Any entrepreneur understands that investments are crucial to starting and expanding a company. At Harrison Law, PLLC, we support business owners at every step, regardless of industry or size. We work with entrepreneurs to negotiate and review investment term sheets to ensure that their business secures a favorable investment agreement. To speak with our experienced business lawyers regarding your company’s success, consider contacting our office at (480) 320-2310 today.
What Is an Investment Term Sheet?
An investment term sheet is a document that lists the terms and conditions by which an investor will make a financial investment into a company. At the most fundamental level, an investment term sheet outlines the amount of the proposed investment and details the share of the company the investor would like in return. This document may also include more specific details regarding voting rights, the role of the investor in company affairs, and the steps that the investor will take to protect their percentage investment.
Term sheets are nonbinding agreements, meaning they are not legally binding. Rather, investment term sheets serve as a basic framework and the foundation for more detailed and binding documents. Once all the necessary terms and conditions are agreed upon, the details of the agreement will be outlined in the term sheet and later reflected in a more formal, legally enforceable contract.
What Are the 5 Key Points of an Investment Term Sheet?
An investment term sheet is one of the most important documents that will be drafted while establishing or expanding a company. Even the most minor missteps during the process can have a major impact on the success of your business. If drafted improperly, too much power may be handed over to investors and future strategic decisions may be influenced. For this reason, it is essential to prepare as much as possible and ensure that you understand all the key building blocks associated with investment term sheets. The five key points of a term sheet include the following:
- Nonbinding terms. Acknowledge that neither party is legally required to act in accordance with the terms outline on the term sheet.
- Company valuations, investment amounts, and anti-dilutive provisions. Ensure that all provisions related to the investor’s stake in the company are included in the term sheet.
- Voting rights. The State of Arizona defines voting rights in relation to commercial investing. Startup companies and businesses that seek funding typically must grant to the investors the rights to vote as stockholders on major company decisions. The specific voting rights allotted to investors at a given share in a particular company can be outlined in the investment term sheet to avoid potential misunderstandings.
- Liquidation preference. How will the proceeds of a sale be distributed between the entrepreneur and the investor(s)?
- Investor commitment. Clearly outline how long the investor will be required to remain involved in the company.
How Do You Write an Investment Term Sheet?
At Harrison Law, PLLC, we believe that preparing a term sheet is a collaborative effort, with all parties coming together to craft a document that fully and accurately reflects the key agreements made between the entrepreneur and the investor(s). While it is possible to use a basic template to write your investment term sheet, this may not be the most ideal option and may result in key provisions being neglected in the sheet.
The term sheet that you utilize for your company will depend on your unique needs, goals, and expectations. When writing an investment term sheet, it can be helpful to follow these steps to ensure that the process is smooth and efficient:
- Identify the purpose of the investment term sheet.
- Summarize the terms and conditions. Be sure to include details regarding the company seeking investment and any buyers or investors involved. Include all relevant offering terms, such as closing date, securities, pre-money valuation, and details regarding shares of the company.
- Include key clauses of the agreement, such as a listing of dividends, liquidation preferences, and other necessary provisions.
- Finalize the document and obtain signatures from all involved parties.
What Are the Key Clauses of the Term Sheet?
The provisions that you choose to include in your term sheet will vary depending on your needs and long-term goals. Some of the most common clauses that are often included in effective investment term sheets include the following:
- Pre-money valuation: As explained in the Securities and Exchange Commission’s glossary of terms, a pre-money valuation refers to the estimated value of a company prior to investment.
- Anti-dilution: This type of clause allows investors to maintain their voting share percentage in the event that new shares are created, therefore protecting early-stage investors from risk.
- Liquidation preferences: Investment term sheets often include clauses that set forth how money will be distributed in the event of liquidation, bankruptcy, or sale.
- Founder vesting: How do founders earn their legal rights over a period of time? Clauses of this type are designed to incentivize investors to remain involved with the company.
- Board rights and voting rights: For companies governed by a board of directors, it is essential to include details regarding how major decisions will be made and how voting will be conducted within the board.
- Exit options: Both entrepreneurs and investors may find it helpful to have clearly defined exit options.
What Is a Term Sheet Strategy?
For entrepreneurs, creating an effective term sheet is centered around the goal of raising capital while maintaining as much control as possible and mitigating risk. As such, it is imperative to enter into all investor negotiations with a clearly defined strategy. Having a term sheet strategy can help ensure that the process is smooth and that all parties involved have a positive experience. The following tips may help when developing a term sheet strategy for your company:
- Own the process internally: As an entrepreneur, it is your obligation to handle all existing shareholders and investors, keeping everyone privy to all necessary agreements and sticking to an efficient timeline. You may wish to consider seeking an attorney who helps with these matters, ensuring that all issues are skillfully handled.
- Separate commercial and legal issues: Investors are primarily concerned with the commercial side of the agreement and keeping the legal matters separate may be helpful. If you and your investor both maintain legal counsel, your attorneys can often manage legal matters, leaving you and your investor(s) to focus solely on business.
- If you do decide to work with an attorney, consider hiring a business lawyer with industry-specific knowledge to manage the investment term agreement. An experienced lawyer specializing in your area of industry can provide valuable counsel during negotiations, therefore saving you time and money in the long term.
Contact an Experienced Attorney at Harrison Law, PLLC Today
Securing capital investment for your company can be incredibly exciting, but it is important to proceed through all investor negotiations with care and due diligence. At Harrison Law, PLLC, we apply industry-specific knowledge and years of experience to create tailored investment term sheets for our clients. To learn more about how we can help, consider contacting us at (480) 320-2310 today.
© 2023 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved
This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
