The Ins and Outs of Term Sheets: Your guide to understanding the key document of fundraising
A term sheet is a non-binding document that outlines the terms and conditions of a potential business agreement or investment.
It is typically used in the context of capital investments, but can also be used in other types of business transactions.
A term sheet serves as a starting point for negotiations and is usually followed by a more detailed legal agreement. It is important to note that a term sheet is not a legally binding document, but it can be used as a reference point in the event of a dispute.
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There are several key elements that are typically included in a term sheet. These can include:
1. Investment amount:
The term sheet should specify the amount of money that is being invested, as well as any additional terms related to the investment (e.g., equity or debt).
The term sheet should include information about the valuation of the company being invested in. This could include the pre-money valuation (the valuation of the company before the investment is made) and the post-money valuation (the valuation of the company after the investment is made)
The term sheet should specify the ownership structure of the company being invested in, including the percentage of ownership held by each party.
4. Board of directors:
The term sheet should specify the composition of the board of directors, including the number of seats and the parties that will hold those seats.
5. Voting rights:
The term sheet should specify the voting rights of the parties involved, including any special voting rights that may be granted to certain parties.
The term sheet should specify the management structure of the company being invested in, including the roles and responsibilities of key personnel.
The term sheet may include provisions to protect the interests of the parties involved, such as covenants, representations and warranties, and indemnification provisions.
8. Rights of first offer or Rights of first refusal:
A right of first offer (ROFO) is a clause that gives a party the right to be offered the opportunity to purchase an asset or equity before it is offered to third parties. This is similar to a right of first refusal (ROFR), which gives a party the right to match any offer made to purchase the asset or equity. A right of first offer can be beneficial to the holder because it allows them to have the first opportunity to purchase the asset or equity at a price that they are willing to pay. It can also help the holder avoid having to compete with other potential buyers, which can drive up the price.
9. Co-sale rights:
This gives the investor the right to participate in the sale of the company's equity or assets along with the company's founders and other shareholders.
10. Exit strategy:
The term sheet should specify the conditions under which the investment can be exited, including any provisions for the sale or transfer of ownership.
11. Voting rights:
Investors may be granted certain voting rights in relation to the company being invested in. This could include the right to vote on matters such as the appointment of directors or the approval of major business decisions.
12. Information rights:
Investors may be granted certain rights to receive information about the company being invested in, such as financial statements and updates on the company's performance.
13. Board representation:
Investors may be granted the right to appoint one or more members to the board of directors of the company being invested in.
14. Preemptive rights:
Investors may be granted the right to maintain their ownership percentage in the company by participating in future rounds of financing on the same terms as the new investors.
15. Liquidation preference:
Investors may be granted a preference in the distribution of the company's assets upon liquidation or sale. This means that the investor would receive their initial investment back before any remaining assets are distributed to the other shareholders.
16. Drag-along rights:
Investors may be granted the right to require the other shareholders to participate in a sale of the company.
17. Tag-along rights:
Investors may be granted the right to participate in a sale of the company if a majority of the other shareholders agree to sell their shares.
18. Other terms:
The term sheet may include other terms and conditions that are specific to the business or investment in question.
It's important to carefully review a term sheet before entering into negotiations, as it can have a significant impact on the terms and conditions of the final agreement. It's also a good idea to consult with an attorney or other legal advisor to help you understand the implications of these conditions and rights.