Angel investing is complex and angel investors have varying levels of
sophistication. Some investors are incredibly adept, with deep knowledge of term
sheets, market conditions, valuations, and potential outcomes. If that’s you, you can
probably stop reading right now. If you’re new to angel investing, or a
founder preparing for your next raise, keep reading. Here, I’m going to explain
everything you need to know about term sheets.
A well-negotiated term sheet can set the stage for a successful investment,
while a poorly constructed one can lead to financial loss and strained relationships.
I’m going to break down a term sheet into its components, explain key terms, and
offer advice for negotiation. I’m also going to discuss the implications of those
clauses for both the investor and the startup.
What is a Term Sheet?
A term sheet is a non-binding agreement that outlines the basic terms and conditions under which an investment will be made. It’s a template to develop more detailed legal documents and sets the stage for the relationship between the investor and the startup. Think of it as a "handshake deal" in written form; it's not legally binding but signifies a mutual intention to move forward. The term sheet is crucial because it outlines everything from the valuation of the startup to the investor's equity stake, liquidation preferences, and more. It's the document that both parties refer to when drafting the final, legally binding contracts, such as the Shareholders' Agreement and an Investment Agreement.
Types of Term Sheets
Before we get to specific terms, we need an understanding of the different types of term sheets. Here are the main types:
Long-Form Term Sheets: These are comprehensive and include detailed terms and conditions. They are typically used in later-stage investments or more complex deals that require extensive stipulations.
Industry-Specific Term SheetsThe type of term sheet you're dealing with can significantly impact the negotiation process and the final agreement. Therefore, it's crucial for both investors and startups to be familiar with these variations.
Key Terms and Clauses in a Term Sheet
Here's a breakdown of some of the most important terms and clauses you'll encounter:
Valuation
Pre-Money Valuation: This is the valuation of the startup before the investment. It's used to determine the price per share and how much equity the investor will receive.
Post-Money Valuation: This is the valuation of the startup after the investment has been made, including the new capital.
Equity Ownership
Common Stock: These are the basic shares that usually come with voting rights but are last in line during liquidation.
Preferred Stock: These shares come with special rights, such as priority during liquidation and often include voting rights.
Liquidation Preference
This clause specifies the order in which proceeds will be distributed in the event of a sale, liquidation, or bankruptcy of the startup. Preferred stockholders often get paid before common stockholders.
Vesting Schedule
This outlines the timeline over which founders and employees earn ownership of their shares. A typical vesting schedule might be over four years with a one-year "cliff."
Anti-Dilution Provisions
These protect investors from dilution in future funding rounds by adjusting the price of their shares.
Board Representation
This clause specifies who will sit on the startup's board of directors and often includes seats for investors, founders, and sometimes independent directors.
Exit Strategy
IPO (Initial Public Offering): Going public to offer shares to the general Public. Acquisition: Being bought by another company. Merger: Combining with another company.
How to Negotiate a Term Sheet
Negotiating a term sheet is a critical step in the investment process, and it's where both investors and startups can set the tone for a successful partnership.
Term sheets, although potentially complicated, can be navigated more confidently when investors and founders are educated and on the same page. To learn more about term sheets join us at the Render Capital Angel network or contact me directly here.