Term sheets can be time-consuming to create, but there are certain methods to guarantee that the relevant information is included.
A term sheet's objective is to present an intelligible and thorough document that investors and company founders can use to negotiate and agree on the key parameters of their agreement without the fine detail or permanence of a binding instrument.
In today's article, we'll discuss the significance of this precursor document and the essential components to look for in term sheets.
What is a term sheet? A term sheet is a non-binding agreement that outlines the fundamental terms and conditions of a potential investment. Term sheets are a template that acts as the foundation for more elaborate, legally enforceable papers.
A binding agreement or contract that complies with the term sheet details is set out if the parties concerned achieve an agreement on the parameters put out in the term sheet.
What information can I find on term sheets? Term sheets used in a merger or attempted acquisition would normally include information on the initial purchase price bid, the desired payment method, and the assets included in the transaction.
The term sheet may also include information on what, if anything, is excluded from the deal, as well as any items that one or both parties may deem necessary.
Term sheets for startup financing would typically include the following:
information about the corporation, its present shareholders, and its current board of directors;
the company's estimated value and the amount it seeks to raise;
any investor information rights;
any rights to continue as directors for certain founders or investors;
whether or whether investors will have reserved rights' to some critical company decisions;
specifics on how the monies invested will be utilised;
any constraints on the founders' activity;
a description of the rights associated with the issuance and transfer of shares, as well as what occurs when the business is sold or wound up.
A term sheet might be as short as one page or as lengthy as ten pages. In general, founders like simplicity, but it pays to be clear and make sure all of your bases are covered.
When a founder examines a term sheet given by a possible investor, they should check for the following things:
Debt finance and convertible note clauses that might put you out of business
Requesting an excessively big controlling stake, which might imply that you'll be replaced
Terms that may restrict the amount of money that can be raised in the future
Investors that only seek a quick and hot exit and don't have reasonable deadline expectations
What are term sheet key terms I should know of? It's critical for a company to understand these situations:
Anti-dilution
Anti-dilution safeguards your investors in the event of a down round. It offers a variety of protection options, including narrow-based weighted average, full-ratchet, and broad-based weighted average. A broad-based weighted average is safe for you as the founder.
Liquidation Preference
While investor wants to see your business succeed, they also want to be assured that they won't lose money investing in your business.
They have the choice of receiving their invested capital or converting their shares if they choose the liquidation preference.
Your investors may receive the same amount they invested when the business is sold, or they may receive cash based on what portion of the company they control. Make sure the amount on the term sheet does not exceed the amount invested.
Option Pool
This clause protects future officers, consultants, directors, and staff by reserving shares for them. A piece of the cap table may be desired by your investor for future awards.
It's preferable to calculate this post-money for companies and ask investors to partake in the dilution. The standard in most term sheets, however, is to compute it before the money is received.
Reserve Matters
This is a list of things that can only be done with the investor's permission. It involves restricting the owner's capacity to obtain funds from the company other than as agreed.
If you believe that some aspects of the investment are not reasonable, especially if they make it difficult for you to manage your business, you can negotiate with the investor.
Valuation
The investor's ownership proportion is determined by the company's valuation and investment. The value is the most crucial part of your term sheet since it determines how much each shareholder will get when your business is sold.
As an entrepreneur, you should approach this with caution. Negotiate a reasonable price if you want to create a win-win situation for both parties. If you want to gain investors and create solid connections with them, you must be a skilled negotiator.
It will help you as a startup if you can write a comprehensive business plan that includes your marketing approach. For more information on how you can draft an effective business plan, head to our blog, “Why a Business Plan is Essential and how to write it.”.
The majority of uncertainty surrounding term sheets will be eliminated with legal guidance and proper legal writing. If you're unsure, we advise you to seek legal counsel.
For more information on how we can provide greater value to your business, please contact Persona Finance now at [enquiries@personafinance.co.uk].