{"id":411814,"date":"2024-11-07T14:20:33","date_gmt":"2024-11-07T14:20:33","guid":{"rendered":"https:\/\/seedlegals.com\/resources\/negotiating-your-term-sheet\/"},"modified":"2023-08-21T09:28:22","modified_gmt":"2023-08-21T09:28:22","slug":"negotiating-your-term-sheet","status":"publish","type":"post","link":"https:\/\/seedlegals.com\/us\/resources\/negotiating-your-term-sheet\/","title":{"rendered":"How to negotiate your term sheet as a founder"},"content":{"rendered":"

Negotiating Your Term Sheet<\/h2>\n

The\u00a0Articles of Association<\/strong>\u00a0and\u00a0Shareholders Agreement<\/strong>\u00a0that underpin a funding round will, between them, contain dozens, perhaps close to a hundred, little things that you, your investors and the various lawyers involved might want to negotiate.<\/p>\n

Rather than taking everyone\u2019s time on the minutiae, a\u00a0Term Sheet<\/strong>\u00a0is simply a shortlist of the dozen or so most important deal terms (company valuation, number of shares offered, equity split, etc.). The idea is that once you\u2019ve agreed those, then and only then do you move onto the next step (the \u201clong form agreements\u201d) and debate the minor points.<\/p>\n

The question with\u00a0Term Sheets<\/strong>\u00a0is who goes first. In some cases your\u00a0lead investor<\/a>\u00a0will want to provide their standard term sheet. In other cases they may be looking for you to take the lead.<\/p>\n

SeedLegals<\/a>\u00a0transforms the negotiation process replacing negotiations done by swapping redlined Word documents with a delightful Term Negotiator interface that lets you and your investors quickly agree on the key deal terms, and then move to the next stage. Plus, we provide you with data and insight to make informed decisions on every deal term.<\/p>\n

The British Private Equity & Venture Capital Association\u00a0<\/a>(BVCA) has a fantastic overview of terms and term sheets. Note that their document is targeted at later-stage (Series A) funding rounds, where the term sheets are substantially more comprehensive and complex than you\u2019ll need for a first or seed round.<\/p>\n","protected":false},"excerpt":{"rendered":"

Find out how to strike the balance between keeping the money on the table and getting a fair deal. Find out the red flags to watch out for and how to negotiate with angel investors and VCs.<\/p>\n","protected":false},"author":169,"featured_media":412602,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[141,146],"tags":[],"event_tags":[],"class_list":["post-411814","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-uncategorized-us","category-funding-guides-us"],"acf":{"hero_image":412602,"post_content":[{"acf_fc_layout":"text","text":"

If you\u2019re fundraising for your company, the first document you\u2019ll have to negotiate will be a term sheet. It\u2019s a document that sets out the key terms of what you and your investor have agreed. It gets you thinking about what you both want the final deal to look like.<\/p>\n

In this article, we\u2019ll explain the key elements of a term sheet. Plus, we\u2019ll go over how you can negotiate it to protect your own rights without falling out with your investors.<\/p>\n

What is a term sheet?<\/h2>\n

A term sheet outlines the key terms of the investment in your company. It\u2019s not legally binding, but it is still important. That\u2019s because it\u2019s used as the base for the final (more detailed) legal documents to be written. The point of a term sheet is to make sure both parties agree on the key elements of the deal. Plus, it\u2019s usually legally binding in relation to keeping information private (\u201cconfidentiality\u201d) and not seeking other offers (\u201cno-shop\u201d).<\/p>\n

Why do I have to negotiate the term sheet?<\/h2>\n

The term sheet sets out the terms of the investment in your company. What goes in there can have a huge impact on things like how your company is controlled, what happens if it\u2019s sold and other things like that. So, you need to make sure it aligns with your company’s goals and protects your interests.<\/p>\n

It isn\u2019t legally binding \u2013 but once it\u2019s agreed, you don\u2019t want to go back on what\u2019s in there without special circumstances (that could damage your relationship with your investors). Plus, the term sheet negotiation stage lets you show your investor that you understand the priorities for your business and how to achieve its full potential.<\/p>\n

What are the key clauses in the term sheet?<\/h2>\n

Term sheets can get pretty lengthy and detailed (you can download the term sheet from the National Venture Capital Association<\/a> if you want to have a look at one).<\/p>\n

In this section, we\u2019ll explain the most important terms you\u2019ll want to focus on at this stage.<\/p>\n

These are the seven key clauses you\u2019ll want to make sure you get right. You might not see all of them in your term sheet if they\u2019re not relevant to your situation (for example, if you\u2019re only raising funds from angel investors, they probably won\u2019t expect a board seat).<\/p>\n

Pre-money valuation<\/h3>\n

This is the value of your company before any new investment is added \u2013 it determines how much of your company you\u2019ll give up when raising the amount you want.<\/p>\n

For example, if your company\u2019s valued at $10 million pre-money and you raise a $2 million financing round, the post-money valuation would be $12 million, meaning the investor receives a 16.67% stake in your company (2 million \u00f7 12 million = 16.67%).<\/p>\n

But if your pre-money valuation was $5 million, and you raised the same $2 million financing round, the post-money valuation would be $7 million, and the investor would receive 28.57% of your company (2 million \u00f7 7 million = 28.57%).<\/p>\n

That\u2019s exactly why valuation is so important.<\/p>\n\n\n\n\n\n\n
<\/td>\n$10 million pre-money valuation<\/b><\/td>\n$5 million pre-money valuation<\/b><\/td>\n<\/tr>\n
Investment amount<\/b><\/td>\n$2 million<\/span><\/td>\n$2 million<\/span><\/td>\n<\/tr>\n
Post-money valuation<\/b><\/td>\n$12 million<\/span><\/td>\n$7 million<\/span><\/td>\n<\/tr>\n
Investor\u2019s ownership<\/b><\/td>\n16.67%<\/span><\/p>\n

(2 million \u00f7 12 million)<\/span><\/td>\n

28.57%<\/span><\/p>\n

(2 million \u00f7 7 million)<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n

Make sure the valuation you\u2019re giving accurately reflects where your company is now and where it could realistically go. Pushing for an overly high valuation might seem beneficial, but it could complicate future funding rounds. For example, if you have to lower your valuation in the future, it\u2019ll be harder to get funding (also, read the \u201cAnti-dilution provisions\u201d section below).<\/p>\n"},{"acf_fc_layout":"content_highlight","highlight_type":"tip","background_colour":"blue","show_icon":true,"content":"Check out our complete guide explaining pre-money valuation<\/a> and what factors influence it.","link":null},{"acf_fc_layout":"text","text":"

Liquidation preference<\/h3>\n

Liquidation preference determines the order and amount investors are paid back if your company\u2019s sold, goes public or is otherwise liquidated (like if it went out of business).<\/p>\n

For example, let\u2019s say an investor has a \u201c1x non-participating liquidation preference\u201d on a $1 million investment. This means that, on a liquidation, they can either take their $1 million first, or convert their preferred stock to common stock and take their share of the remaining proceeds.<\/p>\n

So, if your company\u2019s sold for $5 million, the investor can choose to receive their $1 million upfront, with the remaining $4 million then divided among the common stockholders (as a founder, you\u2019d usually be a common stockholder). But if converting to common stock would give them more than $1 million, they would choose that option instead.<\/p>\n

In most early stage investment rounds, venture capitalist (VC) investors would want a 1x non-participating liquidation preference to give them some protection on their investment. Avoid giving more than a 1x liquidation preference, as that could give you a lower return on an exit of the company.<\/p>\n

Board of directors (and voting rights)<\/h3>\n

The board of directors make key decisions on how the company\u2019s run. And if an investor\u2019s on the board, they may be able to influence these decisions.<\/p>\n

If you\u2019re getting investment from a VC, they\u2019ll typically want a seat on the board \u2013 they\u2019ll want to have a say in how their money is being used. But for angel investors, it\u2019s unlikely you\u2019ll need to give them this level of control.<\/p>\n"},{"acf_fc_layout":"text","text":"

Anti-dilution provisions<\/h3>\n

Anti-dilution provisions are designed to protect investors from losing value in their stock if the company issues new stock at a lower price in future rounds (called a \u201cdown round\u201d).<\/p>\n

For instance, if a future fundraise takes place at a lower valuation, an investor with anti-dilution provisions could convert their preferred stock into more shares of common stock to top them up. There are different types of anti-dilution provisions which determine how much stock an investor would receive:<\/p>\n