Explaining Term Sheets
When you buy an expensive piece of equipment or even sign a contract with a new client, the document you are given as a product warranty states, with a lot of details, what the manufacturer’s liabilities are, and what your ‘care’ obligations are.
Similarly, when you enter a contract with a new client, that client will use the terms of the contract between you two to outline what your obligations are, what work you are expected to do, how and when to deliver it, what happens if you breach the terms of the contract, and so on.
A term sheet, when it comes to an investor wanting to invest some much-needed cash into your start-up, is the same. It will be the investors the ones who will send you a draft of the term sheet for you to agree with (ideal scenario for any investor, of course) or to make a counterproposal (not so ideal for investors, but potentially good for you).
In the term sheet you will be sent, you can expect to see anything from how many board seats the investor(s) want(s), how much equity they expect for their capital injection, your business’ valuation, what you (the founder) and you (the legal entity) are allowed and are not allowed to do etc.
There is no standard term sheet template, like there is no standard product warranty or business contract. At their very core, all the term sheets have some common points, such as:
- Rights and obligations for both investor and investee (as in you, the start-up founder/owner)
- Applicable law and jurisdiction
- Disputes and arbitration
- Types of shares (preferred or not)
- Exit strategy and the investors’ role in it
- Bringing more investors on board
- Executive staff appointments, and more
One of the most important aspects of a term sheet is its intentionally straight forward and simple nature: it is meant to serve as the foundation of the ‘big’ share purchase agreement that will inherently follow.
What the term sheet does, and it does so really well, is to offer you a semi-formal view of what it is expected of you, and of what you can expect from your investors (irrespective of these being venture capitalists or angel investors).
No one knows better than investors and you, the start-up founder, that time is money so, therefore, why would you waste significant time and resources on the big contract (as in the share purchase agreement), when you may not even be able to agree on the general terms and conditions of it?
You need to understand very clearly that a term sheet is not a legally binding document: it is an agreement in principle or, if you wish, a form of pre-contract. If you are familiar with the term, it is like a Memorandum of Understanding: in other words, in principle, you agree to ... etc.
Those of you who are lucky enough to be presented with a term sheet by an investor, please read it carefully, and make sure that you are happy/comfortable with its general terms. Do not sign it if you are desperate for cash, or if you are afraid you might upset the investor(s) and they may withdraw their offer. Remember, at the end of the day, while it may seem that they are doing you a massive favour by investing in you, it is you who are doing them an even bigger one: you will make them money, whether you like it or not, whether you realise it or not.
If you are not happy with some of the terms and conditions, please go back to them and seek clarification. Once you get an investor through the door, you cannot tell them to get out the next day: it is a business relationship you will have to navigate for several years to come, and you will have to do so carefully and masterfully. And, depending on how you start this relationship, it can be a pleasant experience, or a not so pleasant one.
If you are unsure where you stand right now, or if you seek clarity on your path to scale or go-to-market, perhaps you need to consider joining our start-up Business Configurator because, in a world where most investors’ attention span is no longer than three seconds (trust us on this!!!), you do need to stand out, don’t you?
We can offer you clear and tangible solutions to all these pinch points and more. And, as a plus, we are solely dedicated to sustainable start-ups. We can help you configure your start-up for both profit and purpose and, after 12 weeks of intensive business coaching, mentoring, dry-pitching, and networking with industry experts, angel investors, venture capitalists and other start-ups in our community, you will see the real difference we can make to your business: we optimise it to be investment-ready.
Join our Configurator to develop your product/service and be confident about what it can deliver to your customer base.