For Investment Month here at TechSPARK, Nina Searle, Partner at TLT LLP, our Investment Activator Programme partners, is sharing her wisdom on how to approach a term sheet. If you’re a founder of an early-stage startup and are about to begin the investment journey, have a read. 

Term sheets, also known as heads of terms or letters of intent, set out the key terms of a proposed investment. They seek, at an early stage, to ensure the basis of an investment is clear and provide an opportunity for founders to drill into the detail of what they are being asked to sign up to.

Although not generally legal binding (save for certain provisions relating to things like confidentiality, exclusivity and investor fees), it is very difficult to renegotiate a term sheet once signed. So it is essential to understand what they say and be comfortable with what is proposed.

Term sheets can vary in format and depth and will often be tailored to the specific investor, founders and business involved.  The following key areas will typically be covered:

Valuation

How the company has been valued and the amount and structure of the investment. Will money be invested for shares and/or loaned by way of a loan note (which may or may not convert into shares on some subsequent event)? What percentage shareholding in the company is the investor expecting to hold? Check the basis of how this will be calculated (on a fully diluted basis taking into account share options/warrants already granted and proposed?).

Conditions of the investment

What the conditions are for investment. These will often include satisfactory due diligence information and references, regulatory approvals or tax consents and potentially advanced assurance if your fundraising meets the conditions for venture capital schemes such as EIS / SEIS / VCT.

Warranties

Founders (and potentially other shareholders) will be required to “promise” that company information provided to the investor pre-investment is accurate and truly reflects the position of the business. These promises or “warranties” will impose personal liability on those giving them so it’s important to fully understand the liability exposure.

Board composition and decisions

What the make-up of the board will be. Will there be a maximum number of directors? Does the investor expect board representation (through an investor director holding voting rights) or are they happy simply to have a non-voting observer who attends meetings and has the right to speak? How often will board meetings be held and what matters will be for board approval?

Veto or consent matters

Certain matters or actions relating to the target business will require investor or investor director approval going forwards. Founders need to be comfortable that the business can carry on its daily operations without being impeded, whilst accepting that an investor will want to have a say on key commercial matters which underpin their investment.

Information rights

Financial and other information the investor will expect to receive or be able to request on a regular basis to monitor business progress and their investment.

Leavers

Any employee (including a founder) leaving the target business before the investor, will often be required to give up their shares or at least some of them (see Vesting below).  This allows their shares to be offered to others remaining with the business and prevents those leaving from benefitting from future growth (which they have not been involved in generating). The term sheet will set out the price payable for a leaver’s shares which will often vary depending on the circumstances of their departure – often reference is made to “good” leavers and “bad” leavers (and it is important to drill into their meaning as there are no standard definitions).

Vesting

Investors will often ask founders to sign up to a “vesting” schedule at the time of the investment. Vesting can be structured in a few different ways but the underlying aim is to incentivise founders to stay with the business after the investment and support its growth and development.  Where a founder leaves shortly afterwards, they will receive very limited value for their “unvested” shares.  The longer they stay with the business, the more of their shares are deemed to be vested shares, with greater value attributable to them.    

Drag and tag

“Drag along” provisions allow a majority of shareholders to accept an offer to sell their shares and then drag the minority into the sale to the same buyer on the same terms. “Tag along” provisions work in reverse, allowing minority shareholders to require an offer be made for their shares where a majority accepts an offer which changes control of the company.  Both sets of provisions seek to ensure that no-one is left behind should the majority decide to sell.

Anti-dilution ratchet

If a future fundraising attributes a lower valuation to the target than was the case when the investor came on board, an anti-dilution ratchet seeks to redress the balance.  Extra shares will be given to the investor (or they pay a nominal sum for them) so that the average price they have paid for all their shares mirrors what is being paid on the future fundraising.  This is a complicated area with different types of ratchet mechanisms available.  So it’s important to clarify the details within the term sheet.

Although a term sheet is not usually legally binding (save in certain respects), its contents are likely to limit negotiation at the next stage of the process and may have an impact on tax planning.

Our Corporate team advises ambitious businesses looking to grow and raise investment. Please do get in touch if you would like to chat through any of the above.

Author:

Nina Searle, Partner at TLT LLP

Nina leads TLT’s national Fast Growth team, acting for fast growing businesses and their investors on everything from founder agreements and friends and family investments through institutional fundraises and value enhancing acquisitions to exit.

 Her clients include entrepreneurs and scaling businesses, S/EIS and VCT Funds and global corporates.  Nina led on Amdaris’ £6m investment from BGF and Open Bionics’ Series A round, as well as Maven Capital Partners investment in Hublsoft Ltd and BHL’s various insure tech investments.

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