The March 2023 collapse of the Silicon Valley Bank (SVB) sent shockwaves across the global tech industry. While we know that the consequences will be far reaching for the venture industry, the full effects will not be known for a while. The failure of the SVB could not have come at a worse time. Now more than ever the big transitions that we face in energy, healthcare, food, agri and deeptech need funding. Our Van Doorne venture capital (VC) team provides legal support for the funding of these innovative companies. With our blog-series, we hope to provide guidance on venture financings in the Netherlands which will support innovation. We do so by discussing the various terms and conditions that are typically found in term sheets agreed upon by VC investors with companies attracting capital. The majority of the terminology used and the terms and conditions agreed upon in VC transactions originate from the United States (US) market. The US VC market is, in terms of funding, by far the largest VC market worldwide and therefore more mature and standardized than the European VC ecosystem.
The increasing number of successful innovative companies in the Netherlands, the Netherlands' ability to attract world-class talent and serve as one of Europe's main technology hubs for innovative companies, have made the Netherlands an attractive destination for US VC investors. In these blogs, we will dive into the terms agreed upon in equity funding rounds in the Netherlands and specifically focus on the differences between the US and the Netherlands. We will be covering a range of topics, from the basics of term sheets to other more common terms agreed upon in VC financings, including liquidation preferences, anti-dilution protection, leaver provisions and drag and tag-along rights. In this first blog post, we will take you through the basics of VC financing term sheets in the Netherlands.
VC has become an increasingly crucial source of capital for Dutch high growth businesses. Dutch companies received around €2.6 billion of VC funding in 2022 which is half the amount raised in 2021 but still a record amount compared to the years before 2021. The ticket size of equity funding rounds in the Netherlands have also been increasing in the last years. The funding mainly comes from investors outside the Netherlands, of which around 70-80% comes from US investors. As a result, the terms agreed in VC transactions in the Netherlands are to a large extent affected by the terms agreed with by foreign investors in their home market. In view of the huge growth of VC funding, up until 2021, the terms included in the term sheets for VC transactions tended to be on the company friendly side in the Netherlands, as was generally globally the case as well. From Q4 2022, we have seen more down-rounds in view of the current economic and market circumstances and the terms of VC financings are turning towards becoming more investor friendly. With the failure of the SVB and the crunch that it will cause to the venture market, we expect an acceleration of more investor friendly terms.
To kick-off nearly all VC transactions, same as in the US or in other jurisdictions, a term sheet is put into effect. This document outlines the fundamental terms and conditions under which investors will invest, including for example the form of the investment (i.e. in the form of preferred equity or convertible instruments), the valuation of the company and related size of the investment, voting rights and investor-protective provisions. Provisions related to the roadmap of the transaction, such as the closing deadline, conditions to closing or timelines for due diligence, are also often included in VC term sheets. Term sheets in VC financings are generally non-binding agreements. Only certain provisions, such as those regarding exclusivity and confidentiality, are declared binding. Therefore, term sheets more or less serve a similar function as the letter of intent that is often used in more traditional M&A transactions. After negotiating and finalizing the term sheet, the due diligence and negotiations on the long form documentation usually begin.
The main difference between US and Dutch VC funding term sheets is that in the Netherlands there is no specific national VC association such as the National Venture Capital Association (NVCA) in the US or the British Venture Capital Association (BVCA) in the United Kingdom which publish industry-embraced model forms for term sheets and other legal transaction documentation that can be used in VC financings. Some VC investors mainly active in the Dutch market have publicly disclosed their early stage term sheets in order for the market to get a feeling on their standard terms and there is the Dutch Capital Waters Foundation. Capital Waters is originally a private initiative of a boutique law firm specializing in start-ups and VC funding and an investor, supported by partners and experts from the market, which has provided open source documentation for early stage investments, including a term sheet. Although their documents are generally used by start-ups when they are in the lead of drafting the transaction documentation, investors tend to prefer the use of their own templates. When this is a US investor, the term sheet is often based on the NVCA Model Term Sheet and investors from the UK tend to use the BVCA model as a basis.
Although the Dutch market is increasingly moving towards US standards, with the majority of investors investing in Dutch companies based in the US, there are still a number of key differences between US and Dutch VC financings. These include the style of documentation and terminology used, corporate law differences (e.g. type of entity and issued stock), representations and warranties (and exceptions or “disclosure” against these); and certain investor protection mechanisms. In the upcoming weeks, we will look into these differences when explaining the key terms and trends in Dutch VC financings, thereby taking into account the differences with the NVCA model form or other market terms in the US.
To conclude, it is important to emphasize that term sheets play a crucial role in VC transactions and must be carefully drafted and negotiated to ensure that both the investor and the company understand the rights and obligations set out in the term sheet and the legal differences in various jurisdictions. Even though the term sheet is non-binding, the terms included in a term sheet are considered agreed in further negotiations on the long form documentation and will guide the parties through the remainder of the deal. Over the next 4 weeks, we will take a closer look at some of the specific clauses used in term sheets in VC financings of Dutch companies. Next week we will focus on liquidation preference clauses.
If you have any questions about the topics that we have covered or if you would like further assistance, please do not hesitate to contact us. We are always happy to assist and provide further explanation on any (legal) aspect of VC financings.