Six Ways to Master the Term Sheet
A term sheet is something that will affect you and your company for many years to come, so getting it right is crucial. Technically, a term sheet is a non-binding legal document laying out the basic terms and conditions regarding a joint venture between an investor and a company.
Term sheets require a great deal of preparation because they serve as a template for a future binding agreement between the two parties.
The primary purpose of a term sheet, in a nutshell, is to craft a detailed document that both the investor and company owner can use to negotiate a fair deal without the permanency of a binding document. When done right, term sheets can also avoid future disputes regarding expenses and obligations.
The challenge, then, is composing a term sheet with reasonable provisions for both the investor and the company — because there's a lot at stake. Term sheets help investors safeguard their capital and have lasting implications for businesses, especially for those raising equity.
Term sheet mistakes could be costly, as one might end up giving away more equity than they intended or losing control over their business. For this reason, business owners should be well-versed in how to master the term sheet before entering into negotiations with an investor.
A term sheet usually has the following parts, although it may vary depending on the specific agreement:
- Board of Directors: Establishing board members early on assures both parties that the business is appropriately structured
- Information About the Company: This includes the company's name, starting valuation, and other relevant information
- Investment Overview: This pertains to crucial information about the investment, such as the initial investment amount, the percentage it will earn, and investor commitment terms
- Voting Rights: This part will explain how much of the company's future initiatives will be overseen by the investor
- Participation Rights: This portion protects investors should they decide to take back their share by receiving a return before other investors.
- Liquidation Preferences: Companies may choose to specify a liquidation preference that explains how investors would receive the proceeds if the company is sold, as well as a confidentiality agreement
If you're ready to get started, here are six tips for mastering the term sheet.