What is a Term Sheet?
A term sheet is a non-binding agreement between parties that sets out the basic terms and conditions of an investment and which is usually used by startup companies when they commence their operations. The non-binding effect of a term sheet signifies the avoidance of legal formalities that arise when a startup company is seeking investment prospects. Once parties have agreed to the terms of the term sheet, a legally binding agreement or contract is then drawn up with finer details of the agreed commercials.
Who are the parties to a Term Sheet?
The parties to a term sheet are the investors and the promoters of a startup company. The term sheet is prepared by the investor showing the terms of investment that he/ she is willing to make in the startup.
What is the purpose of having a Term Sheet?
The term sheet acts as the foundation for any agreements at the start of the investment. Its purpose is to enable the parties to agree on the major terms and conditions for the investment while avoiding the risks of the complex legal formalities that arise during the process of a startup company seeking capital injection. The term sheet thereby gives investors the confidence to inject capital into a startup company.
What are the key terms in a Term Sheet?
The key terms in a term sheet include the following:
- company valuation – this refers to the value of the company determined by an independent valuation;
- investment amount- this refers to the amount invested by an investor in a company;
- percentage stake- this refers to the amount of shareholding owned by a shareholder in a company;
- voting rights- this refers to rights derived from a specific class of shares in a company which are usually held by ordinary shareholders. They give that class of shareholders that right to vote and make decisions in the corporate sphere;
- liquidation preference- this refers to which investors get paid first in the instance of liquidation. Further, it states how much they will get paid;
- anti-dilutive provisions- this refers to clauses set out to protect investors by shielding their investment from losing value due to an increase in capital; and
- investor commitment- this refers to a commitment from the investor that is given to the seller of shares to purchase the shares for an agreed price.
What is the main risk in getting into a Term Sheet?
The biggest risk that presents every startup company is the number of shares to be subscribed by the investor. Since the investor might have the “capital muscle”, the stake to be acquired with the capital investment by the investor might be higher than that of the promoters. Therefore, the term sheet would highlight the nature and value of shares to be subscribed by the investor, that is, the voting rights of the investors. For instance, the promoters would wish to limit the value of shares subscribed to by the investors such that the investor have limited control in the management of the startup.
Navigating around term sheets is an essential factor necessary in promoting the success of any business enterprise. It seeks to promote investor confidence.
The key intention of this article is to appraise you on the endless possibilities in furthering your company through investments by investors. The term sheet is the foundation of all investments. At Netsheria International, we have an experienced team of lawyers who can advise you on preparation of term sheets as well as the necessary steps in protecting startups and investors.