A term sheet is a written document that spells out the key conditions of parties negotiating a proposed transaction, such as an investment in a business or the sale of a business. A term sheet is not binding, although it may contain partially binding or completely binding terms such as confidentiality. It is one of several common documents that may be used before a final agreement is reached. Maximize your potential for a successful negotiation with a financial advisor in your corner.
Unlike a contract or definitive agreement, a term sheet serves as a framework for discussions that lays out details of the proposed deal. A term sheet, which is commonly used by startups seeking venture capital or angel investors, is typically organized by bullet points.
It may be as brief as one page or many pages. Sometimes it is called a letter of intent or memorandum of understanding, though these two documents can be distinguished: A letter of intent, often seen in acquisitions, resembles a term sheet but is typically in letter form; a memorandum of understanding is generally legally binding.
Term Sheet Contents
Each term sheet is unique, so the components of the document vary widely. Templates for term sheets are freely available and easily modified. While it’s not the final, executed, binding agreement, which will likely consist of several documents, including a share purchase agreement and other agreements, it does state the intent of the parties involved. It may be difficult to renegotiate key points after the term sheet is signed. Here are some items often contained in a term sheet.
- Identities of people involved in the transaction
- Name of the company that is issuing stock or giving a note to investors
- Current shareholders and directors of the company
- Amount of money being invested
- Number of shares being acquired, their price and whether they are common or preferred
- Company valuation implied by the amount of money invested and percentage of ownership acquired
- How invested funds will be used
- Description of what happens in the event of an initial public offering of stock acquisition by another company or liquidation
- Number of board seats and voting rights the investors will get
- Founders’ rights to remain as directors and officers
- Investors’ options to convert debt to equity or other conversion rights
- Company founders’ obligations to investors
- Restrictions on the company taking on additional investors for a set time period
- Provisions controlling dilution of investors’ percentage ownership
- Non-disclosure agreements
- Investors’ right of first refusal on future investment
- Company founders’ obligation to provide information to investors
- Timetable for the negotiation to reach final agreement
- Which parties will pay any legal expenses
In the final agreement, some of these items listed above will be described in detail in separate documents. The full contract is likely to include or refer to an investor rights agreement, the company’s certificate of incorporation, a right of first refusal agreement, voting agreement and more.
Until a term sheet is signed, the terms are open for negotiation. Because it’s not the ultimate contract, the term sheet could specify conditions that need to be met before it is finalized.
Other Term Sheet Features
For investors, the term sheet may also describe the process they will follow to do their due diligence. If the investors are asking to be able to control specific future decisions of the company, these rights will be described here. Investors use the term sheet to ensure their interests are being protected and they’ll be kept informed and able to exert as much influence as possible on major company decisions.
For founders, the term sheet can provide a clear picture of the investors’ intent. In particular, it can reveal whether investors plan to be there for the long term or are interested in a quick exit. Term sheet items founders are sensitive to, in addition to the amount and terms of the funding, include giving up controlling ownership, long time limits on their ability to work with other investors and penalties for breaching terms of the contract.
Term sheets also contain lines for signatures of the parties. Signing will activate the binding portions of the term sheet, if any. Signatures also signal the parties’ intent to eventually hammer out a binding contract finalizing the details.
The Bottom Line
A term sheet is an important first step in investors committing to provide debt or equity funding to a young company. While not usually binding, it is expected to lay out the major concerns of the parties and serve as an outline for a legally binding contract completing the deal.
Tips for Investing
- Consider talking to a financial advisor about whether venture capital investing is something you should explore. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Over the last few years, venture capital has become more accessible to the everyday investor through crowdfunding platforms. Crowdfunding sites offer an opportunity to pool your money with other investors to back startups.
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