7 Cap table of the company after Plug and Play receives 1% advisory shares 
Name  Stock  % Equity 

Founder 1  5,000,000  49.5% 

Founder 2  5,000,000  49.5% 

Plug and Play  101,010  1% 

Total  10,101,010  100% 

 
Now  imagine  the  founders  decide  to make a 10% pool after Plug and Play is granted its 
1% advisory shares: 
 
Table  5.8  Cap  table  of  the  company  after  Plug  and  Play  receives  1%  advisory  shares 
and the employee pool is set up 
Name  Stock  % Equity 

Founder 1  5,000,000  44.55% 

Founder 2  5,000,000  44.55% 

Plug and Play  101,010  0.89% 

Employee pool  1,122,334  10% 

Total  11,223,344  100% 

 
If  Plug  and  Play  does  not  encourage  the  company  to  make  an  employee pool, Plug and 
Play is not truly receiving 1% of a company that includes a team. 
 
5.5.5. Example 5: effective valuation and advisory shares 

Plug  and  Play  is  investing  $100k  in  a  SAFE  with  a  $20  million  valuation  cap  (about 
0.5% equity i.e. $100k / $20 million = 0.005; 0.005 x 100 = 0.5%. 
 
The company is pre-revenue and consists of two founders. 
 

100
  Ventures
Plug  and  Play  determines  that  the  company  is  not  worth  $20  million  and  decides  to 
negotiate  for  advisory  shares  to  drop  the  effective  valuation  to  something  more 
reasonable. 

If  Plug  and  Play’s  target  valuation  is  about  $6.5  million,  Plug  and  Play  will  push  for 
about 1% advisory shares. 
● Equity from Investment: 0.5%
● Advisory Shares: 1.00%
● Total Equity: 1.50%

To calculate effective valuation with advisory shares, use the following equation: 

Effective valuation​ = Investment amount / Total equity (expressed as a decimal) 

Effective valuation​ = $100,000 / 0.015 
Effective valuation​ = $6.6 million 

5.5.6. Example 6: exits 

Investors  commit  $2  million  at  a  $20  million  pre-money  valuation cap buying about 9% 

- in a vacuum - in the company ($2 million / $22 million = 0.090).

Current cap table at time of acquisition: 

Table 5.9 Cap table of a company at time of acquisition 

Name  Stock  % Equity 

Founder 1  5,000,000  50% 

Founder 2  5,000,000  50% 

Total  10,000,000  100% 

Scenario 1 
Company  is  acquired  for  $5  million  and  the  investors  have  to  decide  to  either  elect  to 
receive  their  money  back  ($2  million)  or  convert  to  common  stock  at their valuation cap 
and share ratably in the proceeds. If they convert, the cap table will look like this: 

Ventures 101
 Table 5.10 Cap table of the company if investors convert to common stock 
Name  Stock  % Equity 

Founder 1  5,000,000  45.45% 

Founder 2  5,000,000  45.45% 

Investors  1,000,000  9.09% 

Total  11,000,000  100% 

The  distribution  will  look  like  the  following  (%  Equity  of  the  total  proceeds  i.e.  $5 
million): 

Table 5.11 Distribution of equity if investors convert to common stock 

Name  % Equity  Value of equity 

Founder 1  45.45%  $2.27 million 

Founder 2  45.45%  $2.27 million 

Investors  9.09%  $454 thousand 

Total  100%  $5 million 

The  investors  can  either  elect  to  receive  1x their money back ($2 million), or convert the 

common stock and receive $454K in shares value. They’ll most certainly take the former. 

Scenario 2 

The  company  was  acquired for $25 million. The investors can either receive their money 

back  ($2  million)  or  convert  to  common.  If  they  convert  to common and share ratably in 
the proceeds, the distribution will look somewhat like the following: 

Table 5.12 Distribution of equity when the company was acquired 

Name  % Equity  Value of equity 

Founder 1  45.45%  $11.3 million 

Founder 2  45.45%  $11.3 million 

102 Ventures
 Investors  9.09%  $2.2 million 

Total  100%  $25 million 

In  this  case,  the  investors  will  elect  to  convert  to  common  stock  and  receive  an  extra 
$200K. 

A  rule  of  thumb  that  only  applies  to  acquisitions  prior  to  the  company’s  first  priced 
round​:  If  the  total  proceeds  of the acquisition is higher than the post money valuation of 
the  capped  SAFEs/convertible  notes,  most  times  the  investors  will  convert  to  common. 
In  the  examples  above,  the  post  money  valuation  of  the  investment  is  $22  million  ($2 
million  investment  on  a  $20  million  pre-money  valuation  cap).  If  the  total  proceeds  are 
not  higher  than  $22  million,  investors  will  most  likely  elect  to  receive  their  investment 
back in full. 

Ventures 103
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 VENTURE
CAPITAL
101
HANDBOOK
© PLUG AND PLAY VENTURES

AUTHORS / FAN WEN, JANIS SKRIVERIS, KRISTI CHOI

CONTRIBUTORS / IVAN ZGOMBA, GEORGE DAMOUNY, NOORJIT SIDHU,
MARC STEINER, FRANK VELASQUEZ

THIS DOCUMENT IS STRICTLY FOR INTERNAL CIRCULATION ONLY