Term Sheet

Bradford Toney
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What is a Term Sheet?

A Term Sheet is a fundamental document in the world of startups and small to medium-sized businesses (SMBs). It's a non-binding agreement that outlines the basic terms and conditions of an investment. The term sheet serves as the basis for more detailed, legally binding documents that will be drafted later. It's essentially the blueprint for the relationship between the angel investor and the company.

The term sheet includes key elements such as:

  • Valuation of the Company: How much the company is worth, which will determine how much equity the investor gets.
  • Investment Amount: The total amount of money the angel investor will contribute.
  • Equity Offered: The percentage of ownership the investor will receive in exchange for their investment.
  • Voting Rights: Whether and how the investor will have a say in company decisions.
  • Liquidation Preferences: How the proceeds will be distributed in the event of a sale, dissolution, or liquidation of the company.
  • Conversion Rights: Conditions under which preferred shares can be converted to common shares.
  • Anti-Dilution Provisions: Protection for investors against dilution of their ownership percentage in future funding rounds.
  • Dividend Policy: Details on if and how dividends will be paid to investors.
  • Redemption Rights: The right for investors to sell shares back to the company under certain conditions.
  • Information Rights: The access to financial and operational information of the company the investor is entitled to.

This document is crucial because it sets the stage for the investment. It is often negotiated and can be revised before both parties agree to the terms. Once the term sheet is signed, it indicates that both the investor and the company have agreed to move forward on the basis of the outlined terms.

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Angel Investor Term Sheet vs. Venture Capital Term Sheet

While both angel investors and venture capitalists (VCs) provide funding to startups and SMBs, their term sheets often differ due to the nature and scale of the investments.

Angel investors are typically individuals who offer capital at the early stages of a business, usually in exchange for convertible debt or ownership equity. Their term sheets are generally simpler and involve less money. They might also be more flexible, as angel investors may seek less control over the company and offer more favorable terms to the entrepreneurs.

Venture capitalists, on the other hand, represent firms that invest larger amounts of capital, usually at later stages of a business's development. A VC term sheet is often more complex, reflecting the larger sums of money and greater risks involved. These term sheets usually include more detailed and stringent terms regarding governance, decision-making rights, and financial returns.

Key differences include:

  • Complexity: VC term sheets are typically more detailed and complex.
  • Investment Size: VCs invest larger amounts, so their term sheets often reflect higher stakes.
  • Control and Governance: VCs may require more control over company decisions and board representation.
  • Protective Provisions: These are often more extensive in VC term sheets, to safeguard the investment.
  • Staging of Investment: VCs may stage their investments, releasing funds as the company meets certain milestones.
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Why is a Term Sheet Important?

The importance of an angel investor term sheet cannot be overstated for both the investor and the startup. Here's why:

  1. Clarity of Terms: It provides clear terms of investment, reducing misunderstandings.
  2. Negotiation Framework: It serves as a starting point for negotiations, allowing both parties to understand and align their expectations.
  3. Legal Foundation: It lays the groundwork for the legal documents that will formalize the investment.
  4. Company Valuation: It helps in determining the company's valuation, which is crucial for both current and future fundraising.
  5. Investor Confidence: A well-drafted term sheet can enhance investor confidence by outlining the protections and rights they will have.
  6. Milestone Planning: It can include milestones that the company must achieve, guiding the company's growth trajectory.
  7. Governance Structure: It sets the governance structure, including board composition and voting rights, which is essential for the company's strategic direction.
  8. Exit Strategy: It may outline the exit strategy for the investor, giving them a clear picture of how they can realize their investment's return.
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Term Sheet Benchmarks

When evaluating an angel investor term sheet, certain benchmarks can be considered to assess its fairness and competitiveness. These benchmarks may include:

  • Industry Standards: Typical equity percentages, valuation caps, and discount rates for the industry.
  • Investment Size: Relative to the company's stage and needs.
  • Company Valuation: How it compares to similar companies at similar stages.
  • Equity and Control: Balance of equity offered versus the level of control retained by the founders.

A Term Sheet is a pivotal document in the fundraising process for SMBs, laying out the preliminary agreement between an investor and a company. It's essential for setting expectations, providing legal groundwork, and guiding the company's growth. Understanding and negotiating favorable terms on a term sheet can significantly impact a company's future success and the relationship with its investors.

  • Bodansky, D. (2015). Legally binding versus non-legally binding instruments. Forthcoming in: Scott Barrett Carlo Carraro and Jaime de Melo, eds., Towards a Workable and Effective Climate Regime, VoxEU eBook (CEPR and FERDI).
  • Weijland, W., & Li, J. (2013). The Term Sheets of Business Angels and Venture Capital Investments in High-Tech Start-Ups Compared and the Consequences of the Recent Market Developments to the Term Sheet (Doctoral dissertation, Master Thesis, International Business Law, Tilburg University, Netherlands. Available at https://arno. uvt. nl/show. cgi).
  • Van Osnabrugge, M., & Robinson, R. J. (2000). Angel investing: Matching startup funds with startup companies--the guide for entrepreneurs and individual investors. John Wiley & Sons.
  • Wang, L., Zhou, F., & An, Y. (2017). Determinants of control structure choice between entrepreneurs and investors in venture capital-backed startups. Economic Modelling, 63, 215-225.
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