A term sheet is a document that sets out the the key economic and legal aspects of a planned investment summarises. It is often agreed between founders and investors at the start of a funding round.
The term sheet serves as the basis for further negotiations, due diligence and the drafting of the final investment agreements. It provides clarity at an early stage as to the conditions under which an investment is, in principle, to take place.
Typical contents of a term sheet include:
- Amount of the investment
- Pre-money and post-money valuation
- Investors’ shareholding ratio
- Type of company shares issued
- Voting and information rights
- Rights of control and approval
- Liquidation preferences
- Protection against dilution
- Vesting arrangements for founders
- Tag-along and drag-along rights
- Exit arrangements
- Exclusivity and confidentiality
- Timetable leading up to the closing
A simplified example:
| component | Example |
| Pre-money valuation | €4 million |
| Total investment | €1 million |
| Post-money valuation | €5 million |
| Involvement of the new investors | 20 % |
| Purpose | Product development, sales and team building |
In addition to the valuation and equity stake, other conditions may have a significant impact on the founders.
Particularly important regulations are:
- Liquidation preference: Sets out how the proceeds from a sale are to be distributed amongst the shareholders in the event of an exit.
- Vesting: Determines the period over which founders acquire or retain their shares in full.
- Protection against dilution: Protects investors, under certain conditions, from having to provide further funding at a lower valuation.
- Rights of consent: Define decisions that may only be taken with the consent of certain investors.
- Rights to information: Rules governing the financial and corporate information that investors receive on a regular basis.
- Tag-along rights: Enable minority shareholders to sell their shares as part of a sale.
- Drag-along rights: Minority shareholders may be obliged to sell their shares under specified conditions.
A term sheet is often largely non-binding. This means that the actual investment only becomes binding once the final contracts have been concluded. However, certain provisions may already be legally binding, in particular:
- Confidentiality Agreements
- Exclusivity clauses
- Cost arrangements
- Governing law and jurisdiction
- Rules governing the termination of negotiations
Whether any of these points are binding, and if so which ones, depends on the specific wording.
The typical process following the signing of a term sheet is as follows:
- Due diligence
Among other things, investors assess the company’s finances, business model, contracts, technology, market and legal risks.
- Contract negotiation
The key points of the term sheet are incorporated into investment agreements, shareholders’ agreements and other documents.
- Fulfilment of outstanding conditions
This may include resolutions under company law, adjustments to the shareholding structure or the clarification of intellectual property rights.
- Signing
The parties involved will sign the final contracts.
- Closing
The investment is finalised, the capital is paid in, and the new shares are transferred or issued.
For founders, a term sheet offers a number of advantages:
- Early clarity on key terms and conditions of investment
- a structured basis for further negotiations
- a lower risk of fundamental misunderstandings
- faster preparation of the final contracts
- greater comparability between different investment options
Common mistakes when dealing with a term sheet include:
- to focus solely on the company valuation and the amount of investment
- to underestimate the economic impact of liquidation preferences
- to accept far-reaching approval rights without scrutiny
- Failure to take sufficient account of vesting and leaver provisions
- to confuse binding and non-binding clauses
- failing to take future funding rounds and exit scenarios into account
- to sign the term sheet without a legal and tax review
The highest investment offer is not automatically the best. Founders should consider the whole package – including voting rights, terms of investment, strategic added value and the long-term partnership with the investors.
innoWerft helps founders to better understand the financial implications of typical term sheet provisions, to assess funding offers and to prepare for negotiations with investors in a structured manner. The final legal and tax review should be carried out by suitably qualified advisers.