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A term sheet is a summary of the key business terms of the proposed transaction. It should be short, easy to understand, and it should be free of legalese—save perhaps a sentence about the non-binding nature of the proposal. Term sheets are helpful in reaching agreement on the principal business terms as they are very short (1-2 pages) and concise, and easily understandable by those at all familiar with the terms.
Each type of financing, (e.g. convertible notes, preferred stock) will have a fairly typical set of topics that are covered in the term sheet. For convertible notes, this will include interest rates, conversion conditions, and so on. For a preferred stock offering, the term sheet will cover price per share, liquidation preferences, et cetera. Part III will help you understand the common terms in typical angel financings such that you can quickly evaluate any term sheet you may come across. We’ll also cover more unusual terms. Examples of the types of terms sheets you will encounter are collected in the appendix.
To be clear, there are no “standard” terms for term sheets. There are typical terms and industry norms, but there is still quite a range out there. Some accelerators, like Y Combinator, put forth very entrepreneur-friendly term sheets and encourage very little negotiation of them. Some angel groups put forth very investor-friendly term sheets. Once you have reviewed the types of investments here and seen a few in the field, you will start to get a sense for what is typical for different financings.
For term sheet terms that are most often associated with a single type of financing, we discuss them within that section. Some terms are applicable across a broad range of financing types, and these we will cover in General Investment Terms.
Sample term sheets of each type of financing can be found in Appendix A.
No matter what kind of deal you’re negotiating, there are a couple of things to keep in mind:
dangerAvoid binding term sheets. Binding term sheets are, in general, not advisable except in very unusual circumstances. A term sheet, by virtue of its brevity and lack of legalese, is not intended to capture every business term (remember, it is short, preferably a page or two in length). After reaching agreement on a term sheet, investors will continue refining their thinking about the prospective investment as due diligence reveals information about the company, the market, and other relevant considerations. That information may lead an investor to determine that the deal should not proceed or should proceed on different terms. If the term sheet is binding, however, the investor may not be able to get out of the deal or be stuck with the term sheet terms, even if unsatisfactory.
dangerAvoid ambiguous term sheets. Although term sheets should be short, sometimes they fail to clearly define key terms or use imprecise language that later leads to confusion and conflict. Can you see how this language could lead to problems?
The “board” (which may be a board of directors or board of managers) shall be made up of both Founders and the Investors or their representatives. If more investors are added, the board shall become a representative board of five people, whose number and make up may be changed from time to time by vote all of the membership interests voting, but must always include at least one representative of the Investors as long as the Investors hold together more 5% of the Company on an as-converted basis.
This paragraph introduces confusion on a number of fronts. How big is the board going to be, exactly? And whose representatives will make up the board? An ambiguous term can lead to mistrust and a broken deal. Avoid these scenarios by taking care to use precise language. Frequently your best bang for the buck for lawyer fees can be had when you involve the lawyer at the earliest stages to help architect the transaction.
The term sheet outlines the details of a specific financing and is usually non-binding (save perhaps for exclusivity and confidentiality clauses). For the deal to be closed, legal contracts representing the details of the investment terms need to be drafted, negotiated, and signed. These contracts and potentially amendments to corporate documents are referred to as the definitive documents.
Definitive documents are the legal contracts between the buyers (investors) and seller (the company) that spell out in detail the terms of the transaction, and are drafted by a lawyer. The definitive documents will set forth the entire understanding of the parties. Definitive documents can include an amended corporate charter and/or articles of incorporation that need to be filed with the secretary of state in the state in which the company is incorporated and would be available for the investor to review. The documents must be signed by all parties in order for a closing to be reached.
Closing refers to the moment at which you sign the definitive documents requiring your signature, and send the company your money, typically either in the form of a check or a wire transfer. The company signs the required documents and delivers to you the security purchased.
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