As promised, in this post I will focus on the term-sheet.
First let’s get some definitions straight. A term-sheet is the document that needs to be signed by existing shareholders and new investors to agree on the general terms of a funding round, used as a base to draft the shareholders agreement. The shareholders agreement is a detailed document of the term-sheet.
Here is a document that is very similar to the term-sheet that my startup (Fishfishme) signed with our investors. We used a very common term-sheet structure; you’ll probably find many startups around the world using something similar.
The components of a term sheet are as follows:
- Articles 1 to 5: General information
The name of the company, investors, existing shareholders (including the equity stake position before investment), cofounders, and estimated closing date
- Article 6: Amount of investment
How much each investor is participating in the round
- Article 7: Post-completion issued share capital
Percentage ownership of each stakeholder after the funding round
- Article 8: Company Obligation
This article emphasize that the company should work properly and fairly. Moreover, it should provide shareholders with information and reports on a regular basis.
- Article 9: Investor Consent
This means the approval of investors. If more than 50 percent of investors approve, then you get investor consent. A follow-up article will make this more clear.
- Article 10: Matters requiring investor consent
Things that require investors consent are listed on the last page of the term-sheet. These can be declaring dividends or a change in the share of capital.
- Article 11: The Board
Here you set the structure of the board. You can structure the board however you like, but remember that the board will have great power. It has the power to fire the CEO and decline an acquisition offer.
- Article 12: Board Observer
The role of a board observer is to attend and hear what the board is discussing. However, the observer can also be granted some additional rights. These extra rights are stated in this article.
- Article 13: Pre-emption rights (also known as Right of First Refusal)
This article means that any sales of shares or issuance of new shares should be offered first to the existing shareholders at the same price that is offered by the third party. Shareholders have a short period (usually 14 days) to make their decision.
- Article 14: Tag Along
This article secures the rights of the small shareholders. In case the majority shareholders get an offer to sell their equity, they are required to ask the buyer to make a similar offer to the small shareholders.
- Article 15: Drag Along
This article secures the rights of the majority. In case the majority of shareholders decide to sell, they can force minority to sell with them. This article is used so that when a buyer makes an offer, small shareholders will not be able to kill the whole deal.
- Article 16: Founder Vesting
This clause is here to protect the investors and to make sure that the cofounders don’t disappear after the deal.
Vesting means that the shares are granted with time. For example, if you say that you own 15 percent of the company vesting in three years, then if you keep working with the company for three years you’ll earn 5 percent each year.
- Article 17: Deed of Adherence
This isn’t crucially important, but it’s a clause to make sure that investors are serious.
- Article 18: Options
Options here refer to option shares issued and granted to the company employees, advisors, and key hires. In this article you should decide on the option pool, which usually varies from 10 percent to 20 percent of total shares.
The lead investor of the round usually provides the term-sheet. So let’s say you have three investors: one will take the responsibility to draft the term-sheet and get the other investors to agree on it and bring it to you to sign. You can also suggest a term-sheet to your investors, especially if they are angel investors with no specific term-sheet style requirement.
Some last bits of advice on your term-sheet:
- Don’t give away more than 25 percent in each round. Check Fred Wilson’s post on this.
- Read Brad Feld’s book Venture Deals. After reading this, you’ll probably don’t need a lawyer.
Good luck with raising your round. It’s tough out there, but you just need to learn the rules of the game. Please leave a comment below if you have any questions, I (or someone else) might be able to answer them.