The key elements to understanding venture capital term sheets

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An investor tells you they are willing to put money into your company. Great, it’s time to celebrate! At least this is what many entrepreneurs think. But before you go and spend your last cash on champagne, start counting your coins for a lawyer:)

Closing a deal starts with investor interest, but there is a long way to go for a deal to conclude successfully. A key part of the process is the term sheet. What is it? How is it structured? Why is it important? What do you need to look out for? There are many things you need to consider going into this process and many things you should think about before signing off on the final document.

A term sheet is a bullet-point document outlining the material terms and conditions of a business agreement. After a term sheet has been ‘executed,’ it guides legal counsel in the preparation of a proposed ‘final agreement.’ It then guides, but is not necessarily binding, as the signatories negotiate, usually with legal counsel, the final terms of their agreement. The document may be either binding or non-binding.

Understanding venture capital term sheets: key elements – Phil Riman from wablegal on Vimeo.

Term sheets are very similar to ‘letters of intent’ (LOI) in that they are both preliminary, mostly non-binding documents meant to record two or more parties’ intentions to enter into a future agreement based on specified (but incomplete or preliminary) terms. The difference between the two is slight and mostly a matter of style: an LOI is typically written in letter form and focuses on the parties’ intentions; a term sheet skips most of the formalities and lists deal terms in bullet-point or similar format. There is an implication that an LOI only refers to the final form. A term sheet may be a proposal, not an agreed-to document.

Within the context of venture capital financing, a term sheet typically includes conditions for financing a startup company. The key offering terms in such a term sheet include (a) amount raised, (b) price per share, (c) pre-money valuation, (d) liquidation preference, (e) voting rights, (f) anti-dilution provisions and (g) registration rights.

Y Combinator and Wilson Sonsini Goodrich & Rosati have famously published their Series AA Equity Financing Documents online. They have used this for their own business i.e. YC-funded startups to use when raising angel rounds, but open-sourced them as reference for others. They are not perfect for all situations, but can serve as a useful starting point.

We are of course interested in getting views and opinions from the VC4A community and encourage you to share your own experiences, insights and learnings with the rest of us.