Demistifying Term Sheets: Part 5 - Conversion

Negotiating a term sheet can feel like walking a tightrope, a delicate balance between ambition and protection for both entrepreneurs and investors. Every line of a term sheet carries weight, telling a story about the future of a business. Drawing from years of experience in the VC play, we are pulling back the curtain to highlight what really matters in a term sheet, how both sides should approach it, and the lessons we have learned (sometimes the hard way) to avoid common pitfalls.

In the spirit of transparency, we are sharing a copy of our full term sheet template here.

This article is meant to serve as a guide to navigating term sheet negotiations, highlighting the most critical clauses, and sharing tips for both entrepreneurs and investors. Our term sheet reflects how we do things differently. When our founders Gonzalo Martínez de Azagra and Igor de la Sota set up the fund, they did not just replicate existing VC practices, they built something that truly represents Cardumen Capital’s values.

That said, this guide is not set in stone; it is a living document that evolves as the market changes. But before diving into the details, here is an important starting point: a term sheet is not a promise to invest, in other words, it is not a legally binding document. Even when signed, it is not a guarantee of funding. Instead, it should be seen more as an agreement to keep negotiations private and, in some cases, to pause the company from exploring other offers for a certain period of time.

Now, let us get down to business. While every term sheet is unique, just like every investment offer, there are certain key terms that almost always come up in negotiations. Keep reading to learn what these are and why they matter.

In this article we will shed some light on conversion rights.

Conversion

The conversion term governs how and when preferred shares can be converted into common stock. Preferred shareholders always have the right to convert their shares into common stock, typically at a 1:1 ratio.

When is the Right to Convert Used?

• In a liquidation event: If the payout from common shares exceeds the liquidation preference, investors may choose to convert to maximise returns.
• For voting control: Preferred shareholders might convert if they want to influence or align with common shareholder decisions.

Additionally, there is automatic conversion, a mechanism triggered by specific events:

• Qualified IPO: Preferred shares automatically convert to common shares when the company goes public, typically tied to thresholds like minimum share price or proceeds raised.
• ‍Preferred majority vote: Automatic conversion can also occur if a majority of preferred shareholders vote in favour.

Key Takeaways

Cardumen Insight‍

Standard conversion terms, like a 1:1 ratio and automatic conversion on a qualified IPO, are designed to streamline transitions during key milestones. Clear, well-defined triggers ensure these provisions work seamlessly for both founders and investors.

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