A term sheet is used to outline the main terms under which investors make an investment in your company. It is usually introduced part way through the due diligence process. A typical sequence of events (assuming this is your company’s first outside financing round) would be:
- You make your investment pitch to a group of angels
- Interested angels form a due diligence team and start due diligence activities
- At some point in the due diligence process, if angels reach a comfort level in the investment opportunity, they will introduce a term sheet to start the dialog on the conditions under which they will invest
- Due diligence investigation into the company will continue in parallel with discussions on the term sheet
- Once both activities reach a satisfactory conclusion, the legal paperwork will be drawn up for the investment, the papers will be signed, and the funds will be transfered
An important thing to understand about a term sheet is that it is not necessarily a binding document. Meaning just because the investors and the company have reached agreement on the term sheet (which outlines how much money will be invested and under what terms), investors are not bound to following through with the investment. The main point of a term sheet is to ensure both sides are comfortable with the terms under which the investment will occur. As discussed above, this is usually introduced part way through the due diligence process – when investors have a comfort level in the investment but before they have completed the full due diligence process. Investors will want to get a term sheet on the table so they can ensure both sides are comfortable with the terms of the investment. i.e. there is no point to spending the time to finish a full and detailed due diligence investigation, only to find out at the end that the investors/company cannot agree on the investment terms. So just because you have a term sheet from potential investors, don?t consider the investment a done deal.
Although the term sheet is not necessarily binding, if the investment proceeds to closing it will be used by lawyers to incorporate the terms of the deal into the closing documents, shareholders agreement, etc. So it is important to ensure you understand and are comfortable with the contents of the term sheet before you indicate acceptance of it to the investors. You should get legal advice on the term sheet as it will most likely contain conditions on board makeup, management oversight, voting rights, etc. These conditions will be incorporated into your company’s shareholder agreement so will impact all current shareholders of the company. Depending on how your current shareholder’s agreement is written and how many shareholder’s you have, you may need a majority of your current shareholder’s to approve any new changes to the shareholder’s agreement to accommodate the new investors. Part of good investor relations is to ensure your current shareholder’s are aware of your financing activities and are on-side with the implications of new investors and how it will impact them.
In my next article I will talk about some of the common terms usually found in a term sheet. To view an organized index of all angel financing articles as well as sees a roadmap of future articles, click here. If you have any comments or suggestions for future articles feel free to contact me: craig at mapleleafangels.com