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What Is a Terms Sheet?
A terms sheet is a nonbinding agreement between yourself as the company owner or representative and an investor that outlines the broader terms and conditions of an investment deal. Parties frequently use it as a template and starting point for the more detailed and legally binding documents that'll come in the future. Once the involved parties agree on the term sheet details, they'll move into the next step of forming the legal documents that facilitate the investment in the company.
Terms sheets are typically associated with startups because it's these companies that most often need more investment dollars to start the business or expand operations, but many companies planning on a merger or acquisition use it too. Having a term sheet actually attracts investors and venture capitalists to your company with the means to contribute financially to assist with growing your business.
It's obvious that investors find it appealing to be a part of a company that they believe will bring them a solid return on their investment for years to come. What's even more enticing is when that company has everything in order and the terms of a potential agreement laid out in a way that's clear and doesn't leave much room for misinterpretation or confusion.
While the term sheet doesn't have to go into every single detail or contingency of a deal, it should include the more important parts so investors can read through it and know exactly what they are getting into. Venture capitalists may have many deals in front of them, so as a business owner, you may find it easier to attract the funds you need when you make the process easy on your investor.
What to Include on a Terms Sheet
If it's time to draw up a terms sheet, it means you're at a place in your company when you could use extra funds. This is usually when you're doing really well and just need some investment dollars to expand operations or keep them going at the level and pace you're used to. Here is what most term sheets should include:
- Identification information: You should share your information as the business owner and the investor's information. This will show exactly who is a part of the terms sheet.
- Valuation: This is how much the company is worth, and something that investors will definitely want to know before investing their money to fund your enterprise. The valuation calculation can also include how many shares of the company have already been distributed and at what cost.
- Investment amount: The investment amount should be laid out clearly, so there is no confusion as to how much you're expecting as an investment.
- Percentage stake: The percentage stake is the percentage the investor will own of the company if the deal goes through. For example, if the percentage stake is 20%, then the investor will own 20% of the company, which could make them a majority shareholder depending on how the other 80% is broken up.
- Time frame: It's standard practice to allow for a certain period of time where the investor can go over the terms sheet and make a formal decision.
- Voting rights: Venture capitalists want to maximize their return on investment potential, so they may ask you as the business owner to give up some part of the voting rights in the company. While this can go any which way depending on the agreement, you may want to outline exactly how much voting rights the investor will have if they provide much-needed funding.
- Other provisions: It's typical to include additional provisions for items such as who is responsible for legal fees, an investor's right to company information and future investments, nondisclosure details, and founders' obligations.
A terms sheet should also clearly state that it is a nonbinding agreement, giving both the entrepreneur and the investor the ability to withdraw before legal paperwork is completed. If you want some additional tips on how to understand your term sheet, head to this article .
What to Be Wary of in a Term Sheet
While it would be ideal to have an uncomplicated investment process, you may come upon an investor who tries to institute a variety of provisions in the term sheet that don't benefit you as the company founder. Here are some things to be on the lookout for:
- Unfair financing: If part of your investor's dollars will serve as a loan for your business expenditures, make sure that the note details aren't so harsh that your company could become bankrupt in an attempt to repay it.
- Large controlling stake: Investors want to have some stake in the company, but some investors may ask for a large stake that would give them the biggest share and, therefore, the controlling portion of your company.
- Limiting terms: There are certain things that an investor may ask of you, but they may also want to limit how much fundraising you can go after in the future. Consider if this is beneficial for your business before agreeing to it in the terms sheet.
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Common Terms Found on a Term Sheet
Term sheets can include a lot of jargon that you may not be familiar with when you're just starting out as a business owner. Here are some common terms and their definitions:
- Valuation: You likely already know what the valuation of your company is, especially if you're at the point of needing investors, but you may see the terms pre-money valuation and post-money valuation listed. The pre-money valuation is the value of the company before you've received the new investment, while the post-money valuation refers to the value of the company that includes investment dollars.
- Drag along clause: This clause allows a major shareholder to require a minority shareholder to follow their lead in business decisions, particularly in the sale of a company.
- Dividends: Dividends are what is paid out to shareholders on a regular basis, usually quarterly, based on the company's profits.
- Pro-rata rights: These rights are given to an investor so they can also be a part of additional funding rounds later on. You may even see pay-to-play provisions that require investors to participate in future investment rounds or pay penalties if they don't.
- No-shop agreement: This agreement limits your relationship with other investors after you sign the term sheet. It's normal to have to wait a certain amount of time after signing the term sheet before starting another fundraising round, but the term sheet should outline an expiration date after which it's okay to seek additional investments.
Here is an article that shares additional term sheet terms to become familiar with.
Although a term sheet is not a binding contract , it's still important to know how they work and why they are beneficial for your business. Remember that without one, or even with one that's limiting and confusing, you'll spend more time, effort, and money in coming to an agreement with your investors.
Meet some of our Terms Sheet Lawyers
David H. Charlip, the principal of Charlip Law Group, LC, is one of only 101 Board Certified Civil Trial Lawyers in Miami-Dade, with over 38 years of litigation experience. Mr. Charlip is also one of only 136 Florida Civil Law Notaries. He has managed and litigated cases across the country. Mr. Charlip has advised businesses, drafted business formation and purchase and sale documents and litigated business disputes for over 30 years and is very familiar with all aspects of contractual relations.
With over 16 years of experience in the area of estate planning, trademarks, copyrights and contracts, I am currently licensed in Florida and NJ. My expertise includes: counseling clients on intellectual property availability, use and registration; oversee all procedural details of registration and responses with the USPTO/US Copyright Office; negotiate, draft and review corporate contracts and licensing; counsel clients on personal protection, planning and drafting comprehensive estate plans.
Melissa Taylor, the President and founding partner of Maurer Taylor Law, specializes in business contract review and drafting and is a second-generation attorney with private firm, in-house counsel, governmental, entrepreneurial, and solo practitioner experience. Melissa has a strong legal background, a dedication to customer service, is friendly, warm and communicative, and is particularly skilled at explaining complex legal matters in a way that's easy to understand. Melissa personally handles all client matters from start to finish to ensure client satisfaction.
Lawrence A. “Larry” Saichek is an AV rated attorney and a CPA focusing on business and real estate transactions, corporate law and alternative dispute resolution. With a background including five years of public accounting and six years as “in house” counsel to a national real estate investment company, Larry brings a unique perspective to his clients – as attorney, accountant and businessman. Many clients think of Larry as their outside “in house” counsel and a valued member of their team. Larry is also a Florida Supreme Court Certified Mediator and a qualified arbitrator with over 25 years of ADR experience.
Entertainment Attorney with 30+ years of experience, representing all aspects of the TV, Film, Music and Publishing Industries
Aaron focuses his practice on startups and emerging growth companies, providing general counsel services for companies from formation through exit. Aaron frequently advises clients in connection with routine and unique legal, business, and strategic decisions, including corporate, business and technology transactions, angel and venture financings, mergers and acquisitions, protection of intellectual property, and information privacy and data security.
I enjoy helping businesses of all sizes succeed, from start-ups to existing small and medium sized businesses. I regularly advise corporate clients on a variety of legal issues including formation, day to day governance, reviewing and drafting business contracts and other agreements, business acquisitions and sales, as well as commercial and residential real estate issues, including sales, purchases and leases. As an attorney licensed in both Michigan and Florida, I also advise clients on real estate issues affecting businesses and individuals owning real property in either state, whether commercial, residential or vacation/investment property. I also regularly assist nonprofit organizations in obtaining and maintaining tax exempt status, and provide general legal counsel on all matters affecting public charities, private foundations and other nonprofit organizations.