The Startup CPG Podcast


In this episode of the Startup CPG Podcast, host Daniel Scharff sits down with Adam Marsh and Gabrielle McGonagle, partners at Giannuzzi Lewendon, a top-tier CPG law firm, for a deep dive on term sheets and what every founder needs to understand before raising capital.


Adam has spent nearly 13 years practicing law focused on the CPG space, while Gabrielle brings over a decade of experience at the firm, including work on major exits like BodyArmor's $8 billion sale. Together, they've guided countless CPG brands through fundraising, from pre-revenue startups to companies doing nine figures in revenue, and are frequent partners of Startup CPG's Founders and Funders events.


Daniel, Adam, and Gabrielle break down what a term sheet actually is, why founders should consider proposing their own terms instead of waiting on investors, and the key levers, beyond valuation, that determine how good a deal really is. They cover protective provisions, board control, liquidation preferences, option pools, redemption rights, and more, offering founders a practical framework for knowing what to fight for and what to let go.


Listen in as they discuss:

  • What a term sheet actually is, and why founders should consider proposing their own
  • Why negotiating a term sheet properly upfront saves time and money in the long run
  • What investor blocking rights (protective provisions) are, and how far they can extend
  • Why a seemingly small board block can function as a backdoor block on future financing
  • The critical difference between protective provisions held by an investor versus a board director
  • Why budget approval rights should stay at the board level, not the investor level
  • How founders can maintain board control even as the board grows with each funding round
  • The difference between participating and non-participating preferred stock, and why it matters
  • How option pools work, and why founders should push for them to be calculated post-money
  • What redemption rights, pro rata rights, and reporting obligations mean for founders long-term


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Creators and Guests

Host
Daniel Scharff
Founder/CEO, Startup CPG

What is The Startup CPG Podcast?

The top CPG podcast in the world, highlighting stories from founders, buyer spotlights, highly practical industry insights - all to give you a better chance at success.

Adam Marsh
I get it. Like, your focus is gonna be on that valuation. What is that? Are they low balling me? Are we shocked because they gave us such a great valuation? A high valuation would be great, but it can really be undermined by these things. I'm sure we're gonna talk about control. Rights can really hamper how a founder is used to running a company.

00:26
Gabrielle McGonagle
So.

00:26
Adam Marsh
So you kind of need to balance the valuation and getting a good valuation with the economics and the operational rights that you're giving up.

00:33
Gabrielle McGonagle
It's really important to take time in looking at those protection provisions and not just being like so eager just to sign and agree without thinking through the implications, not only in the next 12 months, but in the next 24 months. Each round, the protective provisions typically expand. So it's important to really consider and weigh what you're giving away and to whom early on instead of just sort of being like overly eager to get that cash in, even though we understand that's the goal here.

01:02
Daniel Scharff
Hello, everyone. Welcome to the Startup CPG podcast. Get ready for a hugely helpful episode for any of you fundraising now or in the future. This is term sheets 101. We've got Adam and Gabby from Giannuzzi Lewendon. They are a top tier CPG law firm and today they are going to break down all of the key aspects of a term sheet. They're dropping so much advice for brands from years of doing this. I really believe this may be one of the most important episodes that we've done. GL is a partner of ours. I suspect a lot of you are going to want to reach out to them after you hear this episode. You can find their contact info in the show notes. All right, here we go. Hello, my friends. Welcome to Term Sheets 101.

01:46
Daniel Scharff
I am so excited that we have Adam and Gabby back from Giannuzzi Lewendon. Their past episodes have been so well received by brands here. I am so pumped for this episode. We're going to talk through a lot of the common questions that people get about Term sheets and this is very timely because we just announced applications for our massive event founders and funders. This happens in December New York, and we'll have our friends from Giannuzzi Lewendon there as well, of course. So I'm so happy to have you guys here. I know if a brand gets a term sheet at the event or right after, they're going to run right over to you and have a bunch of questions. So I wonder, just to kick off, could we do a couple of intros First, Adam. Sure.

02:29
Adam Marsh
Hey, guys. Daniel, it's awesome to be back. It'll be our third podcast together, so it's always good to chat. I'm Adam Marsh, one of the partners here at Giannuzzi Lewendon. Been doing this for almost 13 years now, so there's not a lot in a term sheet that I haven't seen in the past decade. Plus, so pumped to be here and excited to dive in.

02:45
Daniel Scharff
All right, perfect. Gabby.

02:46
Gabrielle McGonagle
Hey, guys. Daniel, again, thanks so much for having us back with. Love chatting with you. Also a partner here at gl. Have been here for ten and a half years. So between Adam and I, we got you covered for our term sheets 101 and some.

03:01
Daniel Scharff
You guys must know each other pretty well. I feel like everybody from GL is like, yeah, this is the only thing I know in this world is CPG law. And I've been here for a long time. Like, I'm sure you guys have some, like, battle stories together.

03:12
Gabrielle McGonagle
Yeah, Adam and I have been in the trenches together. For sure.

03:15
Daniel Scharff
We'll get some stories out.

03:16
Adam Marsh
Yeah, I spend more time with Gabby than I do my wife. So, yeah, we know each other pretty well.

03:21
Daniel Scharff
All right, perfect. So really excited to get into it today. First of all, Adam, could you level set for us, what is a term sheet?

03:28
Adam Marsh
Yeah, great question, important question. So a term sheet, think of it as like summary of terms, right? It could be a two pages, it could be 10 pages, but it's a high level summary of both the economics, the business points, and the governance rights of the company, kind of on a go forward basis. So the term sheet will be your starting point of negotiation when you look to bring on an investor. And that can be in a safe, it can be a convertible note, or it can be your first price round.

03:54
Daniel Scharff
Okay. And the most basic question I have about this, honestly is like, who makes it and sends it though? Is it me, the brand? Is it the investor? I don't have so much experience in this area, honestly. I've done a couple angel investments where the brand would just typically send a safe. And that's pretty basic. And then great, like, you sign it and you're off to the races. But I hear other brands at the later stage talking about like, yeah, when the investor sends the term sheet, like, oh, wait, so they send it. Can you tell me a little bit about what is common?

04:25
Adam Marsh
Yeah, I think there's no right or wrong answer. So oftentimes we'll have an investor come in, they get excited about the company that might be at founders of funders and be like, wow, this brand's amazing. And then afterwards they're going to send you a two page term sheet and it's going to say the company name, the valuation, the security they're getting and a few high level governance rights, right? And they'll say customary protective provisions for a transaction of this nature. Who the hell knows what they actually mean? If we get that, we're going to turn that two page term sheet into a five or six page term sheet, which is going to spell out exactly what all of that means. So that when we move to the long form documents, there's no real negotiation left because you've hammered it out already.

05:04
Adam Marsh
And then frankly, oftentimes we're asked to come up with a term sheet. So I'm doing a series B financing right now. It's $10 million. And went out to the investors and we've proposed our terms, right, because it puts their best foot forward, right? It says, here's what we're willing to or at least a starting point for what we're willing to live with in terms of valuation and rights. It'd always be my preference to offer a term sheet, but there's no right or wrong way to do it.

05:28
Daniel Scharff
I'm always so like nervous as a person and as a brand. And I could just imagine myself thinking that scenario where the investor sent over the term sheet and then I'm talking to Adam like, yeah, can you look at this? And Adam and who rightly seeks clarity on everything and wants to protect me for the long run is like, yeah, here are the additional three pages we need to send back someone a red line. I'd be like, oh no, are they going to hate this? Are they going to be like, oh, this person is a pain in the butt and I don't think I should work with them. But I imagine, as I've learned most times, like, actually, no, it's like totally fine. And people do actually appreciate the clarity.

06:04
Daniel Scharff
Just so you know, what happens in all these different scenarios, is that your experience?

06:08
Adam Marsh
Generally it's almost counterintuitive, right? Because like I have this term sheet in hand, I should just sign it and then we'll figure out. Figure it out later. But the figuring out later is actually where it gets costly because then you're negotiating 25 page documents and the back and forth in that can get really costly and expensive. Whereas you go, all right, investor, this is great. I'm going to loop in my team and we're going to come back with you on some points and you Know what? That negotiation might last a week, but then once you're done with it, you have a game plan you're ready to go, such that when you move to long form documents, the back and forth is quite limited. And frankly, I think that the investor sees, oh, okay. These guys are serious. They know what they're doing.

06:45
Adam Marsh
You can't just push them around. So to a certain extent, while I think there might be some added cost upfront, I really think it saves you in the back end and shows some sophistication on the heart of the company and the founder.

06:57
Daniel Scharff
Okay, and last kind of overview question here before we dive into some of the details. If I just flash a term sheet to you real quick, Adam, what are the first couple of things you really are going to want to pay attention to? Like, if you're a brand, you're probably just looking first at what that valuation number is if they send it over. But, like, really, there are a couple key things that I'm sure you're going to immediately look at to see how good of a deal this really is.

07:20
Adam Marsh
Yeah, totally. Like, so I get it. Like, your focus is going to be on that valuation. What is that? Are they lowballing me? Are we shocked because they gave us such a great valuation? But there's definitely some other considerations to take in to consider. So, like a liquidation preference. Do they have a 1x? Are they asking for a 2x? Are they asking for seats on the board? Or what kind of control rights are there in redemption rights? So, like, the high valuation fee, great. But it can really be undermined by these things I'm sure we're going to talk about. But, like, control rights can really hamper how a founder is used to running a company. So you kind of need to balance the valuation and getting a good valuation with the economics and the operational rights that you're giving up.

07:59
Daniel Scharff
I really appreciate us having this conversation because the saddest thing to me in this life is hearing about a founder who has done all the things that we talk about doing that we all dream about doing, and they've worked for maybe a decade of their life building one of these brands that we all recognize. And you hear about this cool sale that they went through, and then you meet someone who knows them, they're like, oh, yeah, they only had 1% of the company by the time it sold. Like, no.

08:24
Daniel Scharff
So I think most people wish that they could go back in time and really be very thoughtful about this stuff, because at the end of the day, sometimes it does come down to some of the terms that are in this agreement where, yeah, I don't know, maybe you just haven't planned for success the way that you could have if you could go back. So, Gabby, let me loop you in here. One of the topics I really feel like is poorly understood are investor blocking rights. Could you tell me as much as you can about what are they and why are they so important?

08:55
Gabrielle McGonagle
Yeah. So investor blocking rights, also called protective provisions, also called investor rights. It kind of what Adam said, sometimes we get a term sheet that just says, oh, we'll have the customary blocking rights. And what does that mean? That can be the standard five or six, which I'll go into in a second. It can be 25 to 30. So what it really is how much control the investor is going to have over usually what is sort of these like material bigger company moves, company sales financings, but can get down into like real nitty gritty minutiae, operating the business, entering into agreements over $100,000 in payments a year or taking on debt. So it can really run the gambit of a lot of different categories.

09:40
Gabrielle McGonagle
One of the things that we definitely try to focus on is limiting those protective provisions to the big company moments as opposed to the day to day. And things like that are raising preferred equity, senior equity, selling business, increasing the size of the board. Those are like the main big ones that we typically expect in most sort of preferred financings. But even with those, we try to sort of limit them. So we might say something like, okay, you have a block over us raising senior equity if it's less than a 2x. So if our valuation hasn't climbed to a certain amount, then we need your approval before we get senior equity on the cap table. But if we've done well and we've surpassed certain goals and then we're able to do that without the investor sort of blocking it.

10:27
Gabrielle McGonagle
So those investor protections are basically going to limit the founders from taking certain actions that they normally would want to take.

10:36
Daniel Scharff
Okay, you mentioned a couple ones here that I think are really important. Like they could block you from taking on a bunch of debt on the business or raising certain kinds of equity. They could also build in a provision to block you from selling the company if they don't like the terms. The board one is really interesting to me as well.

10:52
Gabrielle McGonagle
Yeah. And the board one is actually really tricky because some people will see a board block and say like, okay, well, we don't need a ton of people on the board. We're happy having a small board. So on its face, like, yeah, okay, fine, we can't expand the board without your approval. No problem. The board seat, though, is going to really come with any senior raise, or, by the way, even not a senior raise, same level, a peripassu raise. Someone's writing a big check, they're going to expect to be on your board. And so that block on increasing the size of the board actually serves as the door block on a financing.

11:26
Gabrielle McGonagle
And that's one of the things I think brands really need to take care of when they're looking at protective provisions is not just looking at what the obvious implication is, but thinking about all of the other ways that blocking. Right. Might be triggered. Like, a financing is going to trigger expansion of a board seat if you want to do a convertible note raise, or a safe, if you need sort of a bridge in between financings that's going to be taking on debt. If you want to get a bank loan, a revolver, which most of our clients at some point in their life have, that's going to be an incurrence of debt that's going to have certain blocks.

12:00
Gabrielle McGonagle
So it's really important to take time in looking at those protection provisions and not just being, like, so eager just to sign and agree without thinking through the implications, not only in the next 12 months, but in the next 24 months. And the other big point is, each round, the protective provisions typically expand. So. So if you're giving a lot away in your first raise, chances are when you take on another investor down the line, they're going to want that. Plus, so it's important to really consider and weigh what you're giving away and to whom early on, instead of just sort of being like, overly eager to get that cash in, even though we.

12:37
Daniel Scharff
Understand that's the goal here, that is such helpful information. I'm so glad that we're talking about this today. I'm just thinking about all the brands that are going to get to hear this and hopefully especially how you're talking about it. Like, yeah, if you give that one thing away now to an earlier investor, the next one, guess what is going to ask for more than like, whoa, okay, this could get pretty out of hand. The other thing that just weighs on my mind a lot is thinking about how much time this can suck up from the CEO or the management team of like, yeah, now I have to check with all these people every time I try to make a move. Like, it just, it's real effort, especially when deal closings can happen pretty hot, right? And then like, okay, cool.

13:17
Daniel Scharff
Give us like a week to find the board members and try to like assemble them and get this in front of them and check with them like. Right, yeah.

13:23
Gabrielle McGonagle
And that is another really important point that you bring up because there are protective provisions that are held by a preferred board member. What we typically see here is preferred blocking rates held by the investor themselves. So in their shareholder capacity as opposed to their board capacity. And the big difference there is they get to act, however, in their own self interest. So if they don't want you to raise more equity just because they don't want to be diluted, they can block it, whereas a director can't block it if it's in the best interest of the company.

13:55
Gabrielle McGonagle
So there's sort of a fiduciary duty on the board side that you don't have on an investor side, which is another reason when you're looking at these protective provisions, not only to be careful, but where you can shift them into preferred director block, that's a much better option than having it sitting just sort of as an investor block.

14:12
Daniel Scharff
That is so interesting. And I know you must have seen this play out so many ways, many times in all the years you guys have been doing this, but I think that's an incredibly important distinction because, yeah, when you're on the board of a company, your fiduciary responsibility is to the best of the company. When you're an individual investor, do whatever you want and try to maximize your own return. And like, oh, those are very different stakeholders that you could be dealing with. So, gosh, what a good point. Okay, can you talk about budget approval rights, Adam, Maybe you could jump in on this one. It's like, is that ever part of an agreement where, like, you would have to actually run your whole budget by an investor or like that?

14:53
Daniel Scharff
To me, honestly, it's just like a nightmare scenario just because I've been part of so many budgetary processes or like, oh, another person part of this. What's common, Adam?

15:03
Adam Marsh
Yeah, I mean, it certainly can be, and that's what we want to try to avoid. So like again, early stage companies, you're reeling and dealing, you're moving quickly, you're committing cash before you even receive revenue. But budgets are based on assumptions that can change quickly. So like, you could have a retailer delay or your co man has an issue and they are shutting down for two weeks, or if a new customer opportunity at Sprouts or Target. Right. So like, you need to be able to be nimble and move quickly. So in those cases, you want to be able to act without having to go back to the investor for approval. So that's why we almost always prefer the budget to just remain at the board level.

15:39
Adam Marsh
The budget should be more of like a planning tool and not a way for the investor to like get into the day to day nitty gritty operations of the company. Perhaps you can agree to some consent right on a big material deviation. But if you have this opportunity, you'd be able to jump at it and you don't want to go to the investor. So let's try to keep it at the board level as much as possible.

15:59
Daniel Scharff
I guess that would just be something that very particular investors might try to include in the agreement. And then you just have to know how to go back to them with a firm hand, like, yeah, we're not going to do this. Here's why. Ideally you have some other offers in hand also that give you a little bit of confidence when you're going back and saying no to something. Right.

16:18
Adam Marsh
For sure. And you'll find that like budget approvals seem to be more like in later stage companies at the earlier stage. Like to my point, some of these guys don't want to be involved. They're writing a million dollar check. They don't really want to be involved in that anyways. It's more when they're writing $10 million checks, $20 million checks, then they might get a little bit more involved in the budget process. But again, to the extent we can keep it at the board level, we try to do that.

16:42
Daniel Scharff
And speaking of those smaller checks, how should people be thinking about board seats, board observer positions as well in those earlier agreements? Like who are the kind of people who are typically going to ask for that stock stuff and when do you think it's appropriate versus maybe an over ask on behalf of the investor?

17:00
Adam Marsh
Yeah, so like if you're doing a safe financing and convertible note financing, frankly I think it's a bit of an overreach to ask for a board seat. It's when this investor's writing a substantial multimillion dollar check, you're doing a series seed or a series A. It's kind of inevitable at that point when you have a lead investor who's really putting some substantial backing behind the company where they're going to ask for a board seat. I don't think that's unreasonable. The founders should always be thinking about maintaining control of the board for as long as possible. So for an early stage company, maybe you're doing your siege or a someone's writing you a 2, 3, $5 million check. And they want to see on the board, great, let's give them a seat on the board. It's a three member board.

17:40
Adam Marsh
The founder or founders appoint to the investor gets one seat. And then the next round where we're doing our A or our B, the board is inevitably going to grow because someone else is going to write a $5 million check and they're going to want to say on the governance of the company, but let's expand that board again to make sure that the founder is still controlled. So let's expand the board to five and there's three founder appointees, one for each investor. But that way you're still maintaining control. And that's why, going back to our initial conversation, I love presenting the term sheet to the investors because we can dictate the terms, we can dictate the size of the board. So as long as we can, let's maintain control of the board. And then observer, right.

18:18
Adam Marsh
Is a great way to kind of breach maybe some differences. So if they want, the investor comes in, say we want two board seats, right. But they're already writing a million or $2 million check. So maybe what's fair, a way to meet in the middle is give them one board seat and give it an observer seat. And that observer, like, they attend board meetings, they get all the same documents, but they're just not entitled to vote on and everything. So that's often a good compromise when the investor might be asking for more or potentially overreaching, throw them in an observer seat, the boardroom gets a little bit bigger, but it can still be manageable that way.

18:53
Daniel Scharff
It's so interesting to think about, by the way, if somebody comes to you guys and they're like, yeah, I like what you're saying. I would like to be sending them my version of the term sheet to try to get ahead a lot of these asks that they might make and just make sure we just have it in our framework. How long does that actually take for you guys to do with a brand? If they're like, I know also like, hey, there might be an issue with how they're structured or something where you have to like fix some stuff first to be like ready to actually receive the investment. But let's just say for the moment that they're ready for it.

19:24
Daniel Scharff
Is that a relatively quick process, like, you need to take time with them and understand their preferences and how they're going to business, and then you can churn out a term sheet relatively quickly. Or is it like a really long process?

19:34
Adam Marsh
It's pretty quick and easy, to be honest with you. Generally we have a call with them, it's an hour long call. We go through what they see as a priority, we go through our years and decades of experience and kind of tell them the pressure points and sensitivities and what companies of their size should expect and then putting together a term sheet, that's a few hours work on our end. Unfortunately, all we do is this. So we've become pretty efficient at putting those together. So it can be done fairly quickly. Of course, you know, on the back end we might need to do a little diligence as the company to understand the structure, their cap table and all that stuff. But putting together a term sheet, pretty basic stuff.

20:13
Daniel Scharff
Of all the things that people work with you guys on, it feels to me like that might be one of the highest ROI ones for them, is just taking the time to do that properly. So, Gabby, one thing I wanted to ask you a little bit about is like what is the difference between economic ownership and control? Because I know there's a lot there.

20:31
Gabrielle McGonagle
Yes. And I think there's a fixation on ownership that I think is sort of misplaced because control is really what dictates how things work down the line. I think whether you're an LLC or you're a corp, sort of the starting position. And this is the case, sort of as long as you're doing a common round financing or you're doing friends and family or past the hat round, in those instances, before you get real negotiated documents, more or less, you can make these material company decisions, like a sale, like a financing, those sorts of things with just a majority. And so in those instances, the ownership may be more in play. Once you're getting strategic investors, private equity, any preferred raise, there is a shift because the majority of ownership alone is not going to control.

21:22
Gabrielle McGonagle
You're going to have those protective provisions that we talked about. You might have specific things like you can't amend an operating agreement without the investor's consent or without the majority of the preferred's consent. And so the further you get, the more money you take on, the further away you get from an ownership alone being material. That said, obviously you still want the majority of the common or the majority of the preferred and you want the fastest path to get those things right. The last thing you want is you're trying to do a financing, you need a majority of the series A to approve and you have a hundred different series A investors and you're having to claw back, you know, get approvals from a bunch of different people. So it's not that ownership is irrelevant.

22:06
Gabrielle McGonagle
Obviously, the tighter the cap table, the more ownership you have as a founder and as a common shareholder, the better, especially economically. Like you talked about before, the last thing you want is to sell the company and own like 1% of it. But it's important not to lose sight of the control that happens outside of the ownership percentage. And like we've talked about, that usually comes in the form of those protective provisions, the board seats, and potentially like a liquidation preference where the control and the class of shares matters more than the overall ownership percentage.

22:37
Daniel Scharff
Maybe we could just jump into that a little bit more about like the class of shares as well. Because this is another one where I feel like it's so poorly understood by people, including me. Can you just talk a little bit more about like liquidation preference? Because I feel like this is one that people just don't spend enough time on, where even if you're just like an employee, honestly at a company, like, you really want to understand this, Because I feel like this is often the thing that means you either get paid out or you don't get paid out.

23:06
Gabrielle McGonagle
Yeah. So I think people typically think of it as common versus preferred. And preferred sort of sits on top of the common in a sale scenario where there are proceeds being distributed out, which means usually the preferred investors are either getting their money back or they're getting some other benefit. And I think this is where the nuance is there is non participating preferred and then there's participating preferred. A non participating preferred basically means the investors are going to get either their money back or their percentage ownership. So if an investor invests $2 million and they own 10% of the company, and then when they go to sell the company, they could either get 2 million back or 10% of the company represents 5 million. Then they'll participate based on their ownership percentage. So they'll get the 5 million back instead of the 2 million.

23:56
Gabrielle McGonagle
A participating preferred is sort of both they get their money back plus their ownership percentage. So in that scenario they would get their 2 million back and then they're going to get 10% of whatever the remaining sale proceeds are. So the participating preferred sort of has that double dip component which is even more dilutive to the common shareholders to that founder group.

24:20
Daniel Scharff
For me, that sounds like one of these sharky, Mr. Wonderful deals, like, yeah, you're going to pay me back like 10 cents on every unit until I get my money back. And Then I own most of your company also after that, like, who actually like, gets to do the participating version of that?

24:35
Gabrielle McGonagle
Yeah, the good thing is it's not common. I mean, I would say like 95% of our deals, if not more than that, are non participating. We typically see a participating preferred more in a distressed scenario and where the investor is really taking a gamble and also will be putting a lot of its own resources into helping build the business, as opposed to a check writer who might be providing some consulting services and maybe like assisting and weighing in on important ways, but not taking over that control level. So the participating preferred, again, a rarity. When you first hear preferred, you shouldn't be spooked and think that's what you're getting into because more likely than not it's going to be a typical non participating preferred, which just gives the investor assurance of downside protection as opposed to a double dipping situation.

25:24
Gabrielle McGonagle
So that's far and away the more common construct.

25:27
Daniel Scharff
Okay, very interesting. And Adam, I wanted to ask you also, because it's not necessarily something in the term sheet, but I think it's very interesting for anyone listening to this, can you talk about the option pool? Because sometimes when the liquidation preference is going to come into play, you're going to have employees who have shares and often their liquidation preference is way below anyone who invested in it. And maybe some, if it doesn't sell at some huge valuation, sometimes those employees, because of their liquidation preference, don't end up getting money. Can you just talk typically about how the option pool works in general?

26:01
Adam Marsh
Yeah, totally. And to one additional point of what Gabby's talking about, the one thing we do see with liquidation preferences, it'll be non participating. But sometimes they'll ask for a 1.5x or a 2x, which dovetails into this conversation because if you have a 2x or a 3x, maybe it's even less likely that these option holders are going to participate. So to your question, Daniel, an option pool or equity incentive pool, it's simply like a portion of the company's equity that's reserved for employees, directors, service providers, advisors. In almost every company in the CPG space will need a pool at some point. Typically it's 10 to 15%. Gabby, correct me if I'm wrong. I think when we sold body armor for $8 billion, it was like 25% a lot higher.

26:47
Gabrielle McGonagle
I think it was in the low 30s.

26:49
Adam Marsh
So there's no right or wrong, clearly. And then the question is, when you get the term sheet on an option pool, is that established on a pre money basis or on a post money basis. If it's done on a pre money basis, that means that only the existing investors and the founders are going to get diluted by that pool. So post money basis, that means the new investor, along with the existing investors and the founders are getting diluted. And we always try to push for that because in essence, that's kind of more fair. Right. So the investor puts in money, he gets diluted by the pool, and then you hire a rock star CMO who gets a percentage of the company. That investor is benefiting from that new hire, that new CMO who's going to take the company from X to Y.

27:32
Adam Marsh
So we always try to push for that because in essence that seems more fair. If that CMO had been at the company for three years, then maybe it's fair that they're not really participating in that upside. But if it's a new pool and a new hire and get a new marketing director and a vice president of finance, they're benefiting from all that. So they should suffer that dilution just like everybody else.

27:52
Daniel Scharff
Okay, that is very good to be aware of. By the way. Probably a lot of people listening right now who are drinking this in. If you want to chat with these guys, this is what they do for a living. We'll make sure we put their emails in the show notes here. If you want to reach out to Adam or Gabby or anyone at gl, they'll be happy to talk to you about this stuff. I really want everyone to think about this stuff carefully because I feel like this is one of those no brainer areas where it really makes sense to work with somebody who's done this before. You can hear everything that they're talking about right now. They have lived this, they have seen it. They know what can go wrong in a lot of these instances.

28:28
Daniel Scharff
They work with a lot of VCs, they like work with a lot of brands. They understand both sides of this. So definitely recommend a chat with them. I know they always get hit up a ton after these episodes.

28:37
Adam Marsh
Yeah, don't be shy. Like we literally represent companies that are pre revenue, that are just an idea and that we represent companies that are doing $100 million revenue and everything in between. So we're more than happy to get on a call, even if it's just to pick our brain for 30 minutes. We love the CPG space. We wouldn't be here without the people listening. Right. So we're more than happy to help.

28:58
Daniel Scharff
Yes. All right, Gabby, let me ask you a specific question about redemption rights. Can you talk about that a little bit and why they can be so important?

29:06
Gabrielle McGonagle
Yeah. So redemption rights are basically an investor, right, that after a certain period of time, the investor has the right to have the company repurchase its investment. You typically see these more with funds, private equity funds. And the reason for that is a lot of those funds have agreements with their own limited partners that they need to make a return on investment within a certain period of time. So typically what you would see is something like if by the fifth anniversary of our investment, the company has not sold, the company will have to repurchase, or the investor can elect to have the company repurchase our equity at either fair market value or the investment amount, whichever is greater.

29:49
Gabrielle McGonagle
Again, depending on when a company is coming in, what the valuation is, what that purchase price looks like, sometimes that's the cost of doing business with some of these funds. Again, because they have their own internal structures where it's just a requirement. But there are some things that you can do to sort of soften that blow. And what I mean by that is one of the biggest issues is should that time come, if the company's doing really well and about to have an exit or has a lot of cash on hand, chances are that investor isn't going to want to be redeemed, right? They're going to want to stay until there actually is an exit. If things are going well, then great. Why would they try to jump ship then? Often we're seeing this in situations where the company is struggling.

30:29
Gabrielle McGonagle
And so in particular, those are times that a company is not going to have the liquidity and the cash on hand to actually effectuate that repurchase. And so it's important if you are agreeing to something like that to try to have certain protections there. Like, for example, first of all, the fair market value is fair, that it's either agreed upon or if there's a dispute, it goes to some third party evaluator. That way you can make sure that you're not getting stuck with this product price tag. That doesn't really make sense. The other thing is you can sort of negotiate sometimes the payment terms of that.

31:01
Gabrielle McGonagle
So rather than saying, okay, on the fifth anniversary, we have to write you a check for your full investment amount, or worse, depending on what the value is, you can say this will be repaid in accordance to the promissory note. That maybe is a two year promissory note. It can be paid off installments. And then if there is a sale before it's fully paid off, it might accelerate those payments. Right. So there are a couple of ways to sort of soften the economic blow to the company. Should the redemption be something that is sort of like a non starter for that fund or for that investor?

31:33
Daniel Scharff
Guys, I feel like maybe we're in the wrong part of this CPG business. But Gabby, Adam, we should start one of these later stage funds that has all this money and then we can require redemption rate. So yeah, if this doesn't work out, you must buy it all back from us. Thank you very much. And if it does work out, we get participating shares and you have to pay us 3x and we get the equity and that's how the people who have money make all the money. All right, there we go.

31:59
Gabrielle McGonagle
It's a great insurance policy.

32:00
Daniel Scharff
Yeah. I'll follow up with you guys on the formation docs for that. Perfect. Okay. So Gabby, oh, I also wanted to ask you about pro rata rights and like when are people typically asking for those and like, why would you want or not want that as a brand?

32:16
Gabrielle McGonagle
Yeah. So pro rata rights, also called preemptive rights, are basically an investor's ability to continue to maintain its ownership interest. So if Adam writes a check into a company and he owns 5% of the company each financing after that, he might say like, well, let me keep writing checks so that I can at least stay at my 5%. I wanted to come in and own 5%. I want to keep owning that 5%. So typically pro rata rights or preemptive rights are just the ability to keep investing, to maintain your amount. It doesn't mean that you can go over that amount. It just level sets you almost always, even when we're putting together sort of like a common round or operating agreement or corp documents, we like preemptive rights. We like pro rata rights in almost all instances.

32:58
Gabrielle McGonagle
If the existing investors want to continue to put money in and believe in the company, that's great. Not only does it keep a tighter cap table, but it's a great story for other investors that you may want coming in to say like, hey, we have these investors from the beginning who like really believe in this, are really happy with what we've been doing and they want to keep investing. So preemptive rights are almost always great. Any investor is going to ask for them because they want to make sure that they're maintaining that.

33:24
Gabrielle McGonagle
The sort of watch out for those is you want to make sure that if you have like a really unique opportunity, like a strategic coming in and saying, hey, I know that you're not doing a fundraise, but we want to come write a check and we want to be a part of this and we want to own 20% of the company. You want to be in a position where you can take on that strategic and you can take on that investment without having to issue additional equity to other investors and open up a financing where you really don't need that cash, but you really instead just want that investor coming in. Similarly, there are certain service providers who will want equity in exchange for providing services. Again, that's not something like a financing round.

34:06
Gabrielle McGonagle
So there are some customary carve outs that we try to negotiate with those preemptive rights and pro rata rights to make sure that yeah, you can maintain your percentage ownership unless it's one of these really special circumstances where the company needs to be able to issue equity even without going to everybody else and offering the same sort of situation.

34:25
Daniel Scharff
I think that's such a good example of one of those things that you could add into a longer document instead of a shorter agreement that like probably no one's going to object to but could really save your heiney when you're negotiating some sweetheart deal later on like with a strategic. So good. Okay, so Adam, one thing I want to ask you about is about like reporting obligations and just from personal experience as just a tiny little fish in this area because I've mainly I've only ever done like a safe type level investment and I never thought to ask for reporting on any cadence and mainly I'm a pretty small investor in those so I don't think they would even do it if I asked.

35:06
Daniel Scharff
But some of them then were amazing and just gave me quarterly reports and they were up into the right and they gave the breakdown and then included in there anything that they needed from investors and it was amazing. And others, honestly there's one I pretty much never heard from again, like are you even working on this? Like what's happening? I guess I don't have the right to ask for it. What should you expect after you take let's call it institutional capital on reporting?

35:35
Adam Marsh
Yeah. So I think before that. Right. Even to your point, Daniel, say for convertible note, like it's just really just good practice to keep your investors up to date with information. It doesn't have to be formal documentation like we're going to talk about. But the companies that succeed are the ones that are commutative with their investors. Even if it's a safe investor writing a $10,000 check like everyone still wants to feel a part of the team, so I'd encourage everyone to always provide those updates. But once you get this institutional capital in like, you're going to be expected to provide some regular financial information. There's these things called the NVCA documents, which all this stuff is based off of and kind of sets forth what you can expect there. So it'll be like monthly or quarterly financials, annual budget, year end financials.

36:22
Adam Marsh
Once you get big enough, they're going to ask for audited year end financials, cap table and otherwise, just like regular access to management. But that said, everything needs to be in balance. Right. If you're a team of five, you can't be spending your entire day preparing these reports or else you're not going to be able to run the business. So it's really just about finding a balance between the size of the company, the level of detail that is really needed by these funds. Yeah, I think that's the key, is finding the balance. And as the company grows, you can provide more frequent statements. But you can certainly expect monthly, quarterly, annual statements once you get a big tech writer in.

37:00
Gabrielle McGonagle
Yeah. And Daniel, one thing you noted when you said sometimes it's really nice you didn't even ask for, you were getting all this information. I find even with a company that's struggling, I know sometimes there's an apprehension to tell investors bad news. That said, if there's a situation where things haven't been going well and the company has been keeping the investors in the loop, then if there's something where they're like, hey, we have to do a down round, it's not what we anticipated, but this is what we're going to try to go out and do. We know there's certain anti dilution rights, but we'd like you guys to waive those.

37:34
Gabrielle McGonagle
If you have an investor group who's really been kept in the loop and who feels like they've been on the journey with you, they're a lot more likely to work with you in those situations, rather than a situation where you're coming to them out of the blue, they haven't heard from you in a year and you're saying, hey, by the way, things aren't going well, so do you mind doing this? And so I think there's also this balance of like, what are my obligations? Which you obviously want to limit versus what am I going to share with my investors in good faith anyway? Because it just creates for a much happier shareholder base even when things don't go well.

38:10
Gabrielle McGonagle
An informed group is always a little bit more flexible and a little bit more apt to want to work together than when you sort of spring it on them.

38:19
Daniel Scharff
I totally agree. And it's a hard thing to do. And the same is true when you're talking to buyers or anyone of just like, finding the right time to like, yes, this is time to give people a heads up about this. And it will increase the trust in this relationship overall. I think investors know it. It's not going to go perfect 100% of the time. If it did, they would be the richest investors in the world.

38:39
Adam Marsh
No, to your point, Daniel, it's right, though. Building that trust amongst your board, amongst your investors, like, that's so important and so valuable and it'll make things go so much more smoothly when things start going sideways. So, yeah, I think it's a really good point you made.

38:55
Daniel Scharff
Honestly, that's when I really want to hear from people. Look, I don't have experience, like, running a board or anything, but I do have experience being part of a team and running a team. And I think a former boss of mine, that was one of the most valuable lessons he taught me is like, I will trust you more if you come to me when there is a problem. Like, if you raise your hand and ask me for help, then I will trust that you actually will tell me when there's something that I really need to be involved in. And that's a great thing to do. And, like, I love that too. If someone on my team actually has a problem they can't get around, like, please tell me. Yeah, that's exactly what I'm here for.

39:27
Daniel Scharff
Let me figure out how I can help you with that. And investors do have a lot of connections and ideas, and that's a great time to engage them. So, Adam and Gabby, as we wrap up here, I would just love to ask generally about, like, when you're trying to negotiate things, what do you feel like of all these things that we've talked about are like, if, when you're playing Jenga, some of the tiles are a little bit easier to push than others, where do you feel like are the easier terms to negotiate and what are the ones that are harder to negotiate? Adam, I'll start with you.

39:56
Adam Marsh
Yeah. So, like, the easy things are kind of the things we've talked about, Maurice, like preemptive rights, anti dilution protection, information rights, confidentiality provisions. Like, let's not get hung up on those things. Those are notice prover. Like, it can seem onerous, but I don't really think I would worry so much about that. Focus on the big ticket items, right? The blocking rights, the valuation, the board controls, the things that we talked about the beginning of this conversation, those are the things that are really going to impact the company on a go forward basis. Whether the no shop period is 30 days or 45 days, probably less material unless you have 10 term sheets in hand.

40:39
Adam Marsh
But limiting those blocking rights, as Gabby suggested, or making sure that liquidation preference is a 1x, I think that's going to ultimately have a much larger impact on the company than the preemptive rights section, the tag along sale, those sorts of items.

40:54
Daniel Scharff
I love it. That's very helpful to know. And Gabby, same question to you and I'm sure because you've been doing this so long, like you've lived it, you've seen that point where you helped somebody actually get a certain provision negotiated and then seen how that actually impacted them later on. So yeah. What would you say on this point?

41:10
Gabrielle McGonagle
Yeah, I mean, echoing what Adam said, obviously the protective provisions I think are the areas that anything that's going to limit a founder's ability to really run the day to day business, like these founders are gunslingers, they're entrepreneurs. It's necessary to move quickly in these sort of early stage companies. So limiting anything that's really going to handcuff you in that way.

41:31
Gabrielle McGonagle
But I think also what I would urge in addition to try to limiting those protective provisions, like what I touched on earlier, to the extent you can move those to a preferred director block as opposed to an investor block, it really will not only reduce the non fiduciary control, but also lessen the anxiety, I think around the brand owner, the founder, having to face that issue because they know that it's ultimately held in a best for the company position rather than potentially having investor who can just hold it up for themselves.

42:06
Daniel Scharff
It's such a good point. And I've heard such crazy things also in this industry and world of like, yeah, that one person's a director, like we want to sell the company and like we don't have any other options. Ultimately it's not a great outcome for that investor who's on the board. And they're going to block it actually because they're raising another fund and they don't want to take the loss right now and have to tell all the people they're raising from about it, which is specifically not what they're supposed to be doing on the board. But like, oh God, it's such a complicated world out there. So I love the idea of just really focusing on limiting the control stuff that people have. So I think you guys made all the right points here. I'm sorry.

42:44
Daniel Scharff
So excited for all of the brands coming in, especially to founders and funders, to have all of this ahead of time so they're not just scrambling when they hopefully get that term sheet from the funders who are coming to the event. So, Adam, Gabby, thank you for another instant classic episode. This is so good. You guys are so generous with your time and expertise, having done this for collectively so many decades with everyone at the team over there. So thank you. And again, I really encourage anybody who has more questions about this to reach out to Adam and Gabby. They will be very happy to chat with you. Very accessible. So thank you guys again. This was just so interesting.

43:22
Gabrielle McGonagle
Thanks for having us.

43:23
Adam Marsh
Yeah.

43:24
Daniel Scharff
What a blast.

43:24
Adam Marsh
Thanks, Daniel. And for people, founders and funders, Gabby and I will be there, so don't hesitate to say hi. Yeah. Thanks to Startup CPG. You guys rock.

43:33
Daniel Scharff
Thank you guys. We really appreciate your support. Well, my friends, we've now arrived together at the end of another episode of the Startup CPG podcast, the top globally ranked podcast in cpg. As you may know, we're not just a podcast. We're a community of brands and experts. And you should join. You can sign up@startupcpg.com you'll then get an invite to our online Slack community. You're going to hear about amazing events near you, all of our special opportunities to get you in front of buyers, investors, brands and more. It's a free community. So what are you waiting for? I will see you there or on our next episode. Bye. Bye.