Startup Incorporation and Funding: Founder Friendly Standard Term Sheet

Founder Friendly Standard is a checklist of legal issues that can influence whether entrepreneurs run their companies or merely take orders from investors. Published in November of 2017, Founder Friendly Standard is the first startup investment template to define “founder-friendly” from the perspective of the entrepreneur. Other popular financing agreements are written by investors; see how they compare in this infographic: https://eisaiah.blog/founder-friendly-standard-...
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This U.S. startup investment term sheet is based on the Founder Friendly Standard v1.1. Founder Friendly Standard LLC (“FFS”) is publishing this term sheet for informational purposes only. FFS is not providing you with legal, investment, tax, or professional advice of any kind. Please consult with an attorney who is licensed in your locale before using this term sheet. FFS makes no representations or warranties as to the accuracy or completeness of the statements contained in this document and expressly disclaims all liability (including any direct, indirect, or consequential loss or damages) for this term sheet and its contents. FFS licenses this term sheet to you under CC BY-ND 4.0 https://creativecommons.org/licenses/by-nd/4.0/. Founder Friendly Standard is a registered trademark of Founder Friendly Standard LLC in Dallas, TX, USA.

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FOUNDER FRIENDLY STANDARD TERM SHEET FOR [COMPANY]

THE OFFERING

Company:

[__________], a ___________ corporation (the “Company”)

Investor:

[__________], a ___________ (the “Investor”)

Securities:

Series A Preferred Stock (the “Preferred”), convertible into Class B Common Stock (1 vote per share)

Valuation:

$[__________] pre-money

Amount of the offering:

$[__________]

Number of shares:

[__________] shares

Price per share:

$[__________] (the “Original Purchase Price”)

FOUNDERS

Founders:

[__________]

Founder Stock:

Class A Common Stock (24 votes per share)

Founder Stock Terms:

Founders’ stock shall be subject to a repurchase right reflecting a 4-year vesting schedule consistent with the vesting terms in the Employee Options section below and shall convert to Class B Common Stock upon any transfer of ownership or sale (including any estate planning transfer).

OFFERING INVESTMENT TERMS

Liquidation preference:

In the event of a liquidation, dissolution or winding up of the Company, the Preferred will have the right to receive the Original Purchase Price plus any declared and unpaid dividends prior to any distribution to the common stock. The remaining assets will be distributed pro rata to the holders of common stock. A sale of all or substantially all of the Company’s assets, or of its intellectual property, or a merger or consolidation of the Company with any other company will be treated as a liquidation of the Company.

Conversion:

The Preferred may be converted at any time, at the option of the holder, into shares of Class B common stock. Mandatory conversion shall occur upon the closing of a firmly underwritten public offering of the Company’s common stock or the consent of holders of a majority of the shares of the Preferred that are then outstanding.

Dividends:

8% of par value, if and when declared by the Board of Directors, prior and in preference to payment of dividends on any other stock.

General voting rights:

Each share of the Preferred will have the right to a number of votes equal to the number of shares of common stock issuable upon conversion of each such share of the Preferred.

Protective provisions:

So long as any of the Preferred is outstanding, consent of the holders of at least 50% of the Preferred will be required for any action that: (i) alters any provision of the certificate of incorporation if it would adversely alter the rights, preferences, privileges or powers of the Preferred; (ii) changes the authorized number of shares of the Preferred; or (iii) authorizes or creates any security that ranks senior to or on par with the Preferred.

INVESTOR RIGHTS & CORPORATE GOVERNANCE

Participation rights:

Major Investors (20% holders) may purchase a pro rata share of any new securities offering by the Company, subject to reasonable exceptions. The pro rata share is calculated as the ratio of (x) the number of shares of Preferred held by such Major Investor (on an as-converted basis) to (y) the Company’s fully-diluted capitalization (on an as-converted and as-exercised basis). This right terminates upon the Company’s initial public offering or an acquisition of the Company. Such rights shall be assignable to affiliated entities, partners, members, successors and commonly controlled funds.

Registration rights:

Piggyback and SEC Form S-3 registration rights (or other rights consistent with local securities regulations).

Information rights:

Investors shall have the right to receive annual financial statements, the Company’s annual budget, as well as quarterly and monthly financial statements.

Tax and Audit:

Company agrees to hire a certified public accountant to prepare and file its tax returns. Beginning three years from the date of this investment, Company agrees to hire a certified public accountant to audit its financials once per year.

Board composition:

Each term of the Board of Directors (the “Board”) shall be one year. For one year beginning on the date of investment, the Board shall be comprised only of the Company’s Founders or managers selected by the Founders. For two years following the date of investment, the Board shall not delegate supervisory or decision-making authority to any Board committee or other body.

Transfer restriction:

180-day lock-up period following an public offering. Bylaws and option plan documents shall include limitations on certain transfers, including on secondary markets, to competitors, or that may trigger public reporting obligations.

Employee options:

All employee options shall be convertible into Class B common stock, and vest as follows: 25% after one year, with remaining vesting monthly over next 36 months. Employees, including Founders, are advised to consult with a tax advisor concerning the possible tax consequences of any equity issuances, including the impact of an IRC Section 83(b) election for US taxpayers.

Employee evaluations:

Founders (or as necessary, divisional or segment managers) shall conduct performance reviews for all employees (or each other as applicable) including themselves on a quarterly basis for at least 4 years, or until the Board resolves otherwise, whichever is later.

ROFR/Co-sale agreement:

All shareholders grant first refusal and co-sale rights to the Company and the investors (as applicable).

Purchase agreement:

The investment shall be made pursuant to a Stock Purchase Agreement with appropriate representations and warranties, covenants and conditions of closing.

Intention of the Parties

Company and Investor agree that the enclosed exhibit, “The Founder Friendly Standard” captures the intent of the parties in creating this Agreement. In the event of any discrepancy between this Agreement and the Founder Friendly Standard, the Founder Friendly Standard will prevail. The enclosed exhibit is an exact copy of version 1 retrieved from https://eisaiah.blog/founder-friendly-standard/

Exhibit “The Founder Friendly Standard”

A company meets the Founder Friendly Standard v1.1 when its equity, financing, corporate governance, and founder labor agreements meet all standards from every section below:

Section 1. Voting equity

These standards set boundaries for voting equity.

1.1 Individuals who work for the company and are instrumental in its inception (“Founders”) receive a class of equity such as Common Stock which provides no less than twenty-four (24) votes to one (1) vote of stock held by investors or employees.

1.2 Investors receive a class of equity such as Class A Preferred Stock which will have one vote per share with a higher par value justified by a liquidation preference.

1.3 Employees and contractors receive a class of equity such as Class B Common Stock which carries one vote per share and does not have a liquidation preference.

1.4 The first board consists only of Founders. The term of the board is one year. After the first year, a new board is elected by the equity holders at the annual meeting. Board decisions are made by a majority vote of the board. Board members cast no more than one vote each on any decision. Board committees are disallowed for at least the first two (2) years.

1.5 New equity of any kind, including stock option pools, dilutes all equity holders equally. Therefore, no investor in the company has anti-dilution rights of any kind.

Section 2. Sweat equity

These standards set boundaries for equity received in exchange for services or “sweat equity.”

2.1 Founders agree in writing they will give and receive performance reviews at the end of each fiscal quarter for the first four (4) years.

2.2 Sweat equity vests each month over a period of four (4) years with a one (1) year vesting cliff. Vesting begins on the date shares are issued.

2.3 Founders keep all information confidential and assign the company all intellectual property created within the scope of their work for the company.

2.4 Due to potentially devastating tax consequences, the company tells individuals receiving sweat equity in the United States to consult with a tax professional about making an election under Section 83(b) of the Internal Revenue Code. Founders who live or pay taxes outside the United States are similarly advised to consult tax professionals about applicable local and national taxes.

2.5 Non-compete restrictions only apply to employee or independent contractor agreements and do not survive termination. The company’s bylaws and other investor agreements are either silent on the issue of non-competition or expressly allow competition.

Section 3. Law

These standards set legal boundaries.

3.1 For at least the first two (2) years of operations, the company does not agree to pay the legal expenses of any investor as a condition of investment.

3.2 For at least the first two (2) years of operations, the company does not agree to binding arbitration with any investor.

3.3 For at least the first two (2) years of operations, the company does not agree to binding arbitration with any Founder.

Section 4. Transfers

These standards set boundaries for equity transfers.

4.1 Upon any transfer or sale of Founders’ super-voting equity, the portion of equity transferred converts to the class of equity described in Section 1.3. This also includes any transfer to Founder’s estate, spouse, or heirs.

4.2 The company has the right of first refusal on any transfer or sale of equity for up to forty-five (45) days, but it cannot veto a transfer or sale. This provision is void after a company’s stock is listed on a public exchange such as the NASDAQ, OTCBB, New York Stock Exchange, etc.

Section 5. Usage

These standards attach the Founder Friendly Standard to a company’s agreements.

5.1 The company’s equity, financing, corporate governance, and Founder labor agreements invoke the Founder Friendly Standard as follows: Intention of the Parties. The Parties agree that the enclosed exhibit, “The Founder Friendly Standard” captures the intent of the parties in creating this Agreement. In the event of any discrepancy between this Agreement and the Founder Friendly Standard, the Founder Friendly Standard will prevail. The enclosed exhibit is an exact copy of version 1 retrieved from https://eisaiah.blog/founder-friendly-standard/.

5.2 By using The Founder Friendly Standard, you agree that the Founder Friendly Standard LLC is not providing you with legal or tax advice and is not a party to any agreement where this work is attached. This work is licensed to you under CC BY-ND 4.0 which can be found online at https://creativecommons.org/licenses/by-nd/4.0/. Founder Friendly Standard is a registered trademark of Founder Friendly Standard LLC in Dallas, TX, USA.