For entrepreneurs and small businesses seeking investment or wishing to buy or sell a business and/or shares, understanding how to create a Term Sheet is crucial. Whilst Term Sheets are generally not legally binding, they are an important document which set out the party’s intentions and the key matters that have been agreed.
In this guide, we will outline what a Term Sheet is and how to write a Term Sheet.
What is a Term Sheet?
A Term Sheet is a key document in a corporate transaction or investment. It serves as a preliminary outline of the key terms, laying the groundwork for more detailed legal documents to follow.
Think of a Term Sheet as a roadmap that guides the parties involved towards a mutually beneficial agreement. A Term Sheet is generally not a legally binding document. Rather, it’s a tool for supporting communication and understanding between parties. It’s often crucial when it comes to entrepreneurs seeking venture capital.
What’s included in a Term Sheet?
The Term Sheet begins with a concise introduction, identifying the parties involved and the nature of the proposed agreement and key terms and milestones.
2. Key terms and conditions
A Term Sheet identifies key terms and conditions that will govern the proposed agreement. This includes the type of investment or financing, whether it's equity or debt. It will also set out the terms of any sale or purchase including pricing and agreed completion dates. It can also include details of milestones or condition precedents that need to be achieved before the sale or investment can take place.
3. Capitalisation table
If the Term Sheet is being used for an investment, it is really useful to include a capitalisation table. This table outlines the ownership structure of the business, detailing how shares are distributed among shareholders. It may also include price per share, or any other details about the shares. It can also include dilution information and the proposed new enlarged share capital
In some investments, the parties may agree to an anti dilution agreements, which ensure the percentage value of ownership in the case that new shares are sold later on. This ensures that if new investment comes on later, the initial investors’ shares aren’t ‘diluted’. You should take legal advice on these types of arrangements before you commit to them.
Along with anti-dilution provisions, you may consider including liquidation preferences, which ensures initial investors receive their money back before other shareholders. These type of provisions particularly benefit investors.
4. Price/Investment amount
Your Term Sheet should set out what the investment amount is, and how the funds will be used. Whether it's for operational expenses, growth initiatives, or other specific purposes, be explicit in the allocation of funds. You should also agree a price per share including the nominal amounts and share premiums payable.
The Term Sheet should set out the valuation of the business. This is a critical aspect, especially in the context of equity financing. Clearly state the pre money valuation (how much the business is worth before it has any investment) and post-money valuation separately. This will avoid any confusion or disagreements later on.
6. Conditions precedent
The Term Sheet should include any conditions that must be met before the proposed investment or sale becomes binding. For example, approval from regulatory authorities or completion of due diligence.
7. Term and termination
Your Term Sheet shoulddefine the term of the agreement and the circumstances under which it can be terminated. Use straightforward language to enhance understanding. Any milestones or target dates for completion should be set out.
8. Governance and control
The Term Sheet should address governance issues and control mechanisms. This is particularly relevant in venture agreements, where the balance of power and decision-making is crucial. For example, the right to appoint directors to the board and specific share rights should be addressed in the Term Sheet.
9. Law and jurisdiction
Make sure you set out what law and jurisdiction the Term Sheet is governed by, this is particularly important if you are dealing with overseas investors and buyers.
The process of writing a Term Sheet
Now that we have outlined what a Term Sheet should include, let's break down the process of actually writing one.
1. Research and preparation
Before putting pen to paper, conduct thorough research on the legal and financial aspects of your proposed agreement. Familiarise yourself with industry standards and seek legal advice if needed.
2. Choose the right template
Select a template that aligns with your specific needs, whether it's for an investment, debt financing, or a joint venture or sale/purchase. Templates provide a solid foundation and can streamline the drafting process.
3. Define the terms clearly
Adopt a simple and direct approach in defining terms. Avoid legalese and complex jargon. This is meant to be a useful document that can be clearly understood by all parties.
4. Consider financial implications
In the financial section, use numeric values to outline the amount of investment, equity shares, share prices, valuations or debt involved. Be transparent about the financial implications for both parties.
5. Collaboration and review
Engage in collaborative discussions with the involved parties. Seek feedback and ensure a shared understanding of the terms. You want to ensure your Term Sheet reflects both parties.
6. Legal review and approval
Once the Term Sheet is drafted, have it reviewed by legal professionals with experience in start ups and corporate law. This will ensure that your Term Sheet is legally sound, and you’ll be able to ask as many questions as you need. You should also get the Term Sheet reviewed by an accountant.
7. Finalisation and signatures
Make any necessary adjustments based on legal feedback, and finalise the Term Sheet. Ensure that all parties involved sign the document. Remember, at this stage, the Term Sheet remains non-binding. The parties may include some legally binding provisions such as confidentiality, choice of law and jurisdiction.
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A Term Sheet is an important document, whether it is used for securing investment, managing debt, or entering into a joint venture or sale/purchase.
By understanding what a Term Sheet is and how to write one, small businesses are protected and positioned for a more successful transaction taking place. Remember, a well crafted Term Sheet is not just a legal formality; it's a roadmap to a mutually beneficial agreement.
If you need assistance in drafting or reviewing a Term Sheet to guarantee its precision, then speak with our team of skilled corporate lawyers. They can ensure your document is not only accurate but also strategically aligned with your interests. To get started, book a free 15 minute consultation with one of our expert lawyers or by call us on 020 3808 8314.
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