1. Introduction

In the previous section, we have seen how we can divide the financial returns of a venture between the VC and the entrepreneur to bridge valuation gaps, align the incentives of the two parties, and make deals more valuable.

In this section, we get to know popular tools and deal clauses that VCs use to defend their financial interests during the investment period. The major elements are:

  • Anti-Dilution Protection: These clauses adjust the valuation for the VC in the case that investors in subsequent rounds of financing receive more favorable terms. The two most common provisions are the so-called:
    • Full ratchet anti-dilution
    • Weighted average anti-dilution

 

  • Approval Rights: Make sure that the VC has a say and can participate in attractive stock transactions and future rounds of financing. In this context the most common provisions are:
    • Right of first refusal
    • Tag-along rights
    • Preemptive rights.

 

These deal terms usually do not come free of charge for the VC. They are often subject to a "Pay-to-Play" provision that grants the VC special treatment only if he participates pro rata in future rounds of financing.

The following section look at these important elements in more detail.