Investment Documents - Term Sheet

Updated: Jun 4

A term sheet is typically the first document to be signed between the investors and the startup. In this article we take a look at some key elements of typical term sheet.


Purpose of the Term Sheet

The term sheet is intended to lock down key terms of the investment and related conditions. Whereas a typical shareholders' agreement can run for twenty pages or so, a term sheet is a relatively short document (one or two pages) that summarizes the key terms of the investment.


As a shareholders' agreement is a heavy document with detailed clauses for legal reasons, it does not form an ideal basis for negotiating the key terms of an investment. Contrary to the shareholders' agreement term sheet is meant to be used in the negotiations to agree on the main elements of the transaction.


Typical Terms in a Term Sheet


Investment

As the term sheet is about investment, the obvious term to agree is the actual investment. The first one, of course, is how much is to be invested, and in case of a syndicated investment, how the investment is allocated between the investors.


It can also be agreed the investment is made in tranches. In this case, the trigger of each tranch should also be agreed.


Valuation

The second important element to be agreed upon is the valuation of the company, i.e. the consideration what the investors get in exchange for their investment in the company.


Be clear what you agree on: Specify if this is a pre- or post-money valuation, or what is the price per share or the stake in the company investors will get; using more than one of these is totally fine and even recommendable (you do not want the investment to fall down just because there was a misunderstanding on the valuation, to begin with). For the differences between pre- and post-money valuations as well as non-diluted and fully-diluted valuations you can check my previous article here.


Governance of the Company

Investors typically require a seat in the board of directors, so it is feasible to agree on the composition of the board as well as the rights to nominate and remove board members.

Minority shareholders usually also require some kind of veto rights to the major decision regarding the company; e.g. exiting it. These kinds of qualified majority decision requirements can also be outlined in the term sheet.


Option Pool

Especially early-stage startups are running with incomplete teams and need to hire some key personnel in the future. And these key persons are usually incentivized with options or shares. In order to align the views of the founders and investors from day one, it would make sense to agree on the size of the option pool already on the term sheet.


Liquidation Preference

Liquidation preference refers to the investors' right to receive their funds back before other shareholders get proceeds from the company. Despite the name, liquidation preference can apply both in liquidation as well as exit.


In a typical liquidation preference the investors get their money back before proceeds to founders; however, it is not uncommon to see liquidation preferences with multiples, especially if the company takes in multiple VC investments.


In practice 1x liquidation preference would mean that in case of an exit below the valuation the investors have invested in, the investors get their money back first and proceeds above this, if any, are distributed to other shareholders. On the other hand, in an exit above the valuation of the investment, the proceeds are spread pro-rata between all shareholders.


Other Terms

The terms above are typical ones that included most of the term sheets in investing in early-stage companies. However, there might need to agree on additional terms on a case-by-case basis. These terms may include clauses on e.g. founders compensation, recruitments, IPRs, applying for grants and so in.


Is a Term Sheet Binding

I get often asked whether a term sheet is binding or not. And unfortunately, I need to give the typical lawyers answer: It depends. Some term sheets are not binding in any shape or form, some give right to deviate from the terms only if something material comes up in due diligence, some give exclusivity for certain period for the investors to negotiate the investment and so on.


While I do not usually see a need for a binding term sheet, I like to remind all parties that you should only sign a term sheet once you are committed to concluding the transaction. Renegotiating terms after signing this is not a good practice.


Point of View

In many ways, the term sheet is a more important document in investing in a company than a shareholders' agreement. In practice it concludes the negotiations between the parties into key terms which they are prepared to accept. Shareholders' agreement, while finalizing these terms, is more of a document to provide the backbone on running the company after the investment is made. In the next article we will take a dive into the key elements of the shareholders' agreement.


Interested in other investment documents? Find out more below:

Shareholders' agreement

Investment agreement

Syndication agreement

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