What do term sheets cover?
Term sheets are versatile documents, and they typically encompass several vital details:
- The nature of the investment or transaction
- The amount involved
- The company valuation
- Conditions that must be met before finalising the deal, such as due diligence
- Specific terms of the industry and the required legal terms, as explained in further detail below
15 common terms to include in a term sheet
When crafting a term sheet, it’s crucial to include key terms and conditions that pertain to the particulars of the proposed financial deal. Here’s a breakdown of each term, along with an example of when it may be used:
1. Purchase price: the amount of money someone’s willing to pay
“The purchase price for the acquisition of the tech startup has been set at £10 million.”
In everyday terms: this one is pretty straight-forward, it’s simply the phrasing you use to outline how much parties are willing to spend for a slice of the company pie, or whatever you are brokering a deal on.
2. Equity ownership: how much of the company each person gets to claim
“The venture capitalist will gain a 30% equity ownership stake in the company in exchange for their investment.”
In everyday terms: dividing up the metaphorical pie again – according to the agreement in the term sheet, how big of a slice will you get?
3. Anti-dilution provisions: protect current investors from losing their percentage if more shares are issued
“The early investors included strong anti-dilution provisions in the term sheet.”
In everyday terms: one more time with the pie analogy. Imagine you bought 10% of a bakery, and suddenly they make more shares. Anti-dilution helps make sure your portion of ownership stays the same.
4. Information rights: a promise to keep investors in the loop
“The acquirer insisted on information rights to gain full transparency to the company’s financial data.”
In everyday terms: stakeholders aren’t just going to invest emotionally, spiritually and financially into your business, then never want to hear about it again – most won’t be those rare golden hand shakers. It should be in your interests to keep them in the know as your company and profit grows!
5. Voting rights: who gets a say in important decisions
“With majority voting rights, the founder could maintain their influence over important decisions for the company.”
In everyday terms: this takes the previous term one step further. Everyone will have opinions, but which shareholders will you allow to have rights to vote?
And of your stakeholders and investors, while everyone gets a vote, do any of the votes (hint: yours) carry more weight than the rest? You might want to add that in.
6. Liquidation preferences: who gets paid first if the company is sold or liquidated
“The liquidation preferences state that all the money left over is mine.”
In everyday terms: you might prefer it that some stakeholders (usually the people who invested the most) get their share of anything left, before others do, in the case of company liquidation.
7. Dividend preferences: who gets paid first when the company distributes profits
“Jenny now gets a 5% dividend preference due to the stage of her investment, as we all agree in this term sheet.”
In everyday terms: under the same principle as the previous term, this usually goes again to the people who invested the most or the earliest. (Note: you don’t have to do it this way, it’s just an example)
8. Conversion rights: allow investors to turn their ownership into a different type
“Shareholders can exercise their conversion rights if the company goes public, allowing them to convert to common shares.”
In everyday terms: imagine trading in your regular season pass for a VIP one. Investors at specific stages in the lifecycle of your company’s journey will want to either upgrade or downgrade for a variety of reasons – those reasons being anything from deeply personal like wanting to sell, to financially motivated like cashing out if your business reaches exponential success and is in line for an initial public offering (IPO).
9. Rights of first refusal: existing owners get the first chance to buy other investors’ old shares
“The ROFR clause grants the existing shareholders the first opportunity to purchase additional shares offered for sale.”
In everyday terms: it’s like calling dibs on a cool gadget your friend wants to sell before they offer it to others. It’s only fair.
10. Drag-along rights: (aka majority rules)
“Since the founders maintain their drag-along rights, they get the final say.”
In everyday terms: it’s like convincing your friends to go to the same restaurant – if most agree, everyone goes.
11. Financial covenants: financial benchmarks that the company must meet
“The term sheet includes financial covenants requiring the company to maintain a minimum EBITDA level each fiscal year.”
In everyday terms: if you promised your investors that they would have enough to spend on a holiday in your next quarter, you better believe that’s something they’re going to want to hold you to in the term sheet. It’s also great motivation for you!
12. Termination provisions: the conditions under which the agreement can be ended
“The termination provisions specify that either party can terminate the agreement if due diligence uncovers undisclosed material issues.”
In everyday terms: it’s the escape route in case the investors or shareholders decide not to pursue the deal after all, or one of the parties has not been forthcoming with information for example.
13. Confidentiality and non-disclosure: to ensure that sensitive information doesn’t leak.
“Both parties agreed to strict confidentiality and non-disclosure clauses to protect sensitive financial information.”
In everyday terms: it’s like agreeing not to spill the beans about a surprise project you’re working on – whether that’s the details of your business venture, or the topic of your best friend’s new podcast.
14. Dispute resolution: how disagreements will be settled
“In case of disputes, the term sheet outlines a dispute resolution process that includes X, Y and Z.”
In everyday terms: it’s creating a plan for what the final decision method will be when the parties can’t agree – rock-paper-scissors, maybe?
15. Exclusivity: no shopping around for better deals while in negotiations
“During the exclusivity period, the investor has the sole right to negotiate with the startup without interference from other potential investors.”
In everyday terms: It’s like agreeing not to check out other shops after you’ve already badgered the sales assistant to find you a pair of boots in your size.