What is a Term Sheet?

A Term Sheet is a document that outlines the key terms and conditions under which an investor is willing to make a financial or monetary investment in a company. It serves as a non-binding agreement between the business and the investor, summarizing the primary terms of any risk or venture capital investment. It is important to note that a term sheet does not carry legal enforcement; rather, it serves as a starting point for discussions between the business and the investor. Multiple versions of a term sheet may be exchanged before the actual investment takes place.

Drafting a Term Sheet

A term sheet outlines the broad parameters on which an investment will be based. It summarizes the key aspects that will be included in the final transaction agreements. These terms are later negotiated and refined in the formal agreements, based on the initial framework laid out in the term sheet. The document provides essential details on which the investor makes their investment decision.

Benefits of a Term Sheet

Although a term sheet does not always lead to an investment, as negotiations may fall through, it remains an essential document that outlines the terms and conditions of a future transaction. It provides significant value to both the company and the investor for the following reasons:

• Clear Overview: The term sheet serves as a clear and concise summary of all critical terms, ensuring transparency and fairness for both parties. It consolidates all essential details into one document, providing both sides with a shared understanding of the investment.

• Binding Clauses: While a term sheet is not legally binding in its entirety, it may include certain binding clauses such as confidentiality and exclusivity clauses:

  • Confidentiality Clauses: These ensure that both parties maintain confidentiality during the negotiation process.
  • Exclusivity Clauses: Also known as "no-shop clauses," these prevent the company from seeking other investors during the negotiation period.

• Reference for Later Negotiations: A term sheet acts as a reference point in the later stages of negotiation, helping both the company and investor stay aligned on key terms as they move towards finalizing the deal.

Is a Term Sheet Legally Binding?

A term sheet is generally not legally binding. Instead, it serves as a document that outlines the basic terms and conditions, with the understanding that both parties agree to enter into a definitive agreement after negotiating the terms.

A typical term sheet covers the following:

• Company Valuation: The valuation of the company.
• Investment Amount and Timing: The amount of investment and its timing.
• Form of Investment: The manner in which the investor will make the investment.
• Non-Solicitation: Agreements regarding non-solicitation of the company's employees.
• Protective Provisions: Protective clauses for the investors.
• Board Representation: The number of directors the investors can elect to the board.
• Founders' Stock Vesting: Terms regarding the vesting of the founders' stock.
• Anti-Dilution Protection: Price-based anti-dilution protection in case of future stock sales.
• Pre-emptive Rights: Investors' rights to purchase any future stock issuances on a priority basis.

Basic Elements of a Term Sheet

The key elements typically included in a term sheet are:

• Investment Structure: Details of the investment structure.
• Corporate Governance: Provisions related to corporate governance.
• Dilution and Exit Rights: Rights related to dilution and exit strategies.
• Other Covenants: Additional clauses for operational or business conduct.

Clauses to Consider When Signing a Term Sheet

When signing a term sheet, some key clauses to keep in mind include:

• Business Valuation: Agreement on the company's valuation.
• Equity Liquidation: How existing shareholder equity will be liquidated.
• Liquidation Preference: Structure for liquidation in case of company dissolution.
• Investor Approval: Restrictions requiring investor approvals for certain actions.
• Drag-Along Rights: Rights enabling majority shareholders to force minority shareholders to sell.
• Tag-Along Rights: Rights allowing minority shareholders to join in a sale initiated by majority shareholders.
• Ratchet Rights: Adjustments to the investment terms based on future valuations.
• Escrow of Founders’ Shares: Provisions regarding founders' vesting and escrow of their shares.
• Exclusivity: Clauses ensuring the company will not negotiate with other investors during the term sheet period.