The first and most important step before making investment
into the company is to decide: What terms should be covered in my Term Sheet?
There
is always a dilemma in the preparation of the term sheet as to whether to draft
a negotiated, detailed, précised term sheet, or to draft a term sheet where
significant terms will be negotiated at the time of due diligence.
What is term sheet?
A term sheet is a document which sets out the broad
parameters of an investment made by an angel investor or venture capital
investor to the startups
The term sheet compiles up the discussions and defines the
terms on which the startup owner and investors have agreed to informally.
Binding Provisions of Term Sheet
Nothing in the term sheet is legally binding on the parties
except for the covenant of ‘Confidentiality and No-Shop Provisions.
Confidentiality:
This is the most important clause of the term sheet where all
the financial data related to investment is disclosed to the investors.
Therefore, insertion of this clause protect the company’s sensitive information
from being revealed by the potential investor to third parties.
“No-Shop” Provisions :
A “No-Shop” provision prohibits the company from exploring
alternate financing with any third party for a short span of time.
Further, company must make sure that this provision should
not be are too restrictive or extend for too long a period of time, especially
when the company is in need of funds.
Basic Provision of Term Sheet
Term Sheet reflects the following:
1) Type of Security:
One of the initial terms that must
be included in the term sheet is the type of security whether investment is
made in common stock or preferred stock etc,
2) Price of security:
The price per share will be based
on the capitalization and valuation of the company.
i.
Pre-money valuation: the investor’s
estimate of what the company is worth before his or her investment of funds.
ii.
Post-money valuation: the expected value of
the company after investment of the proposed funds.
4) Capitalization:
Investors analyze their investment in a company
based on the capitalization of the company. Whereas the capitalization is based
on the total number of shares which are outstanding plus all of the shares that
are expected to be outstanding if options and warrants were exercised and
convertible securities were converted.
Below are the List of the Key Terms of A Term Sheet
1. Consideration for the money invested:
The investors often
prefer to invest in convertible preferred stock. It gives them a preference
over common shareholders in respect of dividends and upon a sale of the company
gives them the option of converting into common stock if the company is
successful.
2. Type of stock
given: The stock allotted to the investor must be defined
clearly in the term sheet. The
investors are more preferable to invest in preferred shares that entitles them
to vote and will receive preference in the payment for their stock in the event
of the company’s liquidation which is why the investors found it as an
attractive investment.
3.
Non-solicitation: Most of the venture capital investors
insist on inserting a lock-up period clause where the company would be
prohibited from accepting an investment or acquisition proposal from any other
party during
the preparation process of term sheet.
4.
Involvement of Board of Directors: The
investors insist on the right to appoint at least one member to the company’s
board who are responsible for setting company policies, approving financing
etc, in return for its capital investment. So, it is necessary to include the
details of involvement of investors in board of the company.
5.
Prevention of Equity Dilution: The venture capital firms will require an anti-dilution clause insertion
to the term sheet to protect
them from future sales of shares at a lower value.
6.
Tranches: In cases where
the investors’ invest in tranches
to the startup then the period of tranches must be specified in the term sheet
as it reduces both the founders and investor's risk.
7.
Right to buy shares back: Venture capital investors always want to protect their financial
interests in a company. Therefore Venture capital
investors normally insist to include
right of first refusal (ROFR) clauses in their term sheets. This
clause allows existing owners to reclaim shares that are about to be sold to a
new investor and prevent ownership division in company.
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