A term sheet is a non-binding agreement setting forth the basic terms and conditions under which an investment will be made. It serves as a template to develop more detailed legally binding documents. For an investing round, a term sheet is a critical document because it outlines the key financial and legal terms of the investment.
Here are the typical components of a term sheet in an investment round:
- Valuation of the Company:
- Pre-Money Valuation: The valuation of the company before the investment.
- Post-Money Valuation: The expected valuation of the company after the investment, including the new capital.
- Investment Details:
- Amount being invested.
- Type of security being issued (e.g., common stock, preferred stock, convertible notes).
- Investor Rights:
- Dividends: Terms concerning the payment of dividends, if any.
- Liquidation Preference: The payout order in case of a sale, dissolution, or liquidation of the company.
- Anti-Dilution Provisions: Protections for investors in case future investments are made at a lower valuation.
- Voting Rights: How and on what issues investors may vote.
- Founder Issues:
- Vesting: Conditions under which the founders earn their shares over time.
- Employment Agreements: Terms of the employment for the founding team.
- Control and Decision Making:
- Board Composition: Details on the makeup of the company’s board of directors.
- Protective Provisions: Specific matters that require approval from investors, such as selling the company or raising additional capital.
- Conversion Rights:
- Conditions under which preferred stock can convert to common stock.
- Redemption Rights:
- Whether investors can require the company to buy back their shares after a certain period.
- Right of First Refusal (ROFR):
- Gives investors the right to participate in future financing rounds to maintain their percentage of ownership.
- Pro-Rata Rights:
- Allow investors to invest additional funds in future rounds to avoid dilution of their ownership percentage.
- Drag-Along Rights:
- Requires minority shareholders to sell their shares if a majority of shareholders agree to a deal.
- Information Rights:
- Rights to receive periodic financial statements and other important information.
- Confidentiality and Non-Compete Clauses:
- Terms to protect the company’s sensitive information and to prevent investors from investing in direct competitors.
- Exclusivity:
- Obligates the company to negotiate exclusively with the investor for a certain period.
- Legal Fees:
- Specifies who will bear the legal costs of the investment transaction.
- No-Shop Clause:
- The company agrees not to seek other investment offers for a specified period.
Once the term sheet is agreed upon, it guides legal counsel in the preparation of definitive agreements. It is important to note that while the term sheet itself is not typically legally binding (except for certain provisions like confidentiality, exclusivity, and legal expenses), it is a crucial step in the investment process as it reflects the intent of both parties and forms the basis for the legally binding documents that will follow.