If the relationship between the startup founder and the investor is like a marriage, then the term sheet would be the prenup – a safety to shield both parties from getting scorched too badly in the event of a fallout.
Here are the basics:
The term sheet is the document that outlines the terms by which an Angel or venture capitalist will make a financial investment in your business. It’s often drawn up by the investor.
An important note about the term sheet is, it is not a legal promise from the VC or Angel to invest.
According to Bruce Gibney of Founders Fund in the ebook: Term Sheets Explained in Plain English, “a signed term sheet doesn’t guarantee money coming in the door. A term sheet is only a contract to the extent that: (1) it requires you to keep the negotiations confidential and (2) it may prevent the company from looking at other suitors for a period (the “no-shop” or “exclusivity” provision).
While investment term sheets are not a “one size fits all” affair, you’ll typically find the following in a term sheet:
1: Valuation
Based on industry metrics and expected growth, the investors will propose a valuation in the term sheet. But that’s in an ideal scenario, in most cases, especially with startups with no operating history it’s difficult to project growth figures. What the investors do in this case is propose a valuation based on proposed (made-up) return on investment.
In another scenario, the investor could use the common initial financing round for a vertical to determine how much a startup is worth.
2: Investment Structure
The term sheet specifies the nature of the investment. Is it equity, debt or convertible notes?
3: Management Structure
The term sheet will also outline the composition of the board of your startup. It will prescribe the board’s appointment and removal procedures.
The board typically is composed of representatives of the founders, investors and independent industry honchos. It’s usually composed so that no individual stakeholder will have control.
These are only few components you’ll find in a typical term sheet. To help you know more about Term sheets and what’s in them, I have added some helpful links:
1: Term sheet for dummies by Founders Fund: : Term Sheets Explained in Plain English
2: Free Sample term sheets: TechStars Series AA Documents and Y Combinator Series AA Documents
3: Brad Feld’s seminal “term sheet series”
Enjoy!
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