Before you sign, here are the answers to five frequently asked questions about term sheets.
1. What’s a “term sheet”?
It’s a non-binding agreement setting out the basic terms and conditions of a proposed investment by a third party. It can save the proposed investor and your company time and money if and when the deal proceeds. It allows parties to agree on the major business terms of the proposed investment, which usually allows the deal to move faster, and it guides legal counsel and advisors to develop detailed and binding legal documents to conclude the deal.
2. Where does a term sheet come from?
Typically, an investor prepares and delivers a term sheet to a company seeking investment. Sometimes a company seeking investment prepares a basic term sheet to describe its offering to prospective investors.
3. What are the typical terms?
The terms typically fall within four categories.
Funding terms set out the economics of the proposed investment, including the following:
the name of the investor
the total size of the round and the amount of the proposed investment
the investor’s valuation of the company
the type of securities the investor will purchase from the company
a cap table
the ways in which the company can use the investment proceeds
any conditions the company must meet before the investor will actually fund the investment
Corporate governance terms effectively set out who will control the company, including the following:
the board structure, including the investor’s right to have board representation
a list of decisions requiring the major investors’ approval
the investor’s ongoing rights to certain company information
Investor protection terms set out possible outcomes, including the following:
what might happen in certain circumstances after the investment is complete
protection of the investor from dilution of their ownership stake in the company
General terms appear in most legal agreements, including those terms that generally continue to be effective whether or not the proposed investment transaction is completed:
payment of professional fees incurred in negotiating the term sheet, conducting due diligence, and closing the transaction
confidentiality provisions prohibiting the parties from telling anyone about the fact or the content of their investment discussions
exclusivity provisions prohibiting the company from negotiating with any other prospective investor unless the parties to the term sheet agree
4. What happens next?
A term sheet is an invitation to begin a conversation about a potential investment. If the company wants to continue it, it usually involves these steps:
Negotiation. Before you sign, negotiate. Before you negotiate, you’ll benefit from consulting legal and other advisors; there’s some expense, but investors do more deals than you do. It’s also crucial that the final term sheet be unambiguous so it can effectively guide your legal and other advisors to prepare the binding legal documents, saving you time, aggravation, and money.
Due diligence. Term sheets are non-binding because the investor usually needs to first conduct more due diligence investigations into the company before agreeing to proceed with the proposed investment.
Binding legal documents. Once the parties sign the term sheet, they (ideally via legal counsel) prepare binding legal agreement(s) reflecting the term sheet details.
Funding. After the parties sign the binding legal documents, the investor advances the funds in accordance with the deal terms.
5. How long does it take to finalize a term sheet and get to funding?
That depends on a number of factors, including:
the time to negotiate the term sheet, which can depend on the parties involved or the transaction size
the time for the investor to conduct its due diligence
the time for the company to secure additional investment, if the deal is such that the company must secure additional investment elsewhere
the transaction’s complexity, which is usually proportionate to its size
To discuss this or any other legal issue, contact any member of McInnes Cooper’s Corporate & Business Team. Read more McInnes Cooper Legal Publications and subscribe to receive those relevant to your business.
This article is information only; it is not legal advice. McInnes Cooper excludes all liability for anything contained in or any use of this article. © McInnes Cooper, 2022. All rights reserved.
Meghan King is a corporate and commercial lawyer in McInnes Cooper’s St. John’s office. Known for her collaborative approach and focus on client success, she routinely advises and represents businesses in a range of commercial transactions, including structuring of loan security and third party agreements.
Contact Meghan at meghan.king@mcinnescooper.com or 709.724.8228.