An Entrepreneurial Guide To Term Sheet – What is a term sheet?

An Entrepreneurial Guide To Term Sheet

An entrepreneurial journey is quite juggling and interesting with loads of challenges, fortunes and misfortunes. But one cannot ignore the pleasure of success. Well..!!!! When you startup as an entrepreneur your startup and funding goes hand in hand. As one must be very well aware of the fact that funding is very crucial or say the breath of the business because without funds or investment you reach nowhere. It is important to learn about term sheet when you set out to deal with funds.

Funding ??? How do you deal with it ???
Being an entrepreneur, it is quite obvious that you borrow funds. And when you set out to borrow you come across investors, VC, legal terms, documents, law and many legally associated things which might be nerve wrecking at times. Because there are numerous entrepreneurs in the field who find it difficult to understand the legal stuff. And one among the crucial document is “Term Sheet”.

So, What is a Term Sheet ???
A term sheet is basically a document that personifies the terms and conditions related to the concerned investment. It is actually a non- binding agreement upon which an investment is dealt with. You can consider term sheet as a template to construct an original law- binding contract or agreement. Therefore a term sheet is just an outline of the major terms, thereby it does not hold any kind of contractual obligations.

The main purpose of a term sheet is to present a blueprint or sample for the accurate formation of the formal legal documents.

An Entrepreneurial Guide To Term Sheet

The metrics or things presented in the term sheet are given below. Since it is a blueprint of things regarding the transaction or agreement, it contains:

  • Valuation of the company
  • Economic rights with respect to the share.
  • Price per share of investment and much more depending upon the agreement or contract.
  • Type of stock
  • Dividends.
  • Option pool.
  • Liquidation preference and much more with respect to the concerned deal or contract.

So once when the negotiation between the business and the investor is agreed upon on the basis term sheet, the following important formal documents are prepared:
1. The stock purchase agreement.
2. Voting agreement.
3. Investors rights agreement.
4. Certificate of Incorporation
5. Rights of first refusal.
6. Co- sale agreement.

Now, you would think why is this “Term Sheet” important despite not having any legal or contractual obligation ???

So, If you think that. Then let me say you that it is very important both for the business or company and the investor. As you are aware that a term sheet presents a clear and transparent view or summary of the transaction which is yet to happen in the future. So, in that case, having a document like a term sheet in hand would help the investor and business have a beneficial negotiation if not walk off.

Apart from that, the confidentiality and exclusivity clause makes the term sheet a valid document to consider. And since it covers the most important aspects and elements regarding the terms and conditions of the transaction, it serves the best to execute a deal or contract.

Know it deeper !!!!!
When you see a term sheet, you will notice that it includes a variety of elements, metric, and terminology which has a meaning and importance with respect to the transaction. The information in the term sheet revolves around these elements, which helps the investor and the company to decide whether they should “ Make the deal or break the deal”.

Some of the important terminologies and terms include:
1. Valuation: Valuation refers to the estimation of worth. The method of calculating the worth varies according to the practice of companies or investors. So, in that case, a clear term sheet presents a clear point of valuation with respect to the Post- money valuation (An estimation after the investment) and Pre- money valuation (An estimation prior to the investment).

2. Dividends: These are actually the sum of money paid to the shareholders at regular interval of time.

3. Option Pool: Option pool refers to the reserve made out of stock. It is used by the company to serve as rewards instead of money. It usually ranges between 10- 20% upon the value of the company.

4. Liquidation Preference: Some of the common liquidation events associated with a company are merger, selling off assets and acquisition. So a term sheet clearly presents how the liquidation event is to be carried out. Eg: Settling the preferred stockholders first and then the rest. Thereby it mentions the order and proportion of preference.

5. Stock: A company generally has the common stock and preferred stock on hand. The preferred stock holds special rights and is generally given to the investor and the common stock lies with the founder. The term sheet mentions the protection rights of the parties and the stock held by them.

6. Anti- dilution: It generally caters to protect the investor from any kind of future dilution or share investment.

7. Stock Conversion: This is one of the prime provisions mentioned in the term- sheet. It is related to the investor’s liquidation preference. Conversions deals with transforming a common stock to a preferred one.

8. Participation: This is one more key provision mentioned in the term sheet. It mentions and explains who gets the share in the remaining proceeds of the company in the liquidation event.
If you are are a startup, you need not fear about the mentioning of elements.

All you have to do is transparently mention the following in clear terms:

  • The type of stock allocated to the investor say common or preferred.
  • Terms of dilution.
  • Participation of Board of Directors.
  • Rights on shares and reclamations.
  • Priority of liquidation.
  • Delivery of investment amount at requisite stages.
  • Considerations and valuations.

An entrepreneur might initially find it daunting and panicking, but then he will understand the importance of term sheet when he has to deal with a sophisticated investor. Because it helps them protect their rights as well as the investor’s rights. So an entrepreneur should not feel this process as a complicated one rather make it a point to analyze more and stay updated. Because a little negligence would lose your stance in the market and trade.

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