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Term Sheets - What you need to know

November 25, 2019 / Source: GTAN

Fear of the unknown is common for startup founders. Taking a leap of faith in your company is both exciting and nerve wracking, so it’s important to cover your bases with the right planning. Creating a term sheet can help for when investors start coming forward or to avoid making a mistake that founders may regret later, as the business grows.

What is a term sheet?

A term sheet is a document that lays out the terms of the investment: detailing what you as the startup are giving and what you are getting in return. Term sheets also lay out the guidelines of how both parties will act to protect the investment.

Term sheets are important and can be complex, but they don’t necessarily have to be difficult. The key is knowing what to expect, what you want out of a term sheet, what you won’t bend to, and of course having good representation to review all of the fine print.

According to Forbes, “term sheets can vary depending on what type of funding round you are in, how much is at stake, and who is involved. Generally term sheets for seed rounds are much shorter than for series A or beyond. The less at stake, the less complex it should be, as no one wants to unnecessarily splurge on extra legal fees, or burning time. The process can be significantly simplified when using a third-party funding portal.”

In a seed round, the investor will typically be the one providing the term sheet. This may change, especially when there are multiple investors in later and larger rounds.

Common items in a term sheet include:

  • Who is issuing the note or stock
  • Type of collateral being offered
  • The valuation
  • Amount being offered
  • Shares and price
  • What happens on liquidation or IPO
  • Voting rights
  • Board seats
  • Conversion options
  • Anti-dilution provisions
  • Investors rights to information
  • Founders obligations
  • Who will pay legal expenses
  • Non-disclosure requirements
  • Rights to future investment
  • Signatures

When a founder is reviewing a term sheet proposed by a potential investors, they should look out for:

  • Harsh debt financing and convertible note terms that could bankrupt you
  • Asking for too large of a controlling stake, which may suggest you’ll be replaced
  • Terms that can limit further fundraising
  • Investors that simply want a short and hot exit, and don’t have realistic expectations of timelines

Do you have a fresh, new idea and are looking for investors? The next GTAN|RAW event is on Tuesday December 3, 2019. Learn more about pitching at GTAN|RAW here.