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Raising capital is one of the highest-stakes legal events in a company's life. Every clause in a term sheet will be negotiated into definitive documents that govern the investor relationship for years. Founders who do not understand the terms they sign often lose control of the business before they realise it.
Leo outlines term sheet concepts and flags unfavourable terms. For completing a funding round, engage a commercial attorney experienced in venture transactions.
A South African funding round typically involves:
In early-stage rounds, SAFE notes (Simple Agreement for Future Equity) or convertible loan notes are increasingly used to defer valuation negotiations until a priced round.
A term sheet is non-binding (except for exclusivity and confidentiality clauses) but sets the terms that will appear in definitive documents. Fight hard here — it is much harder to renegotiate once definitive documents are being drafted.
Pre-money valuation: The company's value before the investment. If the pre-money valuation is R20m and the investor puts in R5m, the post-money valuation is R25m and the investor owns 20%.
Post-money valuation = Pre-money valuation + Investment amount
Dilution: Every new share issued dilutes existing shareholders proportionally. A fully diluted cap table shows dilution including all option pools, convertible notes, and warrants.
Option pool shuffle: Investors often require an option pool to be created or topped up before their investment (pre-money), which dilutes founders but not the investor. Negotiate for the option pool to be created post-money or sized only for the immediate 12-month hiring plan.
South African investment rounds commonly use preference shares (not ordinary shares):
| Feature | Ordinary Shares | Preference Shares |
|---|---|---|
| Voting | Yes (1 vote per share) | Often non-voting or limited |
| Dividends | Discretionary | Priority (often non-cumulative at early stage) |
| Liquidation | Residual | Priority return before ordinary shareholders |
Liquidation preference: The investor receives their investment back (and sometimes a multiple) before ordinary shareholders in a liquidation or exit. Types:
Protects investors if new shares are issued at a lower valuation (a "down round"):
Investors typically require shareholder approval (via preference share vote) for:
Founders' position: Accept protective provisions for material transactions (the list above is reasonable). Resist provisions that would require investor consent for operational decisions (hiring above a salary, any new contract above R500k, etc.).
Investors typically negotiate board representation:
An independent director (acceptable to both parties) is valuable — breaks deadlocks and provides governance credibility.
Originated by Y Combinator. No maturity date, no interest. Converts to equity at the next priced round, typically at a discount or with a valuation cap.
Discount: SAFE holder converts at a discount to the price paid by the new investors (typically 15–25%). Rewards early risk.
Valuation cap: The SAFE converts at the lower of the cap or the new round price. Protects the SAFE holder if the company raises at a high valuation.
Pro-rata rights: SAFE holders may have the right to invest further in the next priced round to maintain their ownership percentage.
South African SAFEs require adaptation — the US SAFE contemplates Delaware corporations; a South African version must align with Companies Act share issuance mechanics.
A loan with an interest rate (typically 8–15% per annum) that converts to equity at the next round (or a defined trigger). More common in South Africa than SAFEs due to familiarity.
Maturity date: If conversion has not occurred by maturity, the loan becomes repayable. This is leverage over the company — investors often use it to force a round or renegotiate terms.
Conversion mechanics: Must comply with Companies Act Section 43 (debentures) and require a board resolution to issue.
Investors typically require:
Threshold-based rights: Minor investors (< 5–10%) often have information rights but no board rights. Negotiate thresholds to limit the administrative burden.
Before issuing new shares to third parties, existing investors have the right to subscribe for their pro-rata share at the same price. Standard and reasonable — accept this.
Before selling shares to a third party, the seller must first offer them to existing shareholders (or the company) at the same price. Standard — accept it.
The cap table tracks who owns what, on a fully diluted basis:
Founder A 30.0% 1,500,000 ordinary shares
Founder B 25.0% 1,250,000 ordinary shares
Investor X 20.0% 1,000,000 preference A shares (R5m @ R20m pre)
Employee pool 15.0% 750,000 unallocated options
Angel (SAFE) 5.0% 250,000 estimated (unconverted)
ESOP allocated 5.0% 250,000 options (vested + unvested)
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Total (fully diluted) 5,000,000 sharesFully diluted means including all options (vested and unvested), warrants, unconverted SAFEs, and convertible notes as if they had all been exercised or converted today.
Tool: Use a spreadsheet with scenario modelling for each round. Free tools: Pulley (ZA-compatible), Carta (US-focused but usable).
Investors almost universally require founder vesting — a mechanism that returns unvested founder shares to the company if the founder exits early.
Standard vesting schedule: 4 years, with a 1-year cliff.
Good leaver / bad leaver:
Issuing shares to non-resident investors requires South African Reserve Bank (SARB) approval via an Authorised Dealer (commercial bank). Required before the shares are issued. File Form DP(a) (inward investment). Processing: 2–6 weeks.
Foreign investment can reduce B-BBEE ownership scores. If the company sells products or services to government or state-owned entities, B-BBEE compliance is a commercial requirement. Model the B-BBEE impact of each investment round on your scorecard.
Share transfers (not new issuances) attract STT at 0.25% of the market value of the shares transferred, collected by the transferring broker or party.
If shares are issued to employees (including founders) subject to restrictions (vesting conditions), Section 8C of the Income Tax Act defers the tax event until the restrictions lapse. Founder vesting shares fall under Section 8C — tax is triggered when shares vest, not when issued. Founders should be aware of the tax liability that arises with each vesting tranche.
| Term | Risk | Negotiation Position |
|---|---|---|
| Full ratchet anti-dilution | Catastrophic dilution in down round | Broad-based weighted average only |
| 2x participating liquidation preference | Founders get nothing until investor gets 2x + participates | Non-participating 1x at most |
| Investor approval for operational decisions | Loss of operational control | Restrict vetoes to material transactions only |
| Drag-along at 51% | Single investor can force a sale | Drag threshold ≥ 75% of all shareholders |
| No time limit on ROFR | Investor holds up any secondary sale | 20–30 business day exercise period |
| Pay-to-play without notice | Forced participation in future rounds or punitive conversion | Ensure notice period and negotiable threshold |