Common Docs
To develop Common Docs, NACO created a taskforce of members and stakeholders to establish nationally applicable standardized term sheets for angel stage deals.
Standardizing Deal Structure
This project was designed to develop standards that guide investors and founders to structure deals that align their interests, position the company for future investment and growth, protect the rights of each party, and reduce some of the friction inherent in negotiating deal terms. Common Docs are a community resource meant for adoption and use by those working on early financials.
Term Sheet
Use
Pros
Cons
A Common Share deal aligns founders and funders with the same class of shares, and fully negotiates all rights and terms in the Shareholders' Agreement. It may be used at any stage of deal before a Series A, as long as valuation can be agreed upon.
Creates alignment between the founder and investor
Relatively easy and commonly accepted form of term sheet
Avoids different share classes and onerous calculations
Relatively quick and simple to negotiate and execute
Requires a sophisticated investor who can negotiate valuation and additional terms
Due to the required sophistication, it is not a good fit for the Family & Friend investment stage
May not include all the protections an investor wants
It may lock in valuation too early
May not work for US investors
This Preferred Share term sheet, also called "Preferred Light", is commonly used for a later and larger seed round.
Protects investor rights
Sets up the corporate structure in such a way that investor returns are paramount to other (Common) shareholders
Protects the investor against later and more powerful (institutional) investors
Investors from the U.S recognize and like Preferred Share term sheets
There is an element of unfairness to the founders
The term sheet can be complex
May have an impact on the ease of landing future rounds
A Convertible Loan is commonly used as part of the first financing of a company when valuation can't be agreed on, or as a bridge ahead of a larger Seed or Series A round.
Defers valuation discussion and may enable a 'rolling close'
Provides a route from an already priced round to a future priced round: it's the bridge to extend the runway and validate a price increase.
It is a relatively simple deal structure leading to a quick close
Investors are considered lenders and not shareholders and this may provide security rights to protect downside
Provides some flexibility
Often add pressure for investor returns
There are no shareholder rights or ways to influence
The Canadian Simple Agreement for Future Equity (SAFE) is modelled after the Y Combinator SAFE. In this template a cap, a discount, and a maturity date were added to make it more appropriate for the Canadian market.
It is a simple and fast agreement, a figurative 'papered handshake'
It favours the company much like a convertible loan can
It works best in a hot/active market with promising startups
It can assist with obtaining a tax credit in certain provinces
It is an open-ended deal and the investor can be left 'hanging'
Can be used inappropriately, if the founder is not properly knowledgeable on the structure
Some formats may not work in Canada
Explainers
To accompany the standard term sheets, NACO Common Docs produced a series of 'Explainers' to help investors determine which term sheet is best for a given investment.
When to Use Which Term Sheet
This graphic illustrates something discovered as part of the NACO Common Docs research into what is common and market in Canada. Different types of funding mechanisms by stage, as well as tendency for founder-led and investor-led mechanisms at different stages.
Friends & Family Guidance
As these are terms sheets for Angel investors and seed funds, it is important to note that very often outside investment is preceded by money from friends and family. Companies that just started and have no revenue, outside financing or even basic experience in raising outside financing have to rely on help from those sources that are close to home in addition to increasing the mortgage and maxing out the credit card: your uncle or some friends you know have some spare cash and are always willing to help. As easy and as straightforward as it may sound, consider the following case study.
Around 2007 a Vancouver-based tech company launched its first round of financing. Nothing unusual, but the valuation felt a bit on the high side for a company that had not even fully launched its product, $10 million.
The reason for the high valuation could be rationalized however. The founder had sold their first company during the tech boom in 1999 for $23 million in less than a year with barely a finished project. After a few years of enjoying their win and tinkering around with new ideas they were ‘going to do it again’. The expectations were high and the founders reckoned a $100 million exit was possible based on their understanding of the marketplace in particular now that Google had arrived on the scene making exactly those sort of acquisitions. Their market understanding was however limited as they had failed to see how the market had changed: potential acquirors were no longer snapping up ‘ideas’ they were buying tested ‘products’ that had some level of market traction. Here our founders fell short and in no time they had burned through the funds the eager family and friends had supplied thinking they were indeed going ‘to do it again’.
So when the angel market was approached there was almost immediate adverse reaction to the $10 million price tag, some investors rightly worrying about pain it would cause the family and friends group if funds had to be raised below the absurdly high $10 million level. As the investor group was seriously interested a solution was found by way of a convertible loan and while that did not solve the facility and friends issue, it did protect the new investor group that consisted of some larger angel investors from across Canada.
The company indeed got invited by Google to visit and discuss their product although in the end the discussions went nowhere, Google may have been able to get some good ideas out of the meetings but never followed up in the end. The company continued its march and found it harder and harder to raise funds and kept using convertible instruments as the valuation discussion went nowhere and the family and friends had to sit through a painful wait of where the company was headed, remember last time it took these founders only 1 year!
In 2012 the tide turned when a seasoned CEO was brought on who would drive the company’s pivot and commercialization plan, it even landed a term sheet from a Vancouver-based Venture Capital firm. That term sheet however put the value at where the market was: $4.5 million. It meant the family and friends had taken a huge paper loss and the company was not even close to being where it should have been in terms of product launch and revenue. The convertible loan holders were fine as the VC term sheet meant they could convert their original investment and the interest that accrued of almost 5 years into shares at a discount to the $4.5 million valuation the VC had given the company.
The founders, under some pressure, agreed to top up all the friends and family investors with an allocation out of their shares (and they had lots given the fact that both the high initial valuation and convertible had protected their pool) at the price point mandated by the VC. In the end the capitalization table looked very different and the founders addressed a mistake they had made and so managed to keep their relationships with those closest to them intact.
So, this is a key example of why it is so important to treat family and friends in a prudent way. These are the very people that are closest to you, that you love and that you will live with well beyond the timeline of any business deal. Under any normal circumstances you would probably not do business with them anyway precisely because your relationship with them is so important. The last thing you want to inflict on them is a financial loss.
So therefore there needs to be caution when involving mum or dad or your high buddies into writing a cheques into your startup, however promising the idea may be. The first step would be to be candid about the risk of the investment and get them to understand that they may well lose all their money. Once they are comfortable with that risk, one can move to next instrument and identify the best instrument to pair their investment. As the case study from Vancouver tells us, fixing a valuation is not the best approach and addressing it by giving family and friends a very low valuation may not be wise either. It is too early to valuate and if you go with a very low valuation it may end up hurting the founders and their position and also setting a potentially low bar for further angel and VC financing.
The best way therefore is to use convertible instruments and there are two at your disposal: a convertible loan or convertible equity (SAFE).
So whenever the people closest and dearest to you in your life want to invest in your company, do advise them of the risk and pick the best possible term sheet that will create the most value for them, whether Google acquires the business or not.
Due Diligence & Closing Docs
Companies should get in the habit from day one of having all of their corporate materials organized electronically. The day you get your incorporation certificate, create an (electronic) folder and start keeping your company records up to date.
Cloud file systems such as Dropbox or Google Drive make it easy to keep these documents organized, backed up, and available for review by investors.
Due Diligence Material to be Prepared by Company via Online Folder
Investor Materials
Business Plan
Slidedeck
Executive Summary
Corporate or Legal
Incorporation documents
Share Register
Articles of Incorporation
Capitalization (‘Cap’) Table
Financials
Accountant and management prepared historical financials
Budgets and forward looking projections (3 to 5 years ideally)
Week-to-week Cash Management Sheet
Finance Agreements
Agreements relating to any previous or current financings
Shareholder Loan Agreements
Bank Documentation
Credit Cards
Grants
National Research Council contribution agreements
Any other federal, provincial, municipal or private grant agreements
Team
Organization Chart
Founder & Employee Contracts
Consulting Contracts
Advisory Contracts
Team biographies and resumes
Employee Handbook
Employee Benefits Plan
Intellectual Property
Description of all IP
Patents and Provisional Patents
Tax File
All recent year-end tax filings
SR&ED documentation the company uses
GST filings & records
Business Development
Sales Pipeline
Sales Deck
Marketing Collateral
Promotional Materials
Commercial Contracts
All material sales contracts
Partnership Agreements
Licensing deals
Non-disclosure agreements
Media
Press clippings
Links to online coverage
Reports from third parties
Other
Any other relevant information
Closing Docs
Standard documentation to be signed on closing a Common, Preferred or Convertible Financing
Subscription Agreement
Shareholders Agreement
Share Certificates for each Investor
Updated Central Securities Register
Waiver of Preemptive Rights (if so required from existing shareholders)
Directors Resolution regarding Share Issuance
Voting Trust
Conversion of Shareholder Loans
Share Option Plan
Share Option Agreements and/or Share Option Agreements
Directors Resolution approving Share Option Plan
Key Employee Agreements
Vesting or Reverse Agreements
Intellectual Property (IP) Assignments (can be part of Employment Agreements)
Confidentiality Agreements (can be part of Employment Agreements)
Key Person Insurance
Consulting Agreements
Consulting IP Assignments
Register of Directors and Officers
Consent to act Director
Directors Resolutions
Director Indemnification Agreement
D & O Insurance
Property & Liability Insurance
Specifically for Convertible Loans
Convertible Loan Agreement
General Security Agreement
Directors Resolution approving issuance of Convertible
FAQs
When a convertible note is paid back, how should an investor treat the interest?
A convertible note’s interest, if the loan is paid back rather than converting, is treated as income. The interest earned — even if not paid yet — should be recorded annually.
I’m confused about Options, creating an Employee Share Option Plan, and Issuing Options
Stay tuned! We’ll publish an Explainer on this.
My (potential) US Investors have questions, what should I tell them?
Stay tuned! We’ll publish an Explainer on this.
For now, you can tell them we’re not crazy for using Common Share term sheets. In Canada, unlike the US, this does not cause tax issues for founders or employees related to share or option values.
Do you have the full Subscription Agreement to go along with the Term Sheets?
Not yet. Future work may include full Subscription Agreements. The Canadian SAFE, however, is the entire agreement.
These materials seem somewhat out of date and may have an error or two. Do you have any plans to update them?
Yes! Common Docs 2.0 is under way. If you registered to access this version of Common Docs, you will be notified by email when the updated materials are available.
Are you a recognized expert in this area and interested in contributing to Common Docs 2.0?
Please email us at [email protected].