In the early stages of a venture capital deal, the important details about the financing will be documented by the VC in a term sheet and presented to the founder.
A term sheet is a non-binding agreement that outlines the basic terms and conditions of an investment. The term sheet serves as a template and basis for more detailed, legally binding documents once the parties involved have agreed on its terms. It is typically used in venture capital or private equity transactions to establish the terms of an investment.
The term sheet will typically cover all information about the amount of investment, the percentage of equity to be given in return, details of how and when the investor could expect a return, and many other terms related to the deal. These can include clauses on:
- Valuation: This includes pre-money valuation (the valuation of the company before the investment) and post-money valuation (the valuation of the company after the investment).
- Equity stake: The percentage of the company’s equity that the investor will own after the investment.
- Vesting schedule: This describes how the founders’ shares may vest over a certain period.
- Liquidation preference: This is a clause that defines who gets paid first and how much they get when the company is sold or liquidated.
- Board composition: This indicates the makeup of the board of directors post the investment (which may include appointees made by the investor).
- Anti-dilution rights: These protect investors from the dilution of their shares in a future financing round where shares are sold at a lower price than what the investor initially paid.
Founders often get excited by the arrival of a term sheet and are tempted to gloss over the finer details—usually on page 3—that can cost them greatly in the future. It’s important to remember that the term sheet is a starting point for negotiations between the investor and the company, and it isn’t typically legally binding (with the exception of certain provisions like confidentiality and exclusivity). The terms and the potential consequences of those terms should be considered carefully by the founders before signing.
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