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Term sheet structure

Wednesday, November 11, 2020

Hello, my little venture friends!

Have you come up with a startup idea, conducted market analysis, assembled a team, made an MVP, and perhaps already have first sales? So now you need money for marketing, team expansion and product refinement. And you went to the angels to tell them about your future unicorn — and they believed in you and said they would give you money. Dope! How to get this money now?

Startup Jedi

We talk to startups and investors, you get the value.

I have already talked about some tools for raising investment in previous articles: convertible loan, SAFE and KISS, and today you will learn about the Term sheet — a document that should be signed immediately after the investor expressed a desire to invest, thereby securing their promises on paper.

Term sheet is not a contract, but an agreement of intent. As a rule, this document states that it has no legal force and is something like a gentlemen’s agreement.

Even before signing the Term sheet, you should understand how the investor is going to enter the company, since the Term sheet for the convertible loan and the Term sheet with the purchase of equity will differ in content.

For reference: In different versions of the Term sheet, its sections may have different names and, in general, the conditions in the agreements may be very different. First of all, it depends on how the investments will be made: SAFE, KISS, convertible note, equity. Examples of various Term sheets can be found in the links at the end of the article.


Term sheet: convertible note

Term sheet: convertible note

Today we will analyze the main points of the Term sheet in a situation when an investor invests in a startup on a convertible loan:

  1. Structure of Financing. This section indicates the investment amount, the number of tranches and the type of shares.

For reference: Most often, an investor receives Preferred Shares, which have additional privileges compared to Common Shares.

2. Conditions to Close. This clause may include conditions such as a specific date for signing a convertible loan, determined by KPIs, upon reaching which a loan is signed, due diligence, employment of the entire team in a registered company and any other conditions at the request of the investor. For example: signed contracts with clients in the amount of $10,000.

3. All the components of the convertible loan are also points of the Term Sheet: Interest Rate, Valuation Cap, Discount, Maturity Cap, Maturity Date. (Check out the explanation of all these terms with examples here).

4. Liquidity Event. Everything that is a liquidation event is listed here: company closure, sale / merger of a company with transfer of control, etc. The conditions of how the investor receives their money in the liquidation process are also indicated, for example: at the price at the time of sale, or the 2nd initially invested amount, or something else.

5. Important Decisions paragraph contains information about who and how makes decisions on all key issues. So, for example, it can be written here that it is impossible to change the charter and authorized capital of the company, sign convertible loans or any other documents to raise investments, grant someone the rights to the company’s intellectual property, sell the company, distribute dividends, etc. without the written permission of the investor.

6. Participation Right secures the right to participate in the next rounds. Such as, for example, the introduction of the concept of Major Investor.

For reference: Major Investor is a title that an investor can receive once they have invested a certain amount. The privileges of the title are that in the next round of financing, investors are invited to increase investment- and can usually invest up to the percentage they had before the dilution of their share, i.e. such a percentage that the investor received as soon as they entered the company, and their share has not yet had time to be diluted by the next rounds.

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7. Founder Shares. This clause regulates in what amount, after what period and on what conditions the founders of the startup will receive their shares. For this, the concepts of Cliff Vesting periods are used.

For reference: 1 year of cliff and 4 years of vesting means that after a year of work in a startup, shares begin to be assigned to the founder and his entire share is accrued over 4 years.

8. Informational Right, or the right to receive information. This clause regulates the frequency with which the founder sends information to the investor, for example: providing periodic reports from the startup once a month.

9. Option pool. This clause usually sets the size of the share of the company, which will be distributed among employees to increase their motivation. Typically, the option pool is 10%.

10. Voting rights, or the investor’s right to vote. This clause, as a rule, grants the investor the right to vote in the same way as the owner of Common Shares, as well as in cases where only owners of Preferred Shares vote. For example, when the number of shares changes, the rights for Preferred Shareholders change, when shares are redeemed, the number of directors on the board changes, and so on.

11. Exclusivity. Exclusivity secures that for a certain period after signing the Term Sheet, a startup cannot raise additional investments, for example, within 30 days after signing the agreement.

12. Confidentiality. Everything is very clear here: the first rule of the club is not to tell anyone about the club!

13. Bank details of the parties and signatures.


Term sheet: convertible note

Other conditions

When we talk about the pre-equity Term sheet (in this case, the receipt of a share occurs immediately and without a convertible loan), the terms of the agreement need to include the price per share, liquidation privileges, Drag along (the right of the majority shareholder to demand joint sale of shares with minority shareholders) and Tag Along (the right of a minority shareholder to join the sale of shares on the same terms).

In fact, most of these conditions are also spelled out in the Term Sheet with an investor who “entered” the startup on a convertible loan, but only after converting its investment into shares — at the moment of signing the Shareholders Agreement.

You can find a large number of Term sheet templates on the Internet: you can use this or this or this or this or any other). The main thing is to write all the basic conditions. It is important not to forget that they are highly dependent on based on what agreement the investor will enter into the company in the future.

Venture in da house!

11 Nov 2020


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