Watch Out for Goliath 

Blog: Term Sheet — From The Beginning 

I got a call from a recent incubator team founder ready to make a presentation to raise funds. I know the personality of the founder and I worry when he will see a term sheet for the first time, how he will act. As I note below this can be a frightening experience. I asked him to please go on line and look at a term sheet and then we can term about his position. I also gave him the name of a lawyer to help.

At a point when investors are ready to consider going forward as a partner with a startup, an agreement needs to be made. This agreement is called a Term Sheet and will be needed after the investors do a due diligence. The agreement will go much further than just defining the money to be invested and the ownership? It can be expected that the investors will have clauses that protects their interests and will minimize their risk for their investment. The entrepreneur should expect protection from their side also.

The fact is the investors may have done this action numerous times collectively but most likely it is the first time for the entrepreneur. Lawyers will obviously be involved; therefore the entrepreneur should be looking for advice that may even go beyond his advisory team. I advise entrepreneurs it makes sense to get a lawyer involved as soon as possible.

I believe it would benefit to have a term sheet for a start-up before the first encounter with investors.  I have seen opportunities die when an inexperienced entrepreneur is shocked when they see a term sheet for the first time and what the investors are asking for – not realizing the term sheet is negotiable. The entrepreneur should think out what will be the most importance in the agreement for them.

One can find term sheet examples on the Internet. The National Venture Capital Association has one on www.nvca.org.  The entrepreneur should not be frightened by the many numerous clauses as they are overly inclusive, but they can be a good reference.

The term sheet will define the key issues wanted by the entrepreneur and the investors. If the key issues cannot be agreed upon, it will save time and effort by both sides in not going forward.

The term sheet is not legally binding, unless selected items are defined and can legally hold up. The term sheet will typically include the financial terms including the company valuation to be used, both parties’ rights, and the conditions for closing the final transaction.

The most important part of the term sheet defines the deal; the dollars wanted, the form of the investment, the piece of ownership for the investors and the performance expected by the company.

The new entrepreneur can expect that sophisticated investors may have their own term sheet form. This can be dangerous to the entrepreneur because the investment defined by one side can be expected to lean in their direction. This is why it is wise for the entrepreneur to have a lawyer on their side to help prepare and the information the entrepreneur wants in the agreement and then help negotiate the clauses in the term sheet. A mentor coach can also be a help

Following is a list that can be part of a term sheet wherein and most favor the investors. The term sheets could go on forever therefore an entrepreneur should not be frightened as many the terms and clauses will not relate to their deal. But the list below can show how complex a term sheet can be.

There is no doubt the entrepreneur will be seeing most of the items for the first time. Again I urge the entrepreneur to seek a lawyer and knowledgeable advisors for help and guidance:

  • Liquidation preference
  • Participation rights
  • Dividend policy frequency
  • Redemption rights
  • Right of first refusal
  • Pre-emption rights
  • Co Sales rights
  • Board of Directors
  • Drag along rights
  • Pay to play
  • Registration rights
  • Anti-dilution

One can see from an entrepreneur side the importance of having a lawyer to help.  It would be wise for an entrepreneur to do some research on the list above before finalizing a term sheet. This could help an entrepreneur getting a head start for any final negotiations. Interesting enough the entrepreneur can start to see which of their clauses if invoked can be at a deal breaker to them.

If an agreement in a term sheet cannot be reached at this point, the deal is dead

Much of the information presented above is from an organization called Angel Capital Association.