A term sheet is an important investment document that serves as a “snapshot” of important legal and financial terms involving a proposed investment in a company. The precise terms and conditions will usually be detailed in the definitive legal documents in an investment transaction.
In this post, we will look at the common terms that you may likely expect as founders should be thinking about during the term sheet phase.
Who issues the term sheet?
By default a term sheet is expected to be sent by the investor interested to invest in your company. The general exception to this default rule is if the investment is coming from the so called 3 Fs (friends, family, and fools). If this is the case, onboarding a startup lawyer will help ensure that the funding process runs smoothly without any complication.
Some key terms founders should consider:
Investment instrument
The legal instrument is crucial as it will determine the legal claim that the investor will have against the company in exchange for the funding. Generally, we will recommend issuing ordinary shares if the investors are early stage investors such as angels, families and friends. On the other hand, preference shares with added legal protections and safeguards to the investors may be most preferred by financial investors like venture capitals as a preferred instrument.
Another alternative option that is becoming more popular among companies in Malaysia is the issuance of a SAFE (‘Simple Agreement for Future Equity’) note. However, the focus of this post is on the priced round investment. Therefore, we will cover the use of SAFE notes in a separate post.
Pre-money valuation
If there is any issuance of shares in exchange for the capital investment, it is crucial to determine the pre-money valuation of the company in the term sheet as the company secretary will require the details of the new number of shares to be allotted and issued and the issue / subscription price for the shares.
Conditions precedent
Before the funds may be disbursed, there are several matters that need to be satisfied by the company known as the ‘conditions precedent’ (‘CPs’) before the fund is disbursed. The list of the CPs may depend on the funding sum, and the type of investor that you are dealing with during the round.
If the investor appoints a legal counsel to conduct a legal due diligence on your company, the list of conditions precedent may be enhanced based on the due diligence report’s findings and recommendations by the legal counsel. The final CPs that will supersede the term sheet will be incorporated inside a subscription agreement.
Closing
During closing, the company secretary will be expected to furnish documentary evidence that the necessary paperwork including board and shareholders resolution have been satisfied based on the closing items inside the subscription agreement.
In exchange for these closing documents, the investor will disburse the funds and the company will allot and issue the new shares to the new investor. Other closing documents may include updated register of members and return of allotment stating the investor as the new shareholder in the company.
Exclusivity or “no shop” clause
Considering that an investor is taking the time to review your company before making an investment, an investor may expect that you will not go around shopping your deal around to multiple investors. An exclusivity clause prevents you from talking to another investor. Anything between 45- 60 days may be reasonable.
Non- binding
Generally, a term sheet is usually not meant to be legally binding. A good term sheet will clearly state in the preamble that the parties do not intend the document to be legally binding.
Sometimes, investors may wish for the term sheet to be legally binding, and may draft it as such. In our experience, you should engage a startup lawyer to consult on the term sheet considering it may or may not be in the founder’s interests.
In the next post we will look at other customary clauses typically expected inside a term sheet.
