Raising Capital Using the National Venture Capital Association (NVCA) Model Documents

If you’re raising venture capital, you will almost certainly encounter the NVCA model documents. The National Venture Capital Association publishes a suite of standardized forms, including a term sheet, stock purchase agreement, investors’ rights agreement, voting agreement, and right of first refusal and co-sale agreement, that have become the baseline for most institutional venture financings. The documents are founder-friendly in structure and well understood by sophisticated counsel on both sides, which is part of why they dominate the market.

But “standardized” does not mean “non-negotiable.” Within the framework of the NVCA documents, there is a significant range of outcomes depending on how specific terms are drafted. Some of those terms have a modest practical effect. Others will define how much your company is worth when you exit, how much control you retain in the interim, and whether you can raise future rounds without getting wiped out. This post walks through the provisions that warrant your closest attention.

Valuation and Price Per Share

The starting point for any deal is the pre-money valuation, which drives the price per share for the new preferred stock. This is the most obviously negotiated term, and it is worth taking seriously — not just because a higher valuation means less dilution today, but because it sets the baseline for future rounds. Founders sometimes accept a lower valuation in exchange for more favorable terms elsewhere, and that tradeoff can make sense, but it needs to be made with eyes open.

One thing that often catches founders off guard is the relationship between valuation, option pool, and dilution. Investors will frequently require the company to expand its option pool prior to closing, and the pool expansion is typically calculated on a pre-money basis. That means the dilution from the new pool comes out of the founders’ share, not the investors’. Pay close attention to the proposed pool size relative to your actual near-term hiring needs, and push back on an oversized pool expansion if the numbers don’t reflect reality.

Liquidation Preference

The liquidation preference is one of the most consequential terms in a venture deal. It determines how the proceeds are distributed in an exit, whether that’s a sale, merger, or other liquidity event.

The NVCA forms contemplate both participating and non-participating preferred. Under a non-participating structure, preferred holders receive the greater of their liquidation preference (typically 1x the original investment) or their pro-rata share of the proceeds as if converted to common. Under a participating structure, preferred holders take their liquidation preference first, and then also participate in the remaining proceeds alongside common holders on an as-converted basis. Participating preferred, sometimes called “double dipping,” can significantly reduce founder and employee returns in a lower-value exit. Full participating preferred without a cap is the most investor-friendly version; non-participating preferred is the most founder-friendly. Capped participation, where the participating preference falls away once investors have received some multiple of their investment, is a middle ground worth pursuing if full non-participating preferred isn’t achievable.

Multiple liquidation preferences (e.g., 2x or 3x) are less common in early-stage deals, but they do appear and they can be punishing. In a $10 million Series A with a 2x preference, investors would need to receive $20 million before any proceeds flow to common, and in a moderate-exit scenario, that can leave founders and employees with very little.

Anti-Dilution Protection

Anti-dilution provisions protect investors if the company raises future money at a lower valuation, a “down round.” They work by adjusting the conversion price of preferred stock downward, which increases the number of shares of common stock each preferred share converts into.

There are two main flavors. Full ratchet anti-dilution adjusts the conversion price all the way down to the price of the new round, regardless of how many shares are issued at the lower price. It’s the most punishing version for founders and common stockholders and rarely appears in standard early-stage deals. Broad-based weighted average anti-dilution, which is what the NVCA documents contemplate as the default, adjusts the conversion price based on a formula that takes into account both the size of the down round and the existing cap table. It’s the standard, and for good reason: it’s more equitable. The key fight here isn’t usually about which method to use, since broad-based weighted average is essentially market, but rather about what’s included in the denominator of the formula. A broader denominator means a smaller adjustment on a down round, which is better for founders.

Protective Provisions

The voting agreement and certificate of incorporation typically grant preferred holders a separate class vote on a defined list of corporate actions. These protective provisions exist to prevent the company from taking certain actions, such as issuing new stock, incurring debt above a threshold, selling the company, or amending the charter, without investor approval.

Protective provisions are not inherently unreasonable; investors are putting significant capital at risk and deserve some say in major decisions. But the scope of the list matters. A well-negotiated set of protective provisions covers genuinely fundamental transactions. An overbroad list can effectively give investors a veto over ordinary course business decisions. Pay particular attention to provisions covering debt (make sure routine bank financing isn’t swept in), new equity issuances (carve out the option pool), and any ambiguities in language around what constitutes a “sale” or “change of control.”

Board Composition

The NVCA term sheet typically addresses board composition, and this is one of the most practically important provisions in the deal. A standard early-stage structure might be a five-person board with two founders, two investor representatives, and one independent director. The key issues to negotiate are who selects the independent director (and what approval is required to remove one), what happens to board composition in subsequent rounds as new investors come in, and whether investor board representation is tied to continued ownership thresholds.

It is also worth paying attention to observer rights. The NVCA investors’ rights agreement often grants certain investors the right to attend board meetings as non-voting observers. Observers don’t vote, but they are present in the room, and their attendance can affect the dynamics of board deliberations. Limiting observer rights, or requiring that observers be subject to the same confidentiality obligations as board members, is reasonable and worth requesting.

Pro-Rata Rights

Pro-rata rights, sometimes called participation rights or preemptive rights in the NVCA framework, give investors the right to participate in future financing rounds in proportion to their current ownership. For investors, this is about maintaining their percentage and avoiding dilution in later, higher-value rounds. For founders, the picture is more complicated.

Pro-rata rights in the hands of a large investor can crowd out new investors or make future rounds harder to structure. The NVCA investors’ rights agreement typically addresses the scope and mechanics of these rights. Key negotiating points include whether pro-rata rights apply to all future rounds or only certain equity financings, whether there is a minimum ownership threshold that must be maintained to preserve the right, and whether the right is transferable. Major investor pro-rata rights, which allow certain investors to purchase more than their pro-rata share, are worth scrutinizing carefully, as they can put a heavy thumb on the scale in later financing rounds.

Information Rights and Right of First Refusal on Transfers

The NVCA investors’ rights agreement sets out what financial information the company must provide investors and on what timeline, including annual audited financials, quarterly unaudited financials, and annual operating budgets. These are generally reasonable, but it’s worth confirming that the obligations are appropriate for the stage and size of your company and that small holders below a threshold ownership don’t get the full package.

The right of first refusal and co-sale agreement gives investors the right to purchase shares before a founder sells them to a third party, and if the investor doesn’t buy, the right to participate in the sale on the same terms. These provisions are standard and generally unavoidable in a venture deal. The negotiating focus should be on carve-outs for estate planning transfers, transfers to family trusts or entities, and de minimis sales, as well as the mechanics of what happens if the right isn’t properly exercised.

Drag-Along

The drag-along provision allows a specified majority of stockholders to compel all other stockholders to vote in favor of, and participate in, a sale of the company. This protects against a minority stockholder blocking a deal the majority wants to accept.

The NVCA voting agreement includes a drag-along, and it’s worth paying attention to who holds the triggering power. A drag-along that can be exercised unilaterally by preferred holders, without any common or founder approval, is considerably more investor-friendly than one that requires both preferred and common majority approval. The threshold for triggering the drag, the floor price at which it can be invoked, and any protections for common stockholders (such as ensuring they receive at least a specified return) are all worth negotiating.

A Word on the Term Sheet vs. the Final Documents

One of the most common mistakes founders make is focusing all of their energy on the term sheet and then treating the definitive documents as a mere formality. That’s a mistake. The term sheet is a summary of agreed deal points, but the final documents are what govern. There is significant latitude in the drafting of the definitive agreements to expand or narrow what the term sheet contemplates, and experienced investors’ counsel will know how to use that latitude. Getting legal counsel involved early, at the term sheet stage and not after it’s signed, is the best way to ensure that what you agreed to on paper reflects what ends up in the documents you’ll live with for years.

At Stock Legal, we work with founders and emerging companies through all stages of the capital raise process, from initial term sheet review through closing of the definitive documents. If you have questions about a financing you’re considering or are working through, reach out to our team. We’re happy to help.