As an angel investor, one of the most critical documents you’ll come across is the term sheet. This is a document outlining the terms and conditions of your investment in a company. It’s typically the first formal agreement that sets out the basic terms and conditions of the investment, including the valuation of the company, the amount of investment, and the terms of the investment. You can expect to receive a term sheet well before a fundraising round is actually completed.
In this post, the second of our ten part series, we’ll take a closer look at what a company term sheet is, the essential elements of a term sheet, how to negotiate one, and what to be aware of if you’re an angel receiving a term sheet for the first time.
The Basics
A term sheet is a non-binding document that outlines the key terms and conditions of a potential investment in a company. It serves as a blueprint for the more detailed legal documentation that will follow. A term sheet will typically cover the following:
- Valuation of the Company: The term sheet will specify the valuation of the company and the percentage of ownership that you will receive in exchange for your investment.
- Investment Amount: The term sheet will state the amount of money you are willing to invest in the company.
- Liquidation Preference: The term sheet will outline the terms of the liquidation preference, which is the order in which investors are paid back in the event of a sale or liquidation of the company.
- Board of Directors: The term sheet will specify the number of board seats that investors receive and whether any director will have any special voting rights - as an Angel, it is highly unlikely a Company will be willing to grant you a position as a board director, but if you are investing as part of a fundraising round alongside other VC’s, it is important to check whether a director position has been offered to them.
- Protective Provisions: The term sheet will outline any protective provisions that the investor will have, such as the right to approve significant corporate actions, or a right to ‘first dibs’ on new shares if they become available.
Negotiating a Term Sheet
It’s crucial to remember that a term sheet is a non-binding document, and negotiations are still ongoing until the final legal paperwork is signed. As an investor, it’s essential to understand the key terms and conditions of the term sheet and what you’re willing to compromise on.
Some things you may want to consider negotiating on:
- Preference shares/liquidation preference for your shares - is the company issuing preference shares in this round? If so, what are you receiving and what is their liquidation preference? This is a way to secure a specific return if the company is sold or liquidated.
- Information rights - What company records and information will the company provide to you going forward? Will you receive regular updates from the founders or never hear from them again?
However, not all terms will be of equal importance to you as an angel. For example:
- “Participation rights” or “pre-emptive rights” - these rights allow you to reinvest in future rounds of fundraising. These terms are very important to professional venture capitalists, but are broadly less interesting to angels who may not have deep enough pockets to keep up with high growth fundraising for long.
- Anti-dilution protections - if the company raises again a lower valuation or per-share price, will you be topped up for the difference? These are important, but can also be quite complex. It good to have some level of anti-dilution protection, but the exact type may not be a deal-breaker for you.
First-Time Investors
For any Angels investing for the first time, it’s important to be aware of the following:
- Seeking Legal Advice: It’s essential to seek legal advice from a lawyer who specialises in startup investing to ensure that the term sheet is fair and reasonable.
- Understand the Terms: Take the time to understand the terms of the term sheet fully. You should ask questions and negotiate any terms that you’re uncomfortable with.
- Do Your Due Diligence: Before signing the term sheet, you should conduct due diligence on the company and its founders. This will help you identify any potential risks and ensure that you’re making an informed investment decision.
Resources
There are several resources available to help angel investors interpret term sheets. These include:
- Angel Investor Networks: Angel investor networks can provide guidance and support to first-time investors.
- Legal services: lawyers who specialise in startup investing can provide advice on the term sheet, including how it can be negotiated to maximise your investment.
- Example term sheets: we have linked a common example here, so that you can get a general sense of what the term sheet should look like.
Getting Advice
Of course, before making any investments, you should seek financial and legal advice specific to your circumstances. Angel investing involves complex legal structures and agreements, and it’s important to have a thorough understanding of the legal implications of your investment.
If you ever want to chat through any investment opportunities or need help getting your feet off the ground, we are here to assist, and can’t wait to hear more about your goals. Learn more about our venture capital and fundraising practice.
This is part of our Angel Investing 101 series. Previously: How to Become an Angel. Next up: Due Diligence.
