CPG Co-Manufacturing Contracts

Term Sheets Part XIV: The Bible for Co-Man Negotiations

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Daniel Faierman & Chuck Cotter
May 17, 2026

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Daniel Faierman is a Partner at Habitat Partners, an NYC-based early stage VC firm focused on pre-seed to Series A investments in the consumer and software ecosystems. Learn more about Habitat Partners on their website. Daniel has invested in numerous startups and previously operated and invested at organizations including PepsiCo, AB InBev, VMG Partners, and Selva Ventures. Daniel was a former Yale tennis 🎾 player & completed his MBA at the Stanford Graduate School of Business.

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Co-Manufacturing Agreements in CPG: The Clauses That Actually Matter

Most consumer brands do not manufacture their own products. They outsource production to a co-manufacturer, often before the company has much leverage, much capital, or much internal operating infrastructure.

That is normal. But it also means the co-manufacturer is not just another vendor. In many CPG businesses, the co-manufacturer is the company’s production capacity, quality system, supply-chain partner, and, in some cases, the only party that knows exactly how the product is made at scale.

That creates meaningful risk for your business.

A weak co-manufacturing agreement can quietly affect margins, product quality, inventory availability, recall exposure, supply continuity, and even ownership of the company’s core IP. These issues often feel manageable when the brand is small. They become much more serious when the company is growing quickly, negotiating with retailers, preparing for financing, or selling to a strategic buyer.

Below are the provisions, learnings, and focus areas that deserve real attention:

(1) IP Ownership: If This Is Wrong, Everything Else Gets Harder

For many CPG brands, especially in food, beverage, beauty, personal care, supplements, and household products, the most important IP is not a patent. It is usually the recipe, formulation, specifications, manufacturing process, testing protocol, sourcing knowledge, or some combination of those things.

That IP is often protected as a trade secret. Which means the contract matters a lot.

The agreement should be explicit that the brand owns the recipes, formulas, specifications, processes, and all improvements, modifications, and derivatives. Do not assume that because the brand brought the original concept to the manufacturer, the brand automatically owns everything developed during production scale-up.

The manufacturer should receive only a limited license to use the brand’s IP for the purpose of producing the brand’s products under the agreement. It should not have the right to use, disclose, modify, commercialize, reverse engineer, or repurpose the IP outside that relationship.

Confidentiality is part of the same point. The manufacturer should not be able to share the formulation, use it for another customer, or apply what it learned from your product to make a competing or “similar” product for someone else.

This is not theoretical. Imagine a brand is being sold for a life-changing amount of money. During diligence, the buyer asks for the manufacturing agreements and discovers that the brand does not clearly own the formulation improvements developed by the co-manufacturer. Now the brand has to go back to the co-manufacturer before closing and ask for an assignment or clarification.

At that point, the co-manufacturer knows the company is being sold. It knows the deal cannot close cleanly without fixing the issue. It knows it has leverage.

That is not a conversation any founder wants to have in the middle of a sale process, and it’s a conversation I’ve specifically had to have with a manufacturer when selling a brand to a strategic. It can delay closing, create purchase-price pressure, or force the founder to give away economics that should have belonged to the company.

A good agreement should make clear that:

  • the brand owns all product IP, including formulas, recipes, specifications, processes, improvements, modifications, and derivatives;

  • the manufacturer has only a limited license to use that IP to manufacture products for the brand;

  • the manufacturer cannot use the IP for itself or another customer;

  • confidentiality obligations apply to the product IP and related production information; and

  • the brand can take the formulation, specifications, and production knowledge to another manufacturer if the relationship ends.

If the brand cannot leave with its product intact, it does not really control its product.

(2) Read the Agreement Like an Operator, Not Just Like a Lawyer

Some bad manufacturing deals are not hidden in legal nuance. They are right there in the business terms.

Founders should read the agreement the same way they would read an operating plan.

  • Does the pricing work if ingredient costs move?

  • Are the minimum order quantities realistic?

  • Are the lead times compatible with the company’s cash cycle?

  • Who owns raw materials if forecasts are wrong?

  • Is the brand committing to volumes it may not hit? Under what circumstances do you not have to hit volume commitments?

  • Is the manufacturer committing to accepting POs?

  • Is the manufacturer getting exclusivity?

  • Are storage, handling, shelf-life, and quality standards actually addressed?

A lawyer can help with structure, liability, IP, and risk allocation. But the founder also needs to pressure-test the commercial reality of the agreement.

For example, a 90-day lead time may be fine on paper until the brand is selling through faster than expected and does not have the cash to carry that much inventory. A price adjustment clause may look reasonable until it allows the manufacturer to pass through cost increases without documentation. A minimum volume commitment may feel harmless until a retailer delays a launch.

The agreement should be read against the way the business actually operates, not just against the way everyone hopes it will operate.

(3) Pricing: Protect the Margin You Are Building the Business On

Most early-stage brands live with variable pricing. Ingredients, packaging, labor, freight, energy, and other inputs can all move. That is part of the business.

The issue is not whether pricing can change. The issue is whether pricing can change in a way the brand can understand, verify, forecast, and, if necessary, challenge.

If possible, the brand should push for fixed pricing for a defined period, often 12 to 24 months. That may not always be available, especially for a young brand without much volume. If pricing cannot be fixed, the agreement should at least include a clear formula for changes.

Avoid vague language that says the manufacturer may increase pricing due to cost changes. That gives the brand very little protection. Better drafting ties increases to defined inputs, objective benchmarks, documented cost changes, advance notice, and a right to review supporting information.

At a minimum, the agreement should address:

  • when pricing can change;

  • which cost inputs can justify a change;

  • what documentation the manufacturer must provide;

  • how much advance notice the brand receives;

  • whether increases are capped during a period;

  • whether the brand can audit or challenge the increase; and

  • whether unusually large increases trigger renegotiation or termination rights.

This matters because the brand’s margin story is often central to the business. Investors and acquirers are not just buying current revenue. They are underwriting gross margin, contribution margin, scale economics, and the possibility of operational improvement. If the co-manufacturer can move pricing without discipline, the margin profile is less reliable than it looks.

(4) Supply Chain Redundancy: One Co-Man Is Usually Not Enough Forever

At the earliest stage, a brand may have no choice but to rely on a single manufacturer. That is often how the company gets started.

But as the brand grows, single-source manufacturing becomes a real business risk. A co-manufacturer fire, quality issue, capacity constraint, labor disruption, ingredient shortage, insolvency, regulatory problem, or relationship breakdown can interrupt supply at exactly the moment the company needs reliability most.

That is why supply-chain redundancy should be part of the plan, even if the brand cannot implement it fully on day one.

The goal is not to create unnecessary complexity. The goal is to avoid a single point of failure.

A growing brand should think about whether it can qualify a second manufacturer, maintain backup production capacity, preserve the right to move production, and avoid exclusivity that prevents the company from building redundancy. Even if the second manufacturer is not producing at meaningful volume immediately, having one identified, qualified, and ready can materially change the company’s risk profile.

Geography matters too. If all production is in one region, freight costs and delivery times may become inefficient as the brand expands. A West Coast manufacturer may work well for certain retailers and distribution centers. An East Coast or Midwest manufacturer may make more sense as the company grows into other channels or regions. Different geographic suppliers can reduce freight costs, shorten lead times, and make inventory planning more sensible.

Lastly, while you don’t want to deliberately pin a trusted co-man partner against its competitors, it’s important to regularly sense check if the financial terms of your existing co-manufacturing relationship remain competitive. Is there a cheaper alternative co-man that might drive you to respectfully ask a long term partner for better pricing? Early in your venture, it will be tough to negotiate. You are the small guy making up a tiny portion of the co-mans volumes (you just want someone to make your product and take a chance on you). As you grow, you may have more leverage to open up competitive processes that drive down price.

(5) Redundancy also matters in M&A

A strategic buyer looking at a CPG brand wants to know that there is continuity of supply. It does not want to acquire a brand and immediately discover that production depends entirely on one small co-manufacturer with limited capacity, weak documentation, or a contract that cannot be assigned.

At the same time, many strategic buyers underwrite margin gains from eventually bringing manufacturing in-house or moving production into their own network. The buyer may want continuity from the existing co-manufacturer for a transition period, but also the freedom to move production later.

That makes contract flexibility valuable. A buyer wants to see that the brand can keep product flowing after closing, but is not permanently locked into a third-party manufacturing structure that prevents margin improvement over time for the buyer.

The agreement should therefore avoid unnecessary restrictions on moving production, qualifying additional manufacturers, or transferring know-how. It should also require the manufacturer to provide enough specifications, records, and cooperation to allow a transition if the relationship ends.

Founders should be careful with:

  • exclusivity provisions;

  • minimum volume commitments that effectively block backup manufacturing;

  • restrictions on using other manufacturers;

  • vague or missing technology-transfer obligations;

  • lack of access to batch records, specifications, and production data;

  • change-of-control restrictions that could complicate an acquisition;

  • assignment provisions that prevent a buyer from stepping into the contract; and

  • termination provisions that do not allow enough time to transition supply.

Supply-chain redundancy is not just an operations issue. It affects customer reliability, negotiating leverage, freight economics, valuation, and exit readiness.

(6) Termination: Your Leverage Later Depends on What You Negotiate Now

Founders often underestimate how hard it is to leave a bad manufacturing relationship.

The agreement should give the brand practical ways to exit if the manufacturer is not performing. Termination for cause should cover missed specifications, repeated quality failures, late deliveries, confidentiality breaches, IP misuse, regulatory issues, and other material breaches.

Cure periods should be reasonable but not endless. For serious breaches, 15 to 30 days is often more appropriate than a long cure period that leaves the brand exposed. The agreement should also address chronic breach. If the manufacturer repeatedly misses specifications or delivery windows, the brand should not be forced to accept an endless cycle of breach, cure, breach, cure.

Termination for convenience can also be important. The manufacturer may resist it, especially if it is investing in equipment, materials, or capacity for the brand. But some ability to exit after an initial term, often on advance notice, can be valuable if the relationship is not working, the brand has outgrown the manufacturer, or the brand needs to diversify production.

The notice period needs to be long enough to be useful. A brand does not want a termination right that exists on paper but leaves no time to qualify another manufacturer, move inventory, source materials, or update packaging and logistics. In many cases, 180 days is more practical than 30 or 60 days, particularly if the manufacturer also stores inventory or controls critical materials.

Auto-renewal clauses deserve attention. They are common and easy to overlook. A brand should not be locked into another full term simply because it missed a narrow notice window. If there is an auto-renewal, the brand should have a reasonable termination-for-convenience right.

Exit costs also matter. Even if the brand has a termination right, the agreement may require it to buy unused raw materials, pay wind-down costs, satisfy long notice periods, or absorb termination fees. Some of those obligations may be fair, especially for custom inputs ordered for the brand. But they should be clear, limited, documented, and commercially reasonable.

(7) Recall, Insurance, & Non-Conforming Product: Decide Who Pays Before Something Goes Wrong

If there is contamination, mislabeling, undeclared allergens, out-of-spec product, packaging failure, or another quality issue, the agreement needs to say who is responsible.

If the manufacturer produces product that does not meet specifications or causes a recall through its breach, negligence, or failure to follow required procedures, the manufacturer should be responsible for the resulting costs.

That should include the cost of the affected product, recall expenses, shipping and disposal costs, customer charges, reasonable investigation costs, and other downstream losses that are appropriate under the circumstances.

The agreement should also describe how recall decisions are made. The brand usually needs meaningful control over customer-facing communications, retailer communications, and brand decisions. The manufacturer should be required to cooperate, provide records quickly, and preserve relevant information.

Insurance is part of the same risk allocation. The manufacturer should carry appropriate product liability insurance and, where applicable, recall or contaminated-product coverage. The brand should be named as an additional insured where appropriate and should receive certificates of insurance.

If the manufacturer cannot financially stand behind its production, that is a business issue, not just a legal issue.

(8) Audit Rights and Quality Control: Trust Is Not a Quality System

A brand cannot manage what it cannot see.

The agreement should give the brand the right to inspect facilities, review quality systems, access production records, review batch records, and confirm compliance with specifications. Those rights can be subject to reasonable notice and facility rules, but they should exist.

The quality provisions should include clear product specifications, testing protocols, storage and handling requirements, batch traceability, non-conforming product procedures, and recall procedures.

For higher-risk products, including products with allergen claims, “free from” claims, functional claims, or strict regulatory requirements, the brand should consider third-party testing rights. The agreement should also address who pays for testing and what happens if testing identifies a problem.

This is also relevant to redundancy and eventual transition. If the brand does not have access to complete specifications, batch history, quality records, and production requirements, moving to another manufacturer will be harder than it should be.

(9) Negotiating When You Do Not Have Much Leverage

Early-stage brands often hear the same thing from manufacturers: “These are our standard terms.”

Sometimes that is true. Sometimes it is just the opening position.

A young brand may not be able to win every point, but it can often improve the agreement by trading things the manufacturer values for protections the brand needs.

Manufacturers care about planning. They care about volume visibility, production scheduling, raw material ordering, payment timing, and capacity utilization. A brand may be able to offer better forecasting, a longer initial term, faster payment, or more predictable order timing in exchange for lower minimum order quantities, better pricing, more flexible termination rights, clearer quality obligations, or limits on price increases.

It can also help to phase the relationship. Start with a pilot run or short initial term. Prove the product, the process, and the working relationship before committing to longer-term obligations or larger minimums.

And do not ignore alternatives. Even one credible backup manufacturer changes the negotiation. It gives the brand leverage, improves continuity planning, and reduces the chance that the company becomes dependent on a single production partner.

That is also why exclusivity should be treated carefully. A manufacturer may ask for exclusivity if it is investing in the relationship. But exclusivity can prevent the brand from building the redundancy it will eventually need. If exclusivity is unavoidable, it should be narrow, time-limited, tied to performance, and subject to exceptions for capacity constraints, quality failures, missed delivery timelines, geographic expansion, supply-chain resiliency, and change-of-control scenarios.

The Bottom Line

A co-manufacturing agreement is not just an operations contract. For many CPG brands, it is one of the most important agreements the company signs.

The right agreement protects the brand’s IP, preserves margin, supports quality, allows the company to scale, and keeps the brand from becoming dependent on a single supplier.

The wrong agreement does the opposite. It can lock the company into bad economics, limit manufacturing flexibility, create recall exposure, block supply-chain redundancy, complicate an acquisition, or force a painful cleanup during diligence.

Founders do not need to over-lawyer every early manufacturing relationship. But they do need to understand what the agreement controls.

Own the IP. Protect the margin. Preserve the right to move. Build redundancy as the brand grows. And make sure that, when an investor or acquirer eventually reads the agreement, the contract supports the story the company is telling about scale, continuity, and value creation.

If you enjoyed this article, feel free to view recent prior articles:

Ongoing Term Glossary

Anti-Dilution Rights: offer investors protection against dilution in unfavorable financing rounds. This term is usually not contentious from a negotiation perspective between founder and investor - in fact, studies have founds that 92-95% of preferred stock financings include some form of anti-dilution protection.

Authorized shares: the MAX number of shares of each class a company can issue without further shareholder approval.

Automatic Conversion: in the context of convertible notes (or SAFEs), a clause that triggers a convertible note to automatically convert into equity at maturity.

Board of directors: a group of individuals that represent sharesholders in major corporate decisions. A critical responsibility is the oversight of management - simply, the ability to fire of hire the CEO. Other board activities include assesing company performance, providing strategic guidance, developing corporate policy, approving budgets, options plans, mergers/IPOs, and fundraising.

Bridge Financing: when investors agree to provide temporary financing to secure a company’s cash balance before the company raises their next priced round - aka the bridge that gets you to your next priced round.

Capped Price: conversion price per share awarded to noteholder (or SAFE holder) if investor exercises valuation cap

Change in control: a significant shift in the ownership or control of a company, often triggering specific rights or obligations for investors (M&A most commonly)

Clawback provisions: provisions that give the company the right to buy back vested shares at the original issue price or at fair market value after dismissing an employee under defined circumstances (leaving for a competitor, severe misconduct, etc)

Co-Invest: triggered when a fund raises “one-off” new capital from LPs/investors (as opposed to pulling from existing permanent fund) to unlock ability to execute an investment; associated management fees and carry (if any) typically flow back to the fund or individual who raised the co-invest capital. Funds often give major LPs prioritized “co-invest“ rights, which gives such LPs the first rights to participate in the co-invest opportunity before others.

Comparable Company Analysis: a valuation methodology that entails identifying comparable companies and transactions to the company being valued as a means of deriving multiples that can be used to generate a landed valuation

Confidentiality: prevents the startup from disclosing the terms of a term sheet to outside parties (i.e., other investors, startups). This enables both parties to negotiate in good faith.

Convertible Note: a debt instrument that can be converted to equity based on the occurrence of certain events (most commonly during a priced equity financing round).

Conversion: convertible notes (and SAFEs) automatically convert into equity if certain triggers occur. The most common trigger that leads to the conversion of a convertible note (or SAFE) into equity is a priced equity financing round

Corporate governance: a set of principles and mechanisms that balances the interests of company stakeholders (not only shareholders but also employees, customers, suppliers, etc) and affects control over company decision-making

Co-Sale: the inverse of ROFR by nature; if a founder sells shares, the investors will have the opportunity to sell a proportional amount of their stock as well.

Cumulative dividends: accrue value and must be paid to investors upon a liquidity event (even if not declared), acting like a debt-like liability that increases investor returns (not that different from accruing interest on the value of an investment via convertible note before it converts)

Debt repayment terms: in the context of convertible notes, defines specifics associated with principal, interest rate, maturity date, and default provisions.

Definitive documents:  the legal contracts between the investors and the company that detail the terms of the transaction and are drafted by a lawyer

Dilution (D): losing a portion of your ownership as the company sells equity to investors

Discounted Cash Flow Analysis (DCF): a valuation methodology that entails forecasting the future cash flows of a business and discounting the cash flows by a determined cost of capital to derive an enterprise value

Discount: a discount is a term awarded to the convertible noteholder (or SAFE holder) that drives a reduction in the conversion price per share that they are awarded during a qualified financing. Discounts typically range from 10-30% with 20% being the most common.

Dividend Recap: a company borrows new money by issuing debt and uses the proceeds from the debt to pay a one time special dividend to shareholders after board approval. The idea is that the company has a strong enough cash flow dynamic to make interest and principal payments in the future

Down Round: when the pre-money valuation of a future financing is lower than the post-money valuation of the prior financing; often seen as a negative sign for the company

Double-trigger: requires two events to occur to accelerate the completion of your vesting. The first trigger is the acquisition, and the second trigger is the founder or employee getting terminated by the acquirer without cause or good reason in a specified period (typically one year)

Drag-Along Rights: in short, drag along rights enable majority shareholders often including VCs to force minority shareholders to participate in the sale of a company on the same terms. Minority shareholders are “dragged along” disabling them from holding out on a deal to try to get something better for themselves.

Employee Option Pool (EOP): stock that is reserved for existing and future employees to compensate, retain, and motivate workforce

Equity conversion terms: in the context of convertible notes, defines the specific event(s) that triggers conversion of debt to equity, the formula used during conversion (considering the impact of the valuation cap and/or discount – to be discussed), the type of equity received upon conversion by the note holder (common vs. preferred equity), and any associated rights the new equity holders will get after their convertible note is converted to equity (voting, dividends, etc).

Exclusivity: often referred to as a “no shop,” this provision locks parties into negotiating only with each other for a defined period (i.e., 30-60 days)

Exercise (options): buy options at the strike price

Full Ratchet Anti-Dilution Protection: adjusts the conversion price of the protected securities downward all the way the price of the shares issued in the new round. Full-Ratchet is the most investor friendly.

Fund Model: a forecasting exercise that a VC conducts to project what a successful fund will look like in terms of returns from each investment. VCs typically build a pathway to 3.0x net DPI

Indifference point: the price per share at which the noteholder or SAFE holder is indifferent between exercising the discount or valuation cap

Interest Rate & Payments: convertible notes often feature interest rates. Unlike a traditional loan, startups rarely pay the interest in cash to the convertible noteholder periodically. Instead, convertible notes accrue interest until the time of conversion.

Issued Shares: those that the company has issues to shareholders; can’t be greater than the number of shares authorized to be issued for that class

Lead Investor: primary investor(s) (co-leads can exist) in a funding round that set terms and typically are writing the largest check(s); often take a board seat

Legally nonbinding: refers to the nature of term sheets. A signed term sheet does not legally mandate a deal be completed

Liquidation Preference: is one of the rights that makes preferred stock more valuable than common stock and a large part of why investors agree to purchase the right to preferred stock (i.e., SAFEs or convertible notes) or purchase preferred stock directly during financings. Liquidation preference is the legal entitlement to receive a pre-determined portion of a company’s value in the event of a sale or liquidity event before the holders of common stock (i.e. the right to get paid first in an exit).

Major Investor: refers to a participating investor in a financing that surpasses a certain check size threshold, unlocking certain rights. I.e., “all those who invest over $500k will be deemed major investors and shall receive information and pro rata rights”

Maturity: the date at which the debt (plus any accrued interest) is due for repayment. This is typically 12, 18, or 24 months from the issuance of the convertible note. We will talk about conversion momentarily but the norm for a convertible note is that it has converted into equity prior to the maturity date

Maturity Extension: in the context of convertible notes, this entails moving the maturity date back. A common alternative to repayment is for the company and noteholders to agree to an extension on the maturity date of the note

Multiple: a ratio that is calculated by dividing the valuation of an asset by a specific item on the financial statements

Multiplier (Liquidation Preferences): Multiplier refers to the multiple on the original price per share of a class or series of preferred stock an investor is entitled to receive before others get paid. A 1x preference means getting paid one times the original investment, a 3x preference would mean getting paid three times the original investment back before the next most senior preference is paid.

Multiple on Invested Capital (MOIC): compares the value of an investment on the exit date to the initial equity contribution

Non-cumulative dividends only pay if declared by the board (thus do not accrue)

Non-priced financing: financing round in which founder and VC do not explicitly set a share price and thus do not set an associated pre-money valuation (i.e., convertible notes, SAFEs)

Option pool: an amount of common stock primarily reserved in the cap table for future employees (in certain cases, options can be pulled out of the option pool for existing employees/founders as well)

Optional conversion: in the context of convertible notes, entitles the noteholder to convert their note into equity if desired if the note is still outstanding on the maturity date.

Oustanding Shares: shares owned by shareholders such as investors or employees (could be in process of vesting).

Ownership (O): the % of a company a shareholder possesses prior to or post-closing of a financing.

Participation (Liquidation Preferences): is the right of a preferred stock to participate in remaining acquisition proceeds (on an as-converted to common stock basis, along with common stock) after the initial multiplier liquidation preference is satisfied. When preferred stockholders have a participation preference it’s called “double dipping” as preferred stockholder enjoys preferential return of capital in liquidation preference and then enjoys pro rata share of remaining proceeds. Participation can be capped (limited to a certain multiple) or uncapped.

Prepayment: in the context of convertible notes, payment of the principal and accrued interest by the startup before the note matures. This is generally only allowed if there is a majority of supermajority vote in favor of prepayment by the noteholders.

Post-Money Valuation (PO): the valuation of the company after the round size is invested by the VC(s)

Pre-Money Valuation (PM): what the investor is valuing the company at TODAY, prior to the investment

Priced round/financing: a round of financing in which the valuation and price per share of a unit of stock being sold is officially determined (as opposed to a SAFE or convertible note in which case the valuation is left officially undetermined)

Price Per Share (PPS): the cost of acquiring a share of company x, typically determined by pre-money valuation and fully diluted shares outstanding prior to close of financing

Primary transaction: is when the company (the “issuer”) sells shares for the first time to investors. Primary issuances must comply with U.S. securities laws — meaning they must either be registered or qualify for an exemption.

Principal: in the context of convertible notes, the amount of investment provided by the noteholder (investor) to the company through the convertible note. In an unfortunate scenario where the note never converts to equity (we will discuss this), the principal (plus any accrued interest) is what the company owes the noteholder (unless nuanced legal terms dictate otherwise). Assuming the note does convert to equity (the norm), the principal (plus any accrued interest) is the quantity used to calculate how many shares the note holder will receive upon conversion into equity.

Pro rata rights: give investors the right (but not obligation) to participate in future rounds of financing to maintain their initial level of percentage ownership in the company.

Pro rata on a dollar-for-dollar basis: gives the investor the right to invest an amount equal to or less than the amount invested in their first round à VC Z invested 200K in the seed round and has the right to invest 200k in the Series A

Pro rata on a fixed sum basis: least common, investors get the right to continue investing an amount as agreed upon that is decoupled from the investment amount. VC Z, who invested $1M in a seed, negotiates pro rata rights up to $700K - they will be able to invest up to $700K in each subsequent round of financing.

Pro Rata ROFR: gives particular investor(s) the right to another investors voluntarily waived pro rata in a future financing  

Protective provisions (negative controls) are contractual clauses that have the goal of preventing the company and its shareholders from taking actions without getting explicit consent of the investors protected by the provisions. They effectively are veto rights that investors (preferred shareholders) have on actions so that they are protected against expropriation.

Qualified financing: in the context of convertible notes/SAFEs, the round size of an equity financing typically must meet a certain dollar threshold to trigger conversion into equity.

QSBS: a tax benefit under Section 1202 that incentivizes investment into small businesses (often startups) with less than $50 million in aggregate gross asset value. Investors who purchase stock (common or preferred) directly (as opposed to via secondaries) from a c-corp business with less than $50 million in aggregate gross asset value and hold that investment for > 5 years, followed by a sale of the held stock, can avoid paying capital gains tax. The tax exclusion can be up to 100% of the gain, subject to limits: the greater of $10 million or 10x the original investment. Recently big beautiful bill updates: 1/ asset value threshold up to $75 million, 2/ cap limit extended to higher of $15 million or 10x investment, and 3/ exclusion starts to come into play after just three years (at 50% exclusion potential).

QSBS Gain Deferral: if you have to liquidate a position before the QSBS holding period requirement ends, you can defer the tax on capital gains, by reinvesting the gains into another QSBS qualified business within 60 days of liquidation. You also get to roll over the holding period of the original investment, continuing the clock (as opposed to starting over).

Redemption rights: allow the investor to sell their shares back to the company for a guaranteed return (often at the original puchase price), granting them a guaranteed exit/liquidity path no matter what.

Registration Rights: defines the circumstances in which investors can require the company to register its shares or piggyback on a registration of other classes of stock.

Repayment: in the context of convertible notes, the process of paying back the debt (plus any accrued interest) due to noteholders

Restricted Stock: company stock given to employees, usually as a bonus or additional compensation; does not have a strike price unlike options; usually awarded to company directors and executives and is subject to vesting

ROFR: gives existing shareholders the first chance to buy shares from an existing shareholder who is attempting to sell them to an outside third party. In simple terms, if I want to sell my shares in a startup as a founder or investor, I need to give existing company shareholders the right to purchase my stock at the agreed upon price with the third party first

Round Size or Investment Amount (R): how much capital the founder is raising for the financing or VC round

RSUs: refers to an agreement by a company to issue employees shares on a future date. One RSU is the right to get one common share. RSUs, like options, are also subject to a time-based vesting schedule and can be trigger based; however, RSUs don’t have a strike price and are instead released directly to the recipient after vesting without any need to “exercise” or buy them; typically awarded to lower level employees than restricted stock

SAFE: an agreement between an investor and a company that converts into equity in the next financing round if certain conditions are met

Secondary Transaction: the resale of existing shares by a current stockholder. A secondary occurs either: when the company buys back the shares (a redemption), or when a stockholder sells their shares to a third party (a transfer). Secondaries are also subject to securities rules, but the requirements are generally lighter for non-affiliated stockholders — especially in true peer-to-peer sales.

Seniority (Liquidation Preferences): refers to whether preference is senior, junior or even (pari passu) with other preferred stock. Senior preference means having a first-tier liquidation right, junior preference means having a liquidation right that is paid after the senior preferred and pari passu means preference amongst different preferred stock is the same time.

Single-trigger: states that only one event must occur to accelerate the vesting of your equity. If the company is acquired, you gain complete ownership over all your options

Stock options: incentive mechanisms granted to employees, advisors, and consultants. Employees joining a VC-backed startup typically receive an option grant, which allows them to acquire company common shares in the future at a certain price by “exercising vested options”

Strike Price: the predetermined price an employee pays to exercise (aka purchase) their stock options and turn their stock options into actual shares of the company owned outright. Tax regulations (IRS Section 409a) require options grants to have a strike price equal to or above the fair market value of the underlying company stock on the date that the option is granted

‘Success disaster’: employees run the risk of being harmed financially for building a succeeding business that has grown in value significantly

Supermajority: require votes in excess of the majority; frequenty established in the charter and typically only apply to certain scenarios / investor classes. Supermajority thresholds are often set to give a minority investor veto power.

Supervoting: Supervoting shares entails one class of shares having more votes than another voting class of shares. It distances cash flow and voting rights from each other. In the VC industry supervoting has been heavily debated as companies with supervoting like Theranos, Uber, and WeWork have encountered governance controversies. Founders are typically the beneficiaries (for better or worse) as their voting power becomes a multiple (like 10x) of their share count.

Tag-Along Rights: tag-along rights are triggered when the majority shareholders decide to sell the company. In a similar but opposite nature to Drag-Along, Tag-Along protects minority shareholder’s right to exit alongside the majority. While drag-along “forces” the minority to sell, tag-along allows the minority to sell on the same terms as the majority so they are not left behind

Tender Offer: is a proposal by a buyer (often an investor or the company itself) to purchase shares from multiple stockholders during a set time window and at a set price.

Uncapped Note/SAFE: a convertible note (or SAFE) that lacks a valuation cap

Up Round: when the pre-money valuation of a future financing is higher than the post-money valuation of the prior financing; often seen as a positive sign for the company

Valuation: the process of deriving an enterprise value for a company

Valuation Cap: a valuation cap is an investor favorable terms that puts a ceiling on the conversion price at which a convertible note or SAFE would convert into the equity security sold at the qualified financing.

VC Valuation Method: a valuation methodology that entails projecting a company’s exit value in the future and a VC’s required MOIC in order to back into an implied valuation and ownership level at time of investment (starting with the future and backing into the present)

Vesting: the process of gaining ownership over granted stock options

Voluntary conversion: in the context of convertible notes, gives the investor (noteholder) the power to convert into equity whenever desired (even before maturity) under specified details, negating any prepayment potential

Warrants: when issued/contracted, give the warrant holder the right to buy a certain number of shares of the company’s common or preferred stock at a predefined price over a specified period

Weighted Average Anti-Dilution Protection: adjusts the conversion price of the protected securities downward to a value between the price originally paid by the protected investor and the price paid by the investors in the current (down) round.

PM + R = PO ➡️ the pre-money valuation plus the round size = the post-money valuation

PO – R = PM ➡️ the post-money valuation minus the round size = the pre-money valuation

PM / FDSO = PPS ➡️ the pre-money valuation divided by shares outstanding = price per share

R / PO = O ➡️ round size divided by the post-money valuation is the amount of ownership acquired in a financing by participating investors

D / PO = Daniel’s O ➡️ Daniel’s investment divided by the post-money valuation is the amount of ownership Daniel is acquiring in a financing

Fundraising

Rule #1: Communicate early and consistently. Goal: build long term relationships with a roster of investors before you kick off a process.

Rule #2: Ask for help. The only way to get maximal value out of your cap table is by asking for help. Especially when times are tough, great investors can potentially be the difference between make or break.

Rule #3: Keep knocking. As hard as it is, keep communicating with rejectors and make them aware of your progress.

Dont #1: OVER-FOMOing

Don’t #2: Focusing on who instead of what

Don’t #3: Exaggerating objectively “auditable” traction

Don’t #4: Asking for follow up intros from rejectors

Is there a topic you’d like us to cover? Don’t be a stranger! Ever want to dive deeper on a topic in VC Investing or Law?

We can be reached here:

Daniel Faierman ➡️ [email protected] 

Chuck Cotter ➡️ [email protected]

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✍️ Written by Daniel Faierman and Chuck Cotter 

Disclaimer: The information provided in this entry does not, and is not intended to, constitute legal or investment advice; instead, all information, content, and materials available in this entry are for general informational purposes only.