A term sheet is a document used when a business seeks investment as part of a funding round. It ensures that both the business owner and the investor are on the same page regarding how much is to be invested, and on what terms.
A term sheet will form the basis of much of the negotiation around funding deals, and can serve to clarify terms that work in the interests of all parties.
In this article, we will cover what a term sheet does, considerations for inclusion and negotiation, and why it is important to have this agreement in place.
What is a term sheet?
A term sheet, sometimes known as a ‘heads of terms’ or ‘heads of agreement’, is a non-binding document that essentially serves to summarise and act as a precursor to two other key documents – the Shareholders’ Agreement (also known as an ‘investment agreement’ or ‘joint venture agreement’) and the Articles of Association. Often funding is provided as a mixture of debt and equity and if so the term sheet will also set out the key terms of any loan or facility agreement.
Although term sheets are not legally binding in a general sense (unless explicitly stated), they can in some cases stipulate binding confidentiality and exclusivity provisions. The signing of a term sheet by all investors is a standard prelude to the creation of the later binding agreements.
A term sheet serves as evidence to the intent of both the business owner and the investor. As such renegotiation once the term sheet has been agreed is often very difficult – unless the situation changes or new information emerges during due diligence – and can even sometimes cause harm to the business relationship as it can seem to be an act of bad faith. Therefore, it is important to make sure that negotiation of important points is always conducted before finalising the agreement.
The contents of a term sheet can vary widely in different situations, and there is no one-size-fits-all solution for such an agreement. Its makeup will very much depend on the needs of the business in question and the stipulations of investors.
The layout of a term sheet can also take many forms. Although it might be presented in the form of a letter, a list of bullet points, or any of a number of other styles, its function is still the same.
Understanding term sheets and investment negotiation is very important for any business, as it is vital that the terms of any deal work to the benefit of all parties – with nobody left in a bad position. Seeking legal advice before signing such an agreement is always recommended.
It is also very important in enabling the final term negotiation period to progress swiftly and smoothly, so that the funding round can be closed without a protracted and unfortunate situation of endless haggling over various aspects. Also, many start-up businesses tend to look for an instant funding prop firm in the forex space that can provide funding instantly without much hassles or haggling.
What is typically included in a term sheet?
A good term sheet should:
- Cover the main commercial issues and allow both the business owner and the investor to clear up any problems or ambiguities
- Specify any and all conditions that would have to be fulfilled as a prerequisite to entering into other, binding agreements
- Give a timeline for negotiating and completing the funding transaction
- Address due diligence
- Clearly establish if any aspects of the agreement are legally binding.
However, a good term sheet should avoid references to ‘usual terms’ or arrangements that are customary in general. Ambiguity at this stage can lead to problems and misunderstandings over exactly what was agreed – so it is advisable to be thorough and lay key commercial terms out clearly.
A poorly-prepared term sheet containing too little detail – or too much! – can cause an unfortunate slowdown in the negotiation process and significantly increase legal costs, so it is important to ensure this document is prepared by an experienced professional.
Some of the items normally seen on a term sheet might include:
- The current valuation of the business and the amount of investment sought
- Any split between debt and equity
- Information about the business, its directors and shareholders
- Description of what the investment money will be used for
- Rules for the issue and transfer of shares
- Clarification of what happens if the business gets sold or wound up
- The investor’s rights regarding capital, dividends, and other share rights
- Whether investors have ‘information rights’ (the right to be given certain key information about the business such as regular management accounts and agreeing an annual business plan)
- Who has the right to be a director
- Whether there are any restrictions on competition for the business owners as a consequence of the investment
- Whether and to what extent investors will be able to influence key business decisions (known as Investor Consent).
Investor Consent means an investor will have the power to veto major business decisions. This might include major strategic or financial decisions, setting salaries, appointing directors, taking on debts, and other important matters. Often, this is a key area of negotiation in a funding round and important to clarify in a term sheet.
Who creates the term sheet?
During an investment round, the term sheet may be presented by either the business or the investor for the agreement of the other party.
Often, this will depend on the size and experience of the parties involved. A well-established investment firm or experienced angel investor is likely to produce their own standard term sheet for the business owner to consider.
On the other hand, a smaller investor may request that the business presents its own suggested term sheet as part of the negotiation. For many smaller businesses and startups, this can be a good opportunity to suggest terms that are more favourable with regard to relinquishing control over the business – although this must be considered with care, as the proposal still needs to be attractive to the investor.
Whether the business owner is able to draw up their own term sheet or is reacting to one given to them by an investor, it is always sensible to seek professional legal advice. A badly drawn up agreement can do more harm than good – and no business owner wants to get caught out agreeing to terms they later regret.
A well-prepared term sheet can save both parties time and money and allow the funding round to progress efficiently and amicably, with both the business owner and the investor able to lay the groundwork for ultimately making their deal a legal reality.
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Girlings Solicitors is an established and well-respected Kent law firm, offering Business Law, Personal Law and Third Sector services in London and the South East from their three offices in Ashford, Canterbury, and Herne Bay.