How should you respond to the first term sheet you receive?

 The term sheet is a contract between a start-up founder and an investor that has been written following a pitch meeting or a preliminary corporate meeting of ideas regarding the proposed deal. The main terms and conditions of the funding are contained in the document exchanged between the parties (start-up founders and angel investors/venture capital investors). 

As a first step toward finalising the deal agreements and completing the time-consuming due diligence, the term sheet identifies the essential aspects of the agreements and sorts out any discrepancies. Memorandums of understanding (MoUs) and letters of intent (LOIs) are other names for term sheets.

It serves as a template for both in-house and external legal teams to use when drafting final agreements as it merely reflects the important and broad areas of agreement between the parties as a foundation on which the investment will be made. It also serves as a non-binding term sheet which can be used as a basis for final agreements if the parties prefer.


The facts and circumstances of the case must be taken into account when determining whether or not the term sheet is binding. In a term sheet, the key financial and other terms of a proposed deal are outlined, which are subject to negotiations and certain conditions. The agreement serves as a blueprint for creating final legal documents like a joint venture agreement, subscription agreement, shareholder agreement, etc. Due to this, the term sheet forms the basis of all definitive agreements.

Key components of Term Sheet


Offer of New Securities

​Preferred shares generally come with rights that give them precedence over common shares in this section. Investors can choose between preferred and common shares. As an example, preferred shares have mandatory dividends and priority over equity and common shares. However, preferred shares usually do not come with voting rights. As an alternative, common shares typically have one vote that can be exercised if a shareholder vote is required.

Capitalisation following Financing

This section provides the reader with an overview of the company's financial structure following the proposed new funding. By reading the material in this section, the reader will be able to determine the company's pre-money and post-money values. In pre-money valuation, the company is valued before the new investment, whereas in post-money valuation, the company is valued after the investment.

Council rights

In this case, an investor can nominate or choose candidates for the board of directors. Investors typically only ask for the right to nominate a small portion of the board. They may, however, insist on appointing independent directors who also hold a majority, as well as having one or more attendees attend all board meetings.

Dividends

It's a money that is distributed routinely (quarterly or annually) to shareholders by a company from its profits. In the event of insolvency of a company, dividend provisions are a key tool that allows investors to preserve their investment and exit the deal with a chance of at least a return.

Dividends are built up over time by increasing an investor's preferred equity size rather than being paid out regularly. That equity should have grown over time after the investment, providing the investor with a fixed rate of return.

Additional provisions

There are several such clauses, including the investor's right to perform due diligence before closure, exclusivity clauses (the company's commitment to reject competing proposals), and payment of the investors' expenses.

Investor safeguards

Investor approval is necessary for important company decisions. The company may issue shares that are more valuable than the shares it owns, take on secured debt, restructure the business, repurchase shares, and pay dividends. Management-level decisions include selecting and removing top executives as well as altering the company's operations.

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