How can you identify equity instruments in term sheets?

1 Common Stock

Common stock is the simplest and most basic form of equity instrument. It represents a proportional share of the company's ownership, voting rights, and dividends. Common stockholders are the last in line to receive any payouts in the event of a liquidation or sale of the company, after all the debts and preferred stockholders are paid. Common stock is usually issued to the founders, employees, and early-stage investors who are willing to take more risk for higher potential returns. To identify common stock in term sheets, look for clauses that specify the number of shares, the price per share, and the percentage of ownership that the investors will receive.

2 Preferred Stock

Preferred stock is a more complex and flexible form of equity instrument. It represents a preferential claim on the company's assets and profits, as well as some additional rights and protections that are negotiated between the investors and the founders. Preferred stockholders are usually paid before common stockholders in the event of a liquidation or sale of the company, and they may also have a fixed or variable dividend rate, a conversion option to common stock, and anti-dilution provisions. Preferred stock is typically issued to later-stage investors who want to minimize their risk and secure their returns. To identify preferred stock in term sheets, look for clauses that specify the type of preference (participating or non-participating), the liquidation multiple, the dividend rate, the conversion ratio, and the anti-dilution mechanism.

3 Convertible Debt

Convertible debt is a hybrid form of equity instrument that combines the features of debt and equity. It represents a loan that the investors provide to the company, which can be converted into equity at a later date, usually at a discounted price. Convertible debt allows the investors to defer the valuation of the company until a future financing round, and to enjoy some interest income and seniority over equity holders in the event of a liquidation or sale of the company. Convertible debt is often used by early-stage investors who want to bridge the gap between seed and series A rounds, or by strategic partners who want to align their interests with the company. To identify convertible debt in term sheets, look for clauses that specify the principal amount, the interest rate, the maturity date, the conversion trigger, the conversion price, and the valuation cap.