SeedBlink Blog

The term sheet is an agreement that outlines the key terms of an investment, such as valuation, equity stakes, and investor rights. We previously explored its definition and key components in part I of this article.

In the current part II, we’re discussing strategic considerations for negotiating with investors - mainly VCs and private equity investments, highlight how the term sheet differs from other fundraising documents, and outline what to expect once the agreement is finalized.

How to negotiate a term sheet with your investors

Negotiating a term sheet is a pivotal step in securing funding and setting the foundation for your relationship with investors. The key to successful negotiations is balancing investor protections with your ability to drive the company forward. Here’s how to approach the process:

Understand your company's valuation—but don't fixate on it

While knowing your company's valuation is critical and one of the most important aspects of a term sheet, it shouldn't be the only focus. Valuation dictates how much equity you're giving up for the investment, but there are other critical terms that can affect the company's future. Don't overlook important factors such as liquidation preferences and control rights, which can also have a big impact down the road.

Control percentage stakes

When multiple investors are involved in a deal, each may have different preferences or requirements regarding their ownership. For example, some investors may request preferred stock, which gives them certain advantages, such as priority in receiving dividends or liquidation proceeds. Others may seek exclusivity on certain decisions or actions like voting rights on major company matters.

Discuss these terms to ensure that the structure of ownership in your company is balanced and does not overly favor one group of investors at the expense of others or the founders.

Consider board seats

Being a representative on the board of directors is highly important for investors, especially venture capital funds. A board seat allows investors to vote on major decisions, such as approving budgets, executive appointments, or large spending.

While this helps investors protect their interests, as a founder your focus is on the balance of board representation. Too many investor-controlled seats could shift decision-making power away from the founding team.

Legal support is crucial

When negotiating a term sheet, having experienced legal counsel is essential. Lawyers familiar with startup agreements can help you flag potential issues, clarify complex terms like anti-dilution provisions or liquidation preferences, and ensure that the deal serves your long-term vision.

Limitations are particularly important as clauses that restrict your ability to raise additional funds or give certain investors exclusive rights that may not align with your long-term goals.

Build a strong team & focus on relationships

More than just the numbers, many investors place significant value on the strength of the team behind the startup. Investors often seek founders who can execute the business plan and navigate challenges. A solid, trustworthy relationship between founders and investors can sometimes be just as important as the financial terms in the term sheet.

Don’t rush the process

Take the time to thoroughly understand each clause, ensuring that you and the investors are aligned on the long-term vision and that there are no hidden clauses that could limit future fundraising or growth. Getting everything in writing and maintaining clear communication are critical steps to avoid misunderstandings later on.

By preparing well and balancing investor needs with your ability to lead, you can successfully negotiate a term sheet that sets the stage for both capital infusion and sustained growth.

Term sheet vs. other fundraising documents

A term sheet is distinct from other fundraising documents in several key ways, primarily in its purpose, content, and binding nature.

Term sheet vs. Letter of intent

Term sheets and letters of intent are two ways that you can lay out your expectations or perspective of a deal without entering into a formal and binding contract. While letters of intent and term sheets are not (in principle) legally binding as formal contracts, both can be valuable for streamlining and expediting a contract negotiation.

So, what sets them apart?

The main difference between these two types of documents is how they are written. As the name suggests, the letter of intent is a traditional letter from one party to another. On the other hand, the term sheet document is drafted more as a bullet-point list featuring the important terms and agreements between all the parties involved.

Also, a letter of intent usually outlines the intent to engage in a transaction or partnership, often used in a wider range of business negotiations, including mergers, acquisitions, or joint ventures, while a term sheet usually outlines the key terms and conditions of a potential investment or deal, typically used in venture capital and startup funding.

A term sheet focuses more on financial terms and control rights in investment scenarios. In contrast, the letter of intent covers broader aspects and intentions of the transaction, setting the stage for detailed negotiations.

Term sheet vs. Memorandum of understanding

A term sheet and a memorandum of understanding are preliminary documents used to outline the basic terms and intentions of the transaction. However, they differ in scope, specificity, and typical usage.

For the term sheet overview please refer to the above section.

A memorandum of understanding (MOU) is a formal document that outlines an agreement between two or more parties. While it is typically not legally binding, its enforceability depends on the intent of the parties and the specific language used in the document. An MOU reflects the parties' commitment to proceed towards a contract.

Often viewed as the initial step in negotiations, the MOU defines the scope and purpose of discussions. It is commonly used in international treaty negotiations but can also apply to significant business transactions, such as merger discussions.

What happens after a term sheet is signed?

Once a term sheet is signed in a fundraising deal, the process of finalizing the investment officially begins. While the term sheet itself is generally non-binding (aside from a few key provisions), it outlines the framework for the deal. However, this is just the start of a more involved process, which includes due diligence, legal negotiations, and completing all necessary documentation.

Here’s a detailed look at what typically happens next:

Due diligence

Purpose: To verify all the information presented by the company and assess any potential risks.

Once the term sheet is in place, investors will begin a thorough due diligence process. Due diligence is a detailed investigation where the investor reviews the company’s financials, legal aspects, business operations, intellectual property, and other aspects of the business. We’ve written extensively about due diligence, but here’s a quick recap.

What’s involved:

• Financial Review: Investors will examine the company’s financial health, including balance sheets, income statements, and cash flow, closely.
• Legal Due Diligence: This includes reviewing any contracts, intellectual property (IP) rights, employee agreements, and pending litigation.
• Operational Analysis: Investors may review the company’s internal operations, supply chain, and key customer relationships to assess business viability.
• Market Assessment: Investors will evaluate the company’s market position and competitive landscape to ensure its growth prospects align with expectations.

This phase can vary in length depending on the complexity of the business and the investors' concerns. Any red flags uncovered during due diligence may require renegotiation or clarification before moving forward.

Drafting and negotiating definitive agreements

Purpose: To formalize the deal and finalize the legally binding terms.

Following due diligence, the next step is drafting the definitive agreements. These are legally binding documents that outline the detailed terms of the investment, protecting both the investors and the company.

Key documents include:

• Investment Agreement: A broader agreement that details the terms and conditions of the investment. It may include clauses related to warranties, conditions precedent, representations, and the obligations of both parties before and after the investment is made.
• Shareholders' Agreement (SHA): Defines the rights and obligations of the company’s shareholders, particularly after the investment. It typically covers areas such as governance, share transfer, voting rights, and dispute resolution mechanisms. The SHA ensures that all parties understand their roles and responsibilities moving forward.
• Convertible Loan Agreement (if applicable): In some cases, investors may choose to provide funding via a convertible loan instead of directly purchasing equity. This agreement outlines the terms under which the loan will convert into equity, including the conversion rate, timeline, and any conditions for the conversion to occur.

During this phase, both parties negotiate the finer details of these agreements to ensure alignment with the initial term sheet and to clarify specific terms such as liquidation preferences, board composition, and vesting schedules for founders.

Final legal review and signing

Purpose: To confirm all legal obligations and ensure there are no outstanding issues.

Once the final agreements are drafted, both the company's legal team and the investors’ legal representatives will do a final review. This is the last opportunity for either side to raise concerns or request changes.

Lawyers will review the documents to ensure that everything is properly worded, all agreed-upon terms are reflected accurately, and there are no ambiguities that could lead to future disputes.

Closing the deal

Purpose: To officially complete the transaction and exchange the agreed-upon funds for equity.

Once due diligence is completed, the definitive agreements are signed, and the final legal review is complete, the deal moves to the closing stage. This is where the investment becomes official.

What happens at closing:

• Investors transfer the agreed-upon funds to the company.
• The company issues new shares to the investors in exchange for their investment.
• Any changes to the board structure, governance, or company operations agreed upon during negotiations are put into effect.
• Documents are signed by all parties to formalize the transaction.

You don’t have to be an expert right from the start

No doubt, understanding what you sign has its advantages. However, don’t feel overwhelmed by the legal terms and processes you must learn.

Take them one by one, and whenever you are unsure about something, revert back to these guides or reach out to the SeedBlink team for further advice on how to best prepare for a fundraising round.