Adapting to market shifts: the evolution of VC term sheets for investors and founders
The proliferation of start-up ventures and venture capital (VC) investors willing to back them have undoubtedly experienced many evolutions in a very short period of time. From the nascent origins of a tiny VC community only seven or eight years ago, the MENA region has witnessed a steady influx of capital chasing an increasing number of deals and the emergence of more sophisticated start-ups, often founded by individuals and teams who have done it at least once before.
Against this backdrop, VC term sheets have evolved significantly, subtly reflecting the evolving dynamics between investors and founders. In the early days, term sheets in MENA were almost always investor-centric but, over time, they have transitioned towards a more balanced framework, with an increasing emphasis on founder rights, governance structures, and legal protections. This article outlines the evolution of key legal terms in VC term sheets in MENA, from the early stages of venture capital in the region to the present, underscoring the shift in investor approaches and founders’ rights.
As the MENA start-up ecosystem has matured, so have the structures and terms of VC investments. Increased competition among venture capital firms, coupled with a rise in successful exits and regional unicorns, has shifted the balance of power and given founders the ability to negotiate more flexible terms.
The early days: investor-centric terms
In the early days of regional VC deals, term sheets were predominantly structured in favour of investors, reflecting the nascent nature of the start-up ecosystem and the associated risks of early-stage investments. Valuations were often set at conservative levels, and investors exerted substantial control over the terms of the transaction agreements. Pre-money valuations were commonly lower, with minimal room for negotiation on the part of founders, particularly in high-risk verticals.
Control provisions in these early term sheets were heavily weighted towards investors which typically required extensive board and shareholder reserved matters. This often resulted in limited operational autonomy for founders, who were required to seek investor approval for many business decisions.
Transfer restrictions, particularly rights of first refusal (ROFR), were granted to all shareholders, typically providing them with an extended window within which they could exercise their right to purchase any shares that any shareholders intended to sell, prior to the shares being offered to a third-party purchaser. This created a protracted timeline for any potential transfer of shares, which in turn could impede a company’s agility in secondary transactions.
In a similar fashion, pre-emption rights, which granted existing investors the right to participate in future fundraising rounds to maintain their pro rata ownership, imposed additional constraints on a company’s ability to secure fresh capital from outside investors.
These rights limited a company’s ability to bring in new investors without offering the same terms to its current investors first, imposing procedural hurdles that could delay or complicate the fundraising process. In some instances, these restrictions, while protecting the interests of incumbent investors, inadvertently created barriers to a company’s ability to swiftly raise additional capital, scale operations, or execute strategic partnerships, ultimately influencing its overall growth trajectory.
Founder vesting schedules in early term sheets were structured with lengthy cliff periods and strict vesting timelines, generally spanning around four years. This was done to incentivise founders to remain committed to the company for the long term, but it left little flexibility for early liquidity or exit opportunities.
The ecosystem matures: more balanced term sheets between founders and investors
As the MENA start-up ecosystem has matured, so have the structures and terms of VC investments. Increased competition among venture capital firms, coupled with a rise in successful exits and regional unicorns, has shifted the balance of power and given founders the ability to negotiate more flexible terms.
Control terms have also been relaxed in response to growing recognition of the importance of founder autonomy and operational efficiency. Reserved matters and veto rights have been reduced to only material matters that need investor’s involvement, whether on the shareholders' level or the board of directors’ level, like changes to the business plan, issuing new shares, capital structuring, or the sale of the company. This has given founders greater flexibility to run day-to-day operations and make strategic decisions without constant investor oversight.
In contemporary venture capital term sheets, transfer restrictions, particularly the ROFR, have evolved to reflect a more balanced approach between protecting existing investors and providing flexibility for the company’s growth.
ROFR is typically structured in two tiers. The first right is granted to the company itself, which allows the company to repurchase the shares before they’re offered to any external buyer. This empowers the company to maintain control over its capitalisation table and ensure that ownership doesn't shift to potentially misaligned third parties.
Only if the company declines to exercise this right does the ROFR shift to the major investors, typically defined as investors who hold a substantial equity stake, often above a predefined threshold. These major investors are given the opportunity to purchase the shares on the same terms, thereby maintaining their level of ownership and influence within the company.
This dual-tier structure, where the company holds the initial ROFR, followed by major investors, has introduced greater operational flexibility. By granting the company the first right, it gives management the ability to prevent an influx of potentially disruptive or adversarial shareholders, preserving the company’s strategic direction.
On the other hand, limiting the ROFR to major investors – as opposed to all investors – reduces the procedural delays previously experienced in earlier versions of term sheets, where the right was extended to a broader group, streamlining the share transfer process and avoiding unnecessary delays in the company's liquidity events.
The structure and enforceability of pre-emption rights – which give existing investors the right to participate in any future equity issuances to maintain their pro-rata ownership – have also evolved. While pre-emption rights are typically granted to protect investors from dilution, modern term sheets in the MENA region now often include provisions allowing for the suspension of pre-emption rights by the board of directors under certain conditions.
The board may, in its discretion, elect to suspend these rights if it determines that waiving pre-emption is in the best interest of the company. This flexibility allows the board to act swiftly to secure new investment, particularly from strategic partners or high-profile third-party investors, without being bound by the obligation to offer existing shareholders the opportunity to participate in every new financing round.
By enabling the board of directors to suspend pre-emption rights, companies can quickly respond to opportunities that may otherwise be delayed or missed due to procedural constraints. Such a waiver may be invoked, for example, in circumstances where the entry of a new investor brings significant strategic value beyond mere capital, such as industry expertise, networks, or technological synergies, that existing shareholders may not provide.
However, this suspension is typically subject to certain safeguards, ensuring that the decision is made in good faith and with the overall long-term success of the company in mind, balancing the need to prevent excessive shareholder dilution with the strategic imperative of securing key investments.
Vesting schedules have also become more flexible. While the typical four-year vesting schedule has remained in place, with a one-year cliff, founders have gained more favourable vesting terms in certain circumstances. For example, many term sheets include accelerated vesting provisions in the event of a change of control or a sale of the company. This has allowed founders to accelerate the vesting of their shares upon the occurrence of a liquidity event, providing them with greater protection and rewards in the event of a successful exit.
Conclusion
The evolution of VC term sheets in the MENA region reflects the growing sophistication and maturity of the ecosystem. While early-stage term sheets heavily favoured investors, modern agreements have become more balanced, offering greater protections and rights to founders while aligning the interests of both parties.
Today’s term sheets incorporate legal structures that promote collaboration, governance, and long-term growth, ensuring that both investors and founders can benefit from the region’s expanding venture capital landscape. As the MENA ecosystem continues to evolve, so too will the legal frameworks governing venture investments, further cementing the region as a hub for innovation and entrepreneurial success.