When a growth equity or private equity firm sends you an LOI, the first number you look at is the valuation.
That’s normal.
But valuation is only the price. It is not the structure.
The structure determines:
- Who gets paid first in an exit
- Who controls strategic decisions
- Who can force a sale
- What happens if growth slows
- How much autonomy you actually retain
You do not need to read these agreements like an attorney. But you need to understand what certain terms mean and what they are designed to do.
Below are the provisions every software founder and CFO should understand before signing.
1. Pre-Money vs. Post-Money Valuation
Definition
Pre-money valuation is the value of the company before new investment capital is added. Post-money valuation is the pre-money valuation plus the new capital.
If an investor says they are investing $15 million at a $60 million pre-money valuation, the post-money valuation becomes $75 million. That means the investor owns 20% of the company after closing.
Why this term exists
This framework determines ownership percentages. It is how equity is divided between existing shareholders and the new investor.
Plain English meaning
This is simply the math that decides how much of your company you are giving up.
However, this math can be affected by other factors such as the creation of a new option pool, rollover equity mechanics, or transaction expenses.
What to watch for
Always ask:
- Is the option pool being created before or after the valuation is calculated?
- Are all shares included in the fully diluted count?
- Does the ownership percentage being discussed match the final cap table?
It is common for founders to focus on the headline percentage and later realize the fully diluted ownership is lower than expected.
2. Primary vs. Secondary Capital
Definition
Primary capital is money invested directly into the company to fund growth. Secondary capital is money paid to existing shareholders in exchange for their shares.
Why this term exists
Growth investors often structure deals so that founders can take some liquidity while also injecting capital into the business.
Plain English meaning
Primary money helps the company grow. Secondary money helps the founders personally.
For example, if an investor invests $30 million and $20 million goes into the company while $10 million goes to the founders, that $10 million is secondary. The company does not see that cash.
What to watch for
Make sure the company has enough primary capital to execute its strategy. Secondary liquidity reduces personal risk, which can be healthy, but it does not improve cash runway.
3. Preferred Equity and Liquidation Preference
Definition
Preferred equity gives investors special economic rights. A liquidation preference determines who gets paid first when the company is sold or liquidated.
A common structure is a “1x non-participating preference,” which means the investor gets their invested capital back before common shareholders receive proceeds — but must then choose: take the preference or convert to common equity and participate pro-rata. They cannot do both.
A “1x participating preference” is more investor-favorable: the investor gets their capital back first and then also participates pro-rata in whatever proceeds remain alongside common shareholders.
Why this term exists
Investors want downside protection. They are investing large amounts of capital and want assurance that, if the exit is modest, they recover their money first.
Plain English meaning
In a sale, investors stand at the front of the line.
If they invested $20 million and the company sells for $25 million, they receive their $20 million back first. The remaining $5 million is shared by common shareholders.
In a large exit, the preference matters less. In a smaller exit, it can matter significantly.
What to watch for
- Is the preference 1x or higher?
- Is it participating or non-participating? Participating preferred lets investors recover capital AND share in remaining proceeds. Non-participating preferred forces a choice between the two — generally more founder-friendly.
- Are there cumulative dividends attached?
Always model a few exit scenarios to see how proceeds would actually be distributed.
Also consider how preferences stack across multiple funding rounds. If a company has raised a Series A, Series B, and Series C, each round typically carries its own liquidation preference.
In a modest exit, Series C investors are paid first, then Series B, then Series A — with common equity, including founder shares, receiving proceeds only after all preferred stacks are fully satisfied. The higher the total preference stack relative to exit value, the less common equity participates in any meaningful way.
4. Drag-Along Rights
Definition
A drag-along right allows a controlling group (usually the board or majority investor) to force all shareholders to sell their shares if the company is sold.
Why this term exists
Buyers want certainty. If one small shareholder refuses to sell, it can block a transaction. Drag rights prevent that.
Plain English meaning
If the board approves a sale, you may be required to sell your shares even if you disagree.
What to watch for
- Who controls the Board?
- Is there a minimum valuation threshold before drag rights can be exercised?
- Can the investor alone trigger a sale?
Ownership percentage does not automatically mean control over exit timing. Board control usually does.
Tag-along rights: the counterpart protection
The inverse of drag-along rights is the tag-along right (sometimes called co-sale right). Tag-along rights allow minority shareholders — including founders who have retained shares — to join a sale on the same economic terms if a majority investor or controlling party decides to sell. Where drag-along rights protect the buyer’s ability to acquire 100% of a company, tag-along rights protect minority holders from being left behind in a transaction they had no power to block.
5. Put Rights
Definition
A put right allows an investor to require the company (or other parties) to buy back their shares after a specified period, often five years.
Why this term exists
Private equity funds have limited lifespans. A put right provides a mechanism for liquidity if no exit has occurred within a certain timeframe.
Plain English meaning
After a certain number of years, the investor can say, “Buy us out.”
If the shares must be purchased in cash, the company may need to refinance, raise debt, or sell.
What to watch for
- When can the put be exercised?
- Is the purchase price paid in cash?
- What happens if the company cannot afford to buy back the shares?
This clause can create significant financial pressure in later years.
6. Board Composition and Voting Mechanics
Definition
Board composition determines who sits on the board. Voting mechanics determine how decisions are approved.
Why this term exists
Investors want governance influence proportional to their investment and risk.
Plain English meaning
Whoever controls the board controls major decisions.
Even if you own more shares, you may not control strategy if the investor controls the board.
What to watch for
- How many Board seats does each side have?
- Are there weighted voting rights?
- Are there clauses that guarantee investor voting control?
Always focus on how many votes each side controls.
7. Protective Provisions (Major Decision Rights)
Definition
Protective provisions require investor approval for certain actions, such as:
- Approving budgets
- Taking on debt
- Issuing new shares
- Selling the company
- Large capital expenditures
Why this term exists
Investors want veto rights over decisions that could materially impact their investment.
Plain English meaning
These provisions give investors a “no” button on major decisions.
What to watch for
- Is your annual budget subject to approval?
- What are the thresholds for incurring debt?
- Can you pivot strategy without investor consent?
These provisions can significantly affect operational flexibility.
8. Representation and Warranty Insurance (RWI)
Definition
RWI is an insurance policy that covers losses if representations and warranties made in the purchase agreement are incorrect.
Why this term exists
It reduces post-closing disputes between buyer and seller by shifting certain risks to an insurance carrier.
Plain English meaning
If something turns out to be wrong, the buyer may claim against insurance instead of directly suing the founders.
However, certain matters are often excluded.
What to watch for
- What is excluded from coverage?
- Are there deductibles?
- Are certain liabilities uncapped?
RWI reduces risk, but it does not eliminate it.
Understanding the structure of a RWI policy matters. Key terms to review include:
- Deductibles (retention): Policies typically have a deductible of $250,000 to $1 million or more. Claims below that threshold are not covered by insurance — they come out of the seller’s pocket.
- Exclusions: RWI policies routinely exclude fraud, known breaches (items identified during due diligence), forward-looking statements, IP ownership disputes, environmental liabilities, and certain tax matters. These exclusions are standard and non-negotiable.
- Coverage caps (often 10–15% of deal value): Total policy coverage is typically capped in this range. To illustrate, on a $20 million deal, maximum insured recovery would be $2–3 million. Claims above the cap revert to the seller.
- Survival periods: Claims must generally be filed within 18–24 months of closing. After that window closes, coverage lapses.
For anything that falls into an excluded category — fraud, undisclosed known issues, or matters above the coverage cap — founders remain personally liable regardless of the insurance policy. RWI is a risk reduction tool, not a clean release from representations and warranties.
9. Indemnification and Clawbacks
Definition
Indemnification requires sellers to compensate the buyer for specific losses. In some cases, recovery can occur through withholding distributions or clawing back equity.
Why this term exists
It protects the buyer from undisclosed liabilities or breaches of agreement.
Plain English meaning
If certain problems arise after closing, you may be required to give back money or equity.
What to watch for
- Is liability capped?
- How long do obligations last?
This affects the security of your retained ownership.
Several mechanics determine how indemnification actually works in practice:
- Escrow holdback: A portion of the purchase price — often 5–10% — is withheld at closing and held in escrow for 12–24 months. If indemnifiable claims arise, the buyer draws from escrow before seeking payment directly from founders.
- Basket and deductible: Most agreements include a minimum threshold before indemnification is triggered. A “tipping basket” means once aggregate claims exceed the threshold, the entire amount is recoverable. A “deductible basket” means only the amount above the threshold is recoverable. This prevents buyers from pursuing minor claims.
- Cap vs. no-cap: General indemnity obligations are typically capped — often at the escrow amount. However, certain categories are routinely left uncapped: fraud, intentional misrepresentation, fundamental representations (ownership, authorization, capitalization), and certain tax liabilities. If you are exposed on any of these, the cap does not protect you.
- Survival periods: Different claim types survive for different lengths of time. General representations may survive 12–18 months post-close. Tax representations often survive until the applicable statute of limitations. Fundamental representations and fraud claims may survive indefinitely.
10. Repurchase Rights
Definition
Repurchase rights allow the company or investor to buy back shares under specific conditions, often tied to employment or misconduct.
Why this term exists
Investors want key individuals to remain committed and aligned with the company’s long-term success.
Plain English meaning
If certain events occur, some of your shares may be bought back.
What to watch for
- Does this apply to all shares or only certain classes?
- At what price can shares be repurchased?
- What qualifies as “cause”?
- Does rollover equity carry clawback or repurchase provisions? Confirm whether the investor can recapture rollover shares under specific conditions and what triggers apply.
This determines how durable your ownership truly is.
Single-trigger vs. double-trigger acceleration
A related distinction worth understanding is how repurchase rights (and equity vesting) interact with employment events. A single-trigger arrangement means that termination alone — regardless of other circumstances — activates the repurchase or accelerates vesting. A double-trigger arrangement requires two events to occur: termination AND a change of control. Double-trigger is significantly more founder-friendly because it prevents investors from forcing a founder out post-acquisition and immediately recapturing unvested or repurchasable equity. Always confirm which trigger applies to your shares.
11. Option Pool Creation
Definition
An option pool is a reserve of shares set aside for current and future employees.
Why this term exists
The company needs equity incentives to attract and retain talent.
Plain English meaning
New shares are created to give to employees. This dilutes everyone.
What to watch for
- Is the pool created before or after the investment?
- Who bears the dilution?
- Are performance hurdles attached?
Equity incentives are essential, but they change ownership percentages.
12. Investor Monitoring or Advisory Fees
Definition
Some investors charge ongoing fees for operational support or advisory services.
Why this term exists
Investors argue that their involvement adds value and these fees compensate their internal teams.
Plain English meaning
The company pays the investor a recurring fee.
What to watch for
- How large are the fees?
- Do they increase over time?
- Are there additional recruiting or transaction fees?
These fees reduce profitability and should be treated as real operating expenses.
In practice, these fees can represent 0.5% to 2% of annual revenue in later years of the holding period — a meaningful ongoing drag on profitability. Some agreements also include step-up provisions that increase the fee automatically over time, and separate transaction fees triggered by acquisitions, refinancings, or exit events. Model these as real operating expenses when evaluating total deal economics.
Final Thought
Growth equity is not simply a financing event. It is a governance shift.
These provisions determine:
- Who stands first in line to get paid
- Who has veto power
- Who controls the Board
- Who controls exit timing
- What happens if performance falters
Valuation determines price. Structure determines power.
If you understand these terms clearly — in plain English — you will be far better prepared to evaluate whether a deal aligns with your long-term goals. As a CFO, do I have these terms mastered like an M&A attorney? No, but I must understand the concepts and the impact on the business. Want my M&A attorney contacts? Contact me!
Disclaimer
This content is for educational purposes only and does not constitute legal, financial, or investment advice. Every growth equity deal is different — terms, structures, and investor rights vary by transaction, investor, and jurisdiction. Before making any decisions related to a growth equity transaction, consult qualified legal counsel and financial advisors who can evaluate your specific situation. Nothing in this post should be relied upon as a substitute for professional advice.
I have worked in finance and accounting for 25+ years. I’ve been a SaaS CFO for 9+ years and began my career in the FP&A function. I hold an active Tennessee CPA license and earned my undergraduate degree from the University of Colorado at Boulder and MBA from the University of Iowa. I offer coaching, fractional CFO services, and SaaS finance courses.