What is an Investment Term Sheet?
In recent times it has become more common for a new venture to be called a startup, which is on the look-out for funding. Many young entrepreneurs who are working on their first startup are excited to get angel investors and VC funds on board. This is when all the documentation and legalities are looked into. There are a large number of entrepreneurs who find it very confusing and are unable to understand the potential issues with their legal documentation.
The first thing to keep in mind always is that a term sheet may or may not be a legally binding agreement and is not your sure-shot ticket while trying to get funding. A term sheet serves as a formal template to develop more detailed legal documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding definitive agreement or contract that conforms to the term sheet details is then drawn up
What does it cover?
The investment term sheet covers the discussions and includes the terms which both the investors and the founders have come to a conclusion and agree to take things forward. After the investment term sheet, a due diligence process will begin and the investors and founders will eventually negotiate, agree on, and sign the final agreements. The signing of these final definitive agreements is when a binding obligation to do the deal is formally created. So, a term sheet creates no contractual obligations on the investor to invest and on the startup to issue shares to the investor.
The term sheet contains all the information regarding who are the investors, name and identities of the investors and founders, the pre-money valuation of the company, the type of investment, investment amount, if the investors will have a seat at the board and then a number of special rights such as veto rights or affirmative rights. Affirmative right means, if the investors are not in favour of a proposed change, the startup cannot approve or take any steps on that front. The term sheet also mentions whether or not the entrepreneur is required to keep the investment negotiations confidential and it can also state terms which will prevent the startup from trying to find other investors for a specified duration.
What are the extremely important points in an Investment Term Sheet?
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- Investment Amount/ Valuation (Price Per Share)
- Investment Instrument.
- Founder's Ownership.
- Board Structure and Compositions
- Exit Option.
Investment Amount/ Valuation (Price per Share)
The amount which an investor is prepared to offer the startup is the investment amount. The valuation and price per share is determined on the basis of pre-money valuation of the investment amount.
This relates to the kind of instrument used to raise funds, it may either be in the form of preference shares, convertible debentures or equity shares. This is decided by the investors depending on various factors such as the extent of controlling power they feel is required, or the level of protection they wish to have over their investment and based on their role in the growth of the company.
The founder’s ownership, for an early-stage angel, seed or VC investment, is an extremely important issue and it needs to be addressed in the term sheet negotiations and the final agreements. Therefore, the investors usually add some transfer restrictions on the Company’s shareholding.
Board Structure and Composition
The founder can nominate who he would prefer to be on the board of directors, and they will be selected and appointed as per the relevant sections of the Companies Act. The board of directors of the company, usually comprise of the investor’s representative (nominated by the investor). This is done so as to allow the investors to have a person who will safeguard the interests of the investors.
The exit clause is an important and interesting clause. This requires the founders to commit to deliver an exit either by an IPO or through an M&A deal to the investors by a certain date. Incase this does not happen, this clause would typically require the founders to buy back the shares held by the investors at a price that gives a guaranteed return to the investors.
Twenty second takeaway
Mostly, a term sheet is a non-binding document, except for a few clauses, relating to exclusivity, confidentiality and the governing law. The negotiation in a term sheet is one of the most crucial parts of the investment process because this clearly defines the terms and relationship between the investors and company. If it is executed well, it usually leads to more detailed legal documents that close the investment deal and build relationships and get companies started in the right direction.
The next time you require an investment term sheet use Docket’s Standard Investment Term Sheet.
Investment Term sheet.
A term sheet is a nonbinding agreement setting forth the basic terms and conditions under which an investment will be made. A term sheet serves as a template to develop more detailed legal documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is then drawn up.