Private equity investing can offer opportunities, but it also comes with complex deal structures and nuanced terms that require careful evaluation. Unlike public markets, where terms are standardized, private equity deals are highly customizable, making it important for investors to thoroughly understand the specifics before committing capital. In this blog, learn more about private equity deal structure and understanding equity deal terms.

Understanding Equity Deal Terms

A summary of a private equity investment is outlined in the term sheet. This is typically a non-binding document that lays out the proposed terms of the investment—price, amount, and other key factors and provisions. These documents can serve as the foundation for negotiations before any legally binding contracts are signed.

Despite not being legally binding, these documents are still full of legal and financial jargon which can make them dense and difficult to understand. Some of the key elements that could be included in terms sheets are:

• Price per share or pre-money valuation (price per share an investor pays/the company’s worth before new funding)
• Size of round (total amount of funding the company wants to raise)
• Liquidation preferences (order of payout in an exit scenario)
• Anti-dilution protections (safeguards against ownership erosion)
• Governance rights (board seats, veto powers, etc.)
• Conversion mechanisms (for convertible securities)

There is not a universal standard for a term sheet, so each one usually looks different in terms of information included, layout, and length.

Common Private Equity Deal Structures

While the individual pieces of equity deal terms differ from term sheet to term sheet, most transactions fall into the following two categories:

Straight-Priced Equity

With a straight-priced equity structure, investors exchange capital for equity (most commonly common stock or preferred stock) at a predetermined price. The valuation may be expressed as a price per share ($10 per share) or a company valuation ($50 million pre-money valuation). Preferred stock may be more common in institutional deals as it can include protective provisions such as liquidation preferences, anti-dilution rights, and governance controls.

Derivative Securities

On the other hand, derivative securities are financial instruments that convert into equity at a later date, typically under predefined conditions. Common forms of derivatives include SAFEs (Simple Agreements for Future Equity), Convertible Notes, and Warrants & Options:

• SAFEs: Provide the right (but not the obligation) to purchase equity in the future, but without a set price at the time of the investment. SAFEs typically are more popular in early-stage startups and may be offered under equity crowdfunding.
• Convertible Notes: Convertibles are financial instruments that may convert into equity upon a maturity or qualifying financing event, often with a valuation cap or discount rate.
• Warrants & Options: Provide the right (but not the obligation) to purchase equity at a set price in the future.

Derivatives are frequently used in bridge financings or seed rounds where valuation may be uncertain. However, they may offer fewer protections compared to preferred stock.

Key Variations in Equity Deal Terms

The specific terms of an equity deal determine how risk and upside are allocated between founders and investors. The following are some of the most commonly seen variables for preferred stock deals vs convertible notes and SAFEs.

For Preferred Stock

• Pre-Money Valuation / Purchase Price– the worth of the company before new financing is secured/the price per share an investor pays.
• Liquidation Preference– Dictates payout order in an exit (e.g., 1x non-participating vs. 2x participating).
• Anti-Dilution Provisions– Designed to help protect investors from ownership dilution in future down rounds (e.g., full ratchet vs. weighted average).
• Board Seats & Approval Rights– Influence governance (e.g., veto rights on major decisions).
• Information Rights– Requires regular financial disclosures to investors.
• Redemption Rights– Allows investors to request a share repurchase after a certain period.

For Convertible Notes & SAFEs

• Valuation Cap– Pre-determined limit on the maximum value of a company used when converting a convertible note (or SAFE) into equity.
• Discount Rate(e.g., 20%) – Allows conversion at a lower price than later investors.
• Interest Rate– Applicable to convertible notes (typically 5-8% and expressed as an annualized amount).
• Maturity Date– When the note and unpaid interest must be repaid or converted.
• Early Exit Premium– Additional payout if the company exits before conversion.

Key Considerations

Here are a few areas of concern investors should evaluate when reviewing terms sheets and deciding whether or not they want to invest in a private equity opportunity.

1. Deal Economics

Ownership Stake

Investors should carefully consider whether they personally feel as though the proposed equity stake justifies the investment size and risk exposure. Overly diluted ownership may not compensate for the illiquidity and high failure rate of startups, so it’s important for each investor to decide what works best for their risk tolerance and portfolio needs.

Liquidation Stack

The liquidation stack dictates the payout hierarchy during an exit event such as acquisition, IPO, or dissolution. Preferred stock may have a 1x or 2x liquidation preference, which means preferred stockholders would be repaid first (sometimes with a multiple) before common shareholders receive any proceeds. Also in the liquidation stack, participation rights (if applicable) may allow investors to receive both their liquidation preference and a pro-rata share of the remaining proceeds.

Anti-Dilution Provisions

As startups take on additional rounds of funding, earlier investors are at risk of dilution, which could make their original investment worth less. However, anti-dilution provisions can adjust pricings to help minimize the impacts of dilution on earlier investors. There may be a weighted average anti-dilution, which adjusts conversion prices of preferred shares if the new round is at a lower valuation. There may also be a full ratchet anti-dilution, which resets the investor’s price to match the lowest subsequent round.

2. Investor Rights & Protections

Protective Provisions

As part of negotiations, investors may be able to negotiate veto rights over critical decisions like raising new capital, selling the company, or changing bylaws. These protective provisions can prevent founders from making unilateral moves that could harm investor interests.

Pro Rata Rights

Pro rata rights can allow investors to maintain their ownership percentage by participating in future funding rounds to avoid dilution. This could be an important protection for investors if later rounds offer better valuations.

Drag-Along / Tag-Along Rights

These rights help protect both majority and minority shareholders. In the case of drag-along rights, majority shareholders can force minority holders to join a sale, allowing a clean exit for the company. In tag-along rights, minority investors get the right to sell their shares if a majority stakeholder sells, helping protect minority investors from getting left behind.

3. Governance & Control

Board Composition

In some cases, investors can secure board seats and potentially influence strategy and monitor performance on a closer level. If offered, a balanced board can help prevent conflicts while allowing for accountability.

Voting Thresholds

Another aspect of term sheets is voting thresholds, which may require a significant majority approval to pass. This may be for moves like mergers, major expenditures, or CEO changes. Having voting thresholds as part of a term sheet can prevent founders from making impactful decisions without investor alignment.

Founder Vesting

Some term sheets may also outline the vesting schedule for founders. This can help ensure founders remain incentivized by tying equity positions to tenure. This can protect investors if a founder departs early, preventing unearned equity retention.

4. Liquidity Considerations

Liquidation Preferences

Mainly relevant to preferred stockholders, as mentioned above, liquidation preferences dictate which investors get paid first, and how much, in an exit event or dissolution. In a non-participating preference, investors choose between either their liquidation preference or converting their position to common stock. In a participating preference, investors receive both their preference and a share of the remaining proceeds.

Redemption Options

These provisions are rare but can allow investors to request a share repurchase after a set period (for example, 5-7 years), if an exit event does not occur. This can help investors, however many startups resist these clauses.

Secondary Sales

Private market investment opportunities are inherently illiquid, but some deals allow certain forms of limited secondary sales. There may be some restrictions on secondary sales, like right of first refusal, which can limit liquidity options.

Final Thoughts

Investing in private equity requires a disciplined approach to evaluating term sheets, deal structures, and risk allocations. While deals are going to differ from term sheet to term sheet, understanding the common frameworks and key considerations can help investors make informed decisions.

Want to learn more about investing in private equity? Check out the following MicroVentures blogs to learn more:

• Assigning Order: What are Liquidation Preferences?
• Slice of the Pie: Navigating Ownership Dilution in Startup Investments
• How to Start Investing in Startups
• Risk and Reward: Building Your Ideal Portfolio
• Failing Forward: What Investors Can Learn from Failed Startups

Are you looking to invest in startups? Sign up for a MicroVentures account to start investing!

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.