Term Sheets for Investment11Jul2022
1. What is a Term Sheet?
A Term Sheet is a summary of the business, finance and legal terms that will apply to an investment round.
Usually it is a not a legally binding document, except for a few provisions such as confidentiality, costs or exclusivity clauses.
2. Why is a term sheet useful?
Two words: Cost savings!
A Term Sheet is probably the single most cost-saving process in negotiating an investment round.
A Term Sheet is a roadmap for documenting the deal. It is a drafting instruction sheet for the lawyers who are to prepare the investment transaction documents. A well-drafted Term Sheet provides clarity and certainty on key deal points, and narrows the issues that are to be agreed in long-form documents.
Negotiating and agreeing a four page Term Sheet, is much easier than doing so with long-form documents, some of which can be 40 or 50 pages in length.
The attempt to agree a Term Sheet will show at a much earlier stage whether it will be possible for the parties to agree terms for the long-form documents of the investment round.
3. Are there steps I should take to prepare before starting to discuss a Term Sheet?
The most important step is education. Founders need to grasp the technical meaning of the terms, and where the market range is for negotiation of those terms. The critical points to cover are corporate governance, capital structure and rights, dilution, and exit processes.
Seek advice to understand the terms and the market range. Seek advice to ask what is completely unreasonable and what can be conceded.
Also, research or seek advice on the process and documents required for an investment round. It is very important for the founders to fully understand the process.
4. Who prepares the Term Sheet?
In early stages such as seed stage or if there is no lead investor, the founders should prepare the Term Sheet.
If there is a lead investor, counsel for the lead investor will usually prepare the term sheet and the founders will negotiate changes
Whoever prepares the Term Sheet gets the advantage of controlling the terms and the negotiation. There is a benefit to being the first to set out the terms. Psychologically, it means the other party has to negotiate and justify changes to those terms.
5. Can I change the agreed terms in a Term Sheet in the long-form documents later on?
If the Term Sheet is non-binding then yes. Though in practice changing terms may demonstrate a lack of good faith, and could put the investment in jeopardy. Changing the agreed terms in a Term Sheet usually only happens if there has been a change in circumstances either to the business or the trading environment after the Term Sheet was signed.
If the Term Sheet is binding, then this constitutes the agreement between the parties and any changes would need to be agreed by both parties.
6. Can I walk away from a Term Sheet if I change my mind or better terms are offered to me?
If the Term Sheet is non-binding then yes, but there should be a compelling reason to walk away. The risk is that a founder who walks away from a deal agreed in principle will acquire a reputation, and may find it more difficult to raise capital in the future.
If the Term sheet is binding, the agreement is enforceable by either party. If you do not perform the obligations under the Term Sheet, the other party or parties could initiate legal proceedings to enforce the Term Sheet.
If you would like to discuss any of the matters raised in this article, please contact:
Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.