TEN Capital’s Early Exit term sheet is a convertible note with a 3X in 3 year redemption right at “investor sole discretion”
to provide the investor an option for an early exit.
Early Exit Deal Structure
A 3X return in year three from the initial investment yields an IRR of 44%
See How the TEN Capital Early Exit Program Works
Benefits
- Define the exit for your investment since most startups raising equity funding cannot
- Provides the option of short-term exit or long-term equity investment
- Give the startup the opportunity to prove itself and then choose between holding a short or long-term investment
- Easier to implement than revenue-based funding
Features
- Define the exit for your investment since most startups raising equity funding cannot
- Provides the option of short-term exit or long-term equity investment
- Give the startup the opportunity to prove itself and then choose between holding a short or long-term investment
- Easier to implement than revenue-based funding
What exactly does 3X in 3 years mean?
The investor receives 3 times their investment 3 years from the date of investment. So $100K in yields $300K out.
Why use this structure?
I analyzed the results of several angel networks and found that 65% of the investments after three years were still in business but were no longer on the venture track. In most cases, they were growing businesses but were not going to be bought out for a significant return to the investor as the market conditions had changed, the competition had taken over, or the founder was no longer interested in keeping pace to achieve a venture exit.
The best-case scenario was the entrepreneur would sell the business for 2 to 3X after 10 years in which case the investor would get a minimum internal rate of return.
In my investing experience, three years into the investment it became clear if the company would remain on the venture path or not. This was due to competition in the market, a difficult fundraising environment, or just plain poor performance by the company.
I often saw the entrepreneur signal their departure from the venture path by taking above-market rate salaries. I called this taking the “payroll exit” in which case they no longer needed an “equity exit”. This left the investor stranded on the equity plan with no way out.
Since there is no liquid market for private company shares of this type any effort to negotiate a buyout with the startup team was met with a firm ‘no’ or an offer in the range of ten cents on the dollar.
Building your Entrepreneur Ecosystem
I have found a number of investors want to build their entrepreneur community as part of their investment thesis. Those who do will find the 3X in 3 Terms Sheet a useful tool.
To provide funds to more startups you could take the proceeds from one investment to share with the other startups.
For example, a $50 investment would yield $150K in 3 years.
You could take the $150K as follows:
- $50K -Return to investor funds
- $50K -Leave in the startup as equity or debt
- Give the startup the opportunity to prove itself and then choose between holding a short or long-term investment
- $50K -Take from the first startup to fund a second startup or leave in the first startup
This creates an evergreen fund for funding more startups. The most common lament from a startup investor is, ‘I invested my available funds and must wait till I see something return before investing more.’
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FAQs
A Redemption Right gives the investor or startup a right to redeem an ownership stake in the company.
The TEN Capital Early Exit term sheet includes a 3X redemption right giving the investor the sole discretion over their right to 3X their investment ($100K in equals $300K out), at the three-year mark from the date of the investment. Investor Sole Discretion means each investor makes their own decision
Near the three year mark, the investor will have 30 days to decide if they are going to take the redemption or refuse it. If the investor takes the redemption, the payback will commence on the three-year mark. If the investor refuses the right, then the convertible note will mature and the investment will convert to equity. The investor will then receive a return when the business reaches a liquidity event which is primarily by selling the company or going public.
“Maturity Redemption Option. Unless earlier converted into Conversion Units per Sections 2.1 and 2.2, this Note may be, at the option of the Investor, redeemed sixty (60) months from the Date of Issuance of the first Note in the Series for the Corporate Transaction Payment (hereinafter the “Redemption Amount”). From the date which is sixty (60) months after the Date of Issuance of the first note in the Series, the Investor shall have thirty (30) calendar days to notify Company in writing as to its election to receive the Redemption Amount. The Company agrees to pay Investors the Redemption Amount within thirty (30) calendar days after the Investor makes such an election. Should an Investor not elect to receive the Redemption Amount, it is assumed that the Investor’s Note shall continue on under the same terms of this Agreement and the Investor is not further eligible to redeem their Note except for under the applicable conditions of this Section 2.”
This term means the investor has the sole decision on taking the redemption right and does not require a majority vote by other investors or the company
The company typically pays back in a lump sum or a series of monthly payments spread over 6 to 12 months. Since it can be a rather large cash outlay, some companies start escrowing money a year in advance.
If the company cannot pay, then a workout plan is negotiated. The terms of the redemption right give investors consent rights over the company’s cash expenditures. The interest rate continues to charge. If the payback requires more than one year to return the funds, then an increased payment is required to maintain the original IRR.
“Maturity Redemption Option Workout. If the Company is unable to meet the obligations of the Corporate Transaction Payment upon the request of the Majority in Interest, the Majority in Interest shall be entitled to elect a majority of the Company’s Board of Directors, or shall have consent rights on Company cash expenditures, until such amounts are paid in full.”
Usury applies to loans below a threshold set by the state in which the company is operating which is typically $250K to $300K. It caps annual interest rates at 18%.
There’s an interest rate set in the note for ongoing accumulation while the funds are kept in debt form. The interest is not paid out but rather rolled into the equity amount should the investor give up the redemption right and go onto the company’s cap table.
In the event of an early exit, the interest payment continues till the debt is paid off. Typical interest rates are around 10%.
If the revenueis lower than that, the company is at risk for startup failure. If it’s above $500K then it will most likely remain an ongoing business
Since TEN Capital is not a broker we are not performing compliance-level due diligence but rather compiling standard due diligence documents for each investor to review and determine if the company meets their requirements.
Depending on the outstanding debt the company is holding the investor could lay claim to the assets which in most cases includes the patents. There is also an opportunity to take over the business. Finally, it’s a tax return writeup.
Always calculate the IRR on the counter-proposal. Most of the time, the IRR on the counter-proposal is substantially lower than the 44% IRR angel investors want. If the IRR drops substantially consider asking for a “personal guarantee.” Most startups aren’t aware that loans in particular SBA loans come with personal guarantees and must be paid back. If the startup wants a lower rate then perhaps they can sign up for a personal guarantee. This is no longer angel investing but now is lending. If you are interested in lending, you must decide for yourself if you want to pursue the deal.