Two of the most common questions that startups and small business founders before investment are boggled by:
What should be in my Investor Pitch Deck?
What should and how should be the Term Sheet?
To help with that, the below article elucidate about the “term sheet” and how the term sheet needs to be prepared.
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.
Nothing in the term sheet is legally binding on the parties except for the covenant of ‘Confidentiality’ The terms and conditions included in a Term Sheet is confidential information and cannot be disclosed by the parties to any third party without investor's prior approval.
What does term sheet contain?
Term Sheet reflects the following:
1) Valuation -This clause referred in the investment term sheet includes:
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.
iii. Capitalization table: indicates the ownership of both founder and investor, equity dilution and equity value in each round of financing.
iv. Price per share: the per share value of the company stock.
2) Amount of the investment
3) Ownership claims the investor receives in exchange for the investment- The investors prefer to have the claims in return of the investment for their security which is why they invest in convertible preferred stock. It gives them a preference over other shareholders in terms of dividends and profit sharing at time of liquidation of Company.
4) Rights and responsibilities of each party
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 which entitles them to vote and will receive preference in the payment for their stock in the event of the company’s liquidation.
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.