Term Sheets: Breaking Down the Breakdown, Part III

There are no guarantees in business, but when it comes to getting your startup its share of the venture capital pie, you can expect any VC to want as sure-fire a deal as possible. Preference is part of the package, but a variety of protections will also be in the fine print.

One area of protection venture capitalists are concerned about is in anti-dilution. Anti-dilution terms protect the VC against losing valuation during subsequent rounds of funding. If the VC buys in during the Series A round, and a later round brings a lower share price while devaluing the company, the VC stands to lose a significant percentage on its investment. Anti-dilution terms ensure that, in this scenario, the VCs holdings will be increased to mitigate its losses. There are three forms of anti-dilution protection, all three of which award Series A investors with additional shares to balance their holdings. Of the three, "full-ratchet" protection — which effectively grants the Series A investor enough shares to meet the Series B price — is to be avoided if at all possible.

by Joann Yates

Full Story: http://blogs.sun.com/sun4startups/entry/term_sheets_breaking_down_the2