What is a Term Sheet?
A term sheet is a nonbinding agreement setting forth the basic terms and conditions under which an investment will be made. It serves as a template to develop more detailed legally binding documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is then drawn up.
- A term sheet is a non-binding agreement setting forth the basic terms and conditions under which an investment will be made.
- Term sheets are most often associated with startups. Entrepreneurs find that this document is crucial to attracting investors, often venture capitalists (VC), with the available capital to fund their enterprises.
- Valuation of the company, amount of investment, the percentage stake sought, voting rights, liquidation preference, anti-dilutive provisions, and investor commitment are some of the key terms that should be spelled out in the term sheet.
Understanding Term Sheets
Basically, a term sheet should cover the more important aspects of a deal without going into every minor detail and contingency covered by a binding contract. It essentially lays out the groundwork for ensuring that the parties involved in a business transaction agree on most major aspects of the deal, thereby precluding the possibility of a misunderstanding and lessening the likelihood of unnecessary disputes. It also ensures that expensive legal charges involved in drawing up a binding agreement or contract are not incurred prematurely.
All term sheets will contain certain basic elements, such as information pertaining to the identification of the parties involved, valuation, preferred payments, information about all involved assets, initial purchase price including contingencies that may affect that price, a time frame for a response and any other information that is considered salient.
Term sheets are most often associated with startups. Entrepreneurs find that this document is crucial to attracting investors, often venture capitalists (VC), with the available capital to fund their enterprises. With this in mind, these are a few of the important conditions that a startup term sheet should define:
- It is non-binding. Neither the entrepreneur nor the VC is obligated to abide by whatever is outlined on the term sheet in a court of law.
- Valuation of the company, amount of investment, the percentage stake sought, and anti-dilutive provisions should be spelled out clearly.
- Clarifying voting rights. Startups seeking funding are usually at the mercy of VC's, who want to maximize the returns on their investment. This can result in the investor asking for and getting a disproportionate influence in determining the direction that the company will take.
- Describe the liquidation preference. How will the proceeds of a sale be distributed between the entrepreneur and the investor?
- Investor commitment. How long will the investor wait before bailing on their investment?
A term sheet used as part of a merger or attempted acquisition would typically contain information regarding the initial purchase price offer and preferred payment method, as well as what assets are included in the deal. It may also contain information regarding what, if anything, is excluded from the deal or any items that may be considered requirements by one or both parties.
Term Sheets, LOI, MOU
A term sheet may seem similar to a letter of intent (LOI) when the action is predominately one-sided, as in acquisitions, or a working document to serve as a jumping-off point for more intensive negotiations. The main difference between a LOI and a term sheet is stylistic in that the former is written as a formal letter while the latter comprises of bullet points outlining the terms.
Though term sheets are distinct from LOI and memorandums of understanding (MOU), you may hear them referred to interchangeably in casual conversation, as they accomplish similar goals and often contain similar information.