The VC Series – Term Sheets

This article is part of ‘The VC Series’, a series of articles aimed at founders who are thinking of raising funds from VCs. Further information about The VC Series can be found here.

As a founder, you may have already spent weeks or months pitching your business to prospective investors, so it is often a milestone achievement to have got to the position where a VC sends you a detailed term sheet. But what exactly is it and what should it include?

What is a Term Sheet?

The term sheet is a key document in the fundraising process and sets out the basis on which it is proposed that the investment is made.

It is typically prepared by the ‘lead investor’, being the investor that is contributing most to the investment round and who is fixing the value at which other investors can also invest.

Whilst term sheets can sometimes feel like a protracted exercise, there can be considerable benefit to having a well drafted and properly negotiated document – for example:

• by agreeing some of the key terms up front, it should make the process of negotiating the long-form documentation more efficient and cost-effective; and
• by demonstrating a good understanding of the issues and by engaging in fair negotiations with the VC, you are likely to gain the VC’s respect as well as obtaining more favourable terms.

Given the importance in getting the term sheet right, it is important that you engage with lawyers who are familiar with the concepts involved and who can help get the transaction started on the right foot. A good lawyer will also help you focus on the key issues – it is important that you pick your fights wisely!

Is it legally binding?

Term sheets are not intended to be legally binding, and it is important that this is stated clearly in the document. Instead, they set out the blueprint of the investment, with any legal obligation being conditional upon (i) the negotiation and execution of the long-form documentation, and (ii) certain other conditions which need to be met before the investment is completed (the concept of conditions precedent will be dealt with in more detail in a later article in The VC Series).

There are though some important exceptions to this:

• Confidentiality: these provisions seek to ensure that the information disclosed by the company during the process remains confidential and is not used other than for the purpose disclosed – it is important therefore that these provisions are legally binding, irrespective of whether the investment completes.
• Exclusivity: given that VCs will likely spend a significant amount of time and expense evaluating the investment opportunity, undertaking due diligence, and negotiating the investment documents, they will typically expect companies to agree to an exclusive negotiation period.

Key Provisions

We will explore some of the key provisions of a VC Term Sheet in future articles, but they can generally be grouped as follows:

• The Investment: the Term Sheet will set out the enterprise valuation that has been agreed for the company, along with the resulting price per share that the VC will be investing at. It will also clarify the type of security that the investment is in respect of – for example, is it preferred shares, an ASA or a convertible loan note?
• Conditions Precedent: as referred to earlier, a VC might include various conditions which need to be satisfied before it is able to make its investment.
• Economic Terms: VCs will more often than not subscribe for a form of preference share, so you would expect the Term Sheet to set out the key economic terms that will attach to those shares (for example, any liquidation preference or dividend rights).
• Governance Terms: the Term Sheet will detail how decisions will be taken moving forward – for example, the composition of the board, investor information rights, and items that will require investor consent.
• Share Dealings: it will set out how shares will be capable of being issued and transferred, including any anti-dilution protections that the VC will have the benefit of.
• Exit Terms: this will cover areas such as drag-along and tag-along rights, as well as the circumstances in which an investor may be able to require that the company redeems its preference shares.
• Vesting of Founder Shares: if the founder’s shares are to be subject to vesting, then we would expect the Term Sheet to set out in detail the terms on which this will happen (and the associated ‘leaver’ mechanics).
• Confidentiality and Exclusivity: see above

As you can see, you can expect a Term Sheet to cover a lot of different items, and the terms can get complicated quickly. It’s therefore important that you get legal advisors involved as early on as possible, as you will find it difficult to persuade the VC to agree to different terms after the Term Sheet has been signed.

Useful Resource

The British Venture Capital Association (BVCA) is the industry body for the private equity and venture capital industry in the UK, and they have a standardised set of documents for early stage VC investment – included within these is a form of term sheet for Series A investments which can be found here.

The VC Series – Next Article

The next article in The VC Series will deal with due diligence, explaining what a VC will typically be focussing on and what you can do to make the process as plan sailing as possible.