Demistifying Term Sheets: Part 7 - Protective Provisions

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 the following section we discuss some of the most important parts of the term sheet, which we include to ensure alignment on governance.

Protective Provisions

Protective provisions (important decisions) are effectively veto rights granted to preferred shareholders, allowing them to approve or block specific corporate actions. These provisions ensure investors can protect their interests and influence significant decisions that could impact the company’s trajectory or their returns.

How Investors Protect their Interests

Here are common areas where protective provisions are applied:

• Issuing new equity or debt: Prevents excessive dilution of existing shares or unsustainable leverage that could jeopardize the company’s financial health.
• M&A or sale of assets: Ensures that major corporate events align with investor return expectations.
• Amendments to corporate documents: Provides oversight for changes that might affect the rights of preferred shareholders or the company’s governance.
• Dividends and distributions: Safeguards preferred shareholders’ financial priorities when profits are distributed.
• Change in control or key management roles: Allows investors to influence decisions related to leadership transitions or control shifts, ensuring strategic alignment.

Why Protective Provisions Matter

Protective provisions were once a focal point of negotiation, but over time, they have largely become standardised, reflecting a balance between investor safeguards and operational flexibility. When crafted carefully, they foster alignment and trust between stakeholders.

Key Takeaways

Cardumen Insight

‍Protective provisions should safeguard critical investor interests while allowing founders the freedom to execute. As investors, we don’t seek to block the company’s actions but rather to be part of the conversation, ensuring alignment and fostering a collaborative approach to decision-making.