A term sheet is a written declaration of intent regarding an intended investment. This document sets out the key points of the planned transaction on which the founders and investors have agreed. Essential contents are the amount of the intended investment, the underlying valuation of the company, reporting rules, the composition of the advisory board and the chosen liquidation preference.
Apart from any confidentiality or exclusivity clauses it may contain, the term sheet does not yet have any legally binding effect. Rather, it serves as a starting point for the subsequent preparation of the investment set consisting of: Investment Agreement, Articles of Association, Shareholders’ Agreement and Rules of Procedure. Nevertheless, there should be no subsequent deviation from the assurances made in the term sheet in order to ensure successful further negotiations. If a contract is not concluded as a result, this can damage the reputation of the party concerned. For this reason, the content of the term sheet should already be carefully considered and negotiated.
A term sheet is usually set up as follows:
- Company: This section contains a short description of the Company, its business and its current Cap Table.
- Investment Summary/Transaction: This section describes the transaction in more detail including the agreed pre-money valuation, the sum of the investment, any conversion of outstanding Convertible Loans, the classes of shares the new investor gets and what counts into the fully diluted share capital (VSOP/ESOP, shares under the conversion of convertible loans). Further this section contains the valuation of the company as well as any secondaries.
- Use of Funds: This section contains the purpose for the use of the funds, usually this is the working capital and general corporate purposes, but some investments may be designated for special projects like the expansion of the business in other countries.
- ESOP/VSOP/Employee Participation: This section describes the existing employee participation program and an envisaged extension or the intention to implement an employment participation program and in which format (ESOP vs. VSOP).
Here, the Term Sheet will also state whether the VSOP/ESOP will be created after the financing round or will already count into the fully diluted share capital.
- Vesting: This section contains the vesting of the shares of the founders including the amount of shares that underly a vesting, the vesting period and the cliff, cases of an accelerated vesting, definition of good and bad leaver cases and their legal consequences.
- Advisory Board: This section contains the size of the advisory board, its composition (including observer members) and designation rights.
- Reserved Matters/Important Decisions: This provision includes catalogues of 1) Management decision that require the approval of the advisory board 2) Shareholders’ resolutions that require a certain investor majority.
- Information Rights: This provision specific information rights of the Investors and reporting obligations of the management.
- Liquidation Preference: This provision contains the right of the investors to receive prior to other shareholders their investment back in case of a liquidation or an exit.
- Other Rights: The Term Sheet often only refers to customary investor rights. It sometimes specifies certain majorities or requirements for the exercise of a Drag Along Right or reserves the investor rights to a certain group of investors.
- Non-compete/non-solicitation: This provision includes the duration of a non-compete and non solicitation obligation.
- Further Provisions: This section can contain various topics like Representations and Warranties, Preparation of long form documents, Transfer of IP Rights, ESG and Governing Law.
- Confidentiality: This provision contains the obligation to keep the terms of this Term Sheet and its negotiations confidential.
- Exclusivity: This provision often contains the prohibition to negotiate with other investors during a certain amount of time following the Term Sheet.
- Conditions/Due Diligence: The investment will often be made subject to a successful due diligence.
- Costs/Expenses: This provision often includes a cost coverage clause meaning that a certain amount of legal fees of the lead investor is covered by the company.
- Expiration: This clause terminates the offer of the investor in the Term Sheet and therefore the Term Sheet should be signed by then.
- Binding: Except of the provisions with regard to Exclusivity and Confidentiality, a Term Sheet is non binding.