A term sheet is a document that outlines the terms and conditions of a potential investment in a company. It is usually presented by investors to entrepreneurs as a precursor to a formal agreement, and it serves as a blueprint for the investment. The term sheet outlines the key financial and operational terms of the investment, including the amount of money being invested, the valuation of the company, the ownership percentage being acquired by the investor, and the rights and obligations of both parties.
If you’re a startup founder or an entrepreneur, it is crucial to understand the contents of a term sheet. In this tutorial, we’ll provide a comprehensive guide on how to read a term sheet and highlight all the sections and clauses that are found in the most common term sheets.
Introduction
The introduction section of a term sheet provides an overview of the proposed investment. It typically includes the name of the investor and the company seeking investment, the amount of money being invested, and the type of security being issued (e.g., preferred stock, convertible note, etc.).
Valuation
The valuation section outlines the pre-money valuation of the company, which is the value of the company before the investment is made. The post-money valuation, which is the value of the company after the investment is made, is also calculated in this section.
Investment
The investment section outlines the amount of money being invested and the conditions under which the investment will be made. This section also includes details on the payment of the investment, such as the timing of payments and the form of payment (e.g., cash, stock, or a combination of both).
Capitalization Table
The capitalization table, also known as the “cap table,” provides a summary of the company’s ownership structure, including the number of outstanding shares, the percentage of ownership held by each shareholder, and the types of shares issued. The cap table is important because it determines how the investment will affect the ownership structure of the company.
Liquidation Preference
The liquidation preference clause outlines the order in which investors will receive their money in the event of a liquidation event, such as a sale or bankruptcy. This clause is important because it determines how much money investors will receive in relation to other stakeholders, such as founders and employees.
Board of Directors
The board of directors section outlines the composition and responsibilities of the company’s board of directors. This section includes details on the number of board seats and who will fill those seats, as well as the voting rights and decision-making authority of the board.
Protective Provisions
The protective provisions clause outlines the rights and obligations of the investor with respect to the company’s operations. This clause may include restrictions on the company’s ability to take certain actions without the investor’s approval, such as issuing additional stock or entering into major transactions.
Anti-Dilution
The anti-dilution clause is designed to protect the investor from dilution of their ownership percentage in the company in the event of a subsequent financing round at a lower valuation. This clause may include provisions for full-ratchet, weighted-average, or other forms of anti-dilution protection.
Conversion
The conversion clause outlines the conditions under which the investor’s securities can be converted into common stock. This clause is important because it determines how the investor’s ownership percentage will be affected if the company undergoes a change in ownership or if the investor decides to sell their securities.
Warranties and Representations
The warranties and representations section includes a series of statements made by the company’s founders and management team regarding the company’s financial condition, legal status, and other relevant matters. This section is important because it can help to protect the investor from potential fraud or misrepresentation.
Valuation and Investment Amount
The valuation and investment amount sections describe the amount of money the company is seeking to raise and the value placed on the company for the purposes of the investment. These sections typically include information on the pre-money valuation (the value of the company before the investment) and the post-money valuation (the value of the company after the investment), as well as the amount of capital being raised and the percentage of ownership that will be allocated to the investor(s).
Liquidation Preferences
This section outlines how the investor(s) will be repaid in the event of a sale or liquidation of the company. It typically includes information on whether the investor(s) will receive a preference over other shareholders, and if so, the multiple of the initial investment they will receive before other shareholders receive any proceeds.
Conversion Rights
Conversion rights describe how the investor(s) can convert their preferred shares into common shares. This section usually includes information on the circumstances under which conversion is allowed, the conversion price, and any other conditions that must be met before conversion is permitted.
Board of Directors and Voting Rights
This section outlines the composition of the company’s board of directors and the voting rights of the investor(s). It typically includes information on the number of board seats the investor(s) will be entitled to and any special voting rights they may have.
Protective Provisions
Protective provisions are rights granted to the investor(s) to protect their investment. This section usually includes information on veto rights over certain corporate actions, such as changes to the company’s articles of incorporation, mergers or acquisitions, and the issuance of new shares.
Information Rights
Information rights describe the level of access to the company’s financial and operational information that the investor(s) will have. This section typically includes information on the frequency and level of detail of financial reports, as well as any other information that the investor(s) may request.
Founder Vesting
Founder vesting outlines the terms under which the founders’ shares in the company will vest over time. This section usually includes information on the length of the vesting period and any acceleration events that may cause vesting to occur more quickly.
Anti-Dilution
Anti-dilution clauses provide protection for the investor(s) in the event that the company issues new shares at a lower price than the investor(s) paid for their shares. This section typically includes information on the formula used to calculate the adjusted price and any limitations on the anti-dilution protection.
Termination
The termination section outlines the circumstances under which the term sheet may be terminated by either party. This section usually includes information on the notice required for termination and any fees or penalties associated with termination.
In summary, a term sheet is a critical document that outlines the basic terms and conditions of a potential investment in a company during a fundraising round. It is essential to understand the various sections and clauses in a term sheet to negotiate effectively and protect your investment. By reviewing the information outlined above, you should be well-equipped to read and interpret the most common sections and clauses found in a term sheet.
