What is the term sheet?

Once you have pitched to your investors and they agreed to invest, now it’s the time for the documentation. For an entrepreneur and the founder’s, it’s very important to understand the documentation because it contains a lot of important Terms and conditions and some important clauses. So here we will talk about what is the term sheet and what does it contain?

These terms and clauses are very important because it not only determines your shares in the company but also your rights over your own business about decision making and general operation of the business.

The term sheet is the first document that is signed between the investors and the founders.

The term sheet is not a formal contract but instead its just a letter of intent about the funding in general and it is non-binding which means neither the investor nor the founders are obligated to abide whatever is written in the term sheet in the court.

After the signing of the term sheet, there is a time gap of a few weeks before the actual funding rounds, where the investors perform various kinds of checks about the business. They talk to the customers, vendors, etc in order to understand the customer experience and about the operation of the business.

What does the term sheet contain?

It contains a lot of information regarding several topics mentioned below, there is not much explanation regarding all topics instead it is presented in a bullet form with a small description.

• Company: It contains information about the startup/company.
• Investors: It contains information about the investor’s investment in the company.
• Founders: It contains information about the founding team of the company.
• Past investors: It contains information about any of the past investors.
• Investment amount: It is the amount that you are raising in that particular round of funding.
• Valuation: It is the value at which your company is getting valued in both the cases that are before funding and after funding. Before funding is called Pre-money valuation and after funding, it is called post-money valuation.

• Conditions Precedent: Its basically some conditions laid from the investor’s side which needs to be fulfilled from the founder’s in order to finally get the funding amount.
• Anti-Dilution: If the company gets valued lower after the investment, this clause states that the investors will get extra shares in order to lower the investor’s losses.
• Affirmative rights: This means that for some defined actions or steps approval of investors is a must in order to taker that decision. FOr ex while issuing new shares or while taking a decision to sell off the company.
• Liquidation preference: This tells about the distribution of money among the shareholders during any liquidation event like sell-off or IPO etc. There is a 1x liquidation preference that is mostly followed in the market.

There are two types of preference:

1. Straight preferred: In straight preferred the investor will get either the percentage of ownership or the amount, he had invested whichever is higher.

For example, an investor has invested $3 M for 20% ownership and the company gets sold for $10 M, which means that 20% of $10 M is $2 M, now the amount invested $3 M is higher, so the investor will get $3 M.

Another example is like an investor has invested $3 M for 20% and now the company gets sold for $50 M, now the 20% will be $10 M, now the 20% is higher than the invested amount, so the investor will get $10 M.

2. Participating preferred: In participating preferred firstly the investor gets the funded amount and then he gets the percentage of the remaining amount of the amount at which the company gets sold off.

For example, an investor has invested $3 M for 20% and the company gets sold for $10 M, now firstly the investor will get $3 M and now 20% of the remaining amount $7 M that is $1.4 M, which sums up to $4.4 M.

• Representations and warranties: This basically tells about the past of the business. For example about any past ongoing legal measures or any IP or patent issues, etc.
• Exclusivity: Once you got the term sheet from an investor, now with this clause the founders can’t go to some other investors during that time.

These are some of the things present on the term sheet. It's always advisable to have a lawyer for going through these things in order to not face any problem in the future.

All the best!