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Term Sheets: Use Your Heads!

Posted on Jul 23, 2013 by Kenny Mumford  | Tags: simplifying the investment process, term sheets, investment, business angel, entrepreneur  | 0 Comments

This is Part 1 of a series of posts that take a look at how entrepreneurs and investors can simplify the investment process by Kenny Mumford and Claire Corbin.

Looking for investment for your business? Despite what you might think, after you’ve agreed some of the more thorny commercial points like valuation, the process shouldn’t be difficult. That’s partly because experienced investors tend to adopt practices to simplify the process, for the benefit of all concerned. But it never hurts to tip off someone who’s new to the game – or to remind the experienced entrepreneur – about some of the basic ways that you can work with investors to streamline the investment process.

Who……uses Term Sheets?

Everyone!  Well - almost everyone. 

The convention is that an experienced investor will present a potential investee company with the terms that they are willing to offer. After all, you’re in a pretty strong position if it’s your cash. But it’s worth noting that I’ve seen an increasing number of investors ask the company to take the lead in producing a discussion draft.

What……are Term Sheets?

Term Sheets. Head of Terms. Memorandums of Understanding. These are all just different names for a document that outlines the terms of a proposed investment.  

Whatever the name used, the document should summarise the commercial and legal points in sufficient detail to assure all parties that there is consensus on the key terms of the deal. This gives everyone the confidence to commit serious amounts of time (and often money) in moving towards detailed legally binding contracts.

Subject to certain exceptions (exclusivity and confidentiality), Term Sheets aren’t legally binding. But they do carry a moral weight during the negotiations that follow. If a point is clearly set out, well understood and accepted in the Term Sheet, it will be difficult for either party to backtrack from it unless some underlying assumption was wrong.

Why……use Term Sheets?

As well as ensuring broad agreement, Term Sheets can be useful for:

  1. Comparison: how do offers from different investors vary?

  2. Planning: what conditions need to be satisfied before money changes hands?

  3. Education: for those with less experience of the process.

  4. Clarity: avoid difficult misunderstandings and expensive issues arising late in the day.

  5. Exclusivity: reassure your chosen investors that, for a limited period, you’ll not look elsewhere. 

When……to use Term Sheets?

Term Sheets will usually come into play after some initial diligence and some discussion around commercial terms.

To work well, Term Sheets need to come before detailed legal documents are circulated. Getting into full legals before a Term Sheet is signed runs the risk of wasting time finalising the Term Sheet or dedicating time to a detailed legal process without any clear agreement.

How……to use Term Sheets?

For the reasons mentioned above, Term Sheets need to be capable of being agreed relatively swiftly.

Other suggestions to get the most out of Term Sheets are:

  • DO make them as clear as possible, written in plain English (see Passion Capital).

  • DO use a share capital table so that everyone understands the dilutive effect of the investment (and options). 

  • DO go into enough detail to achieve consensus.

  • DO take seriously any binding provisions in relation to exclusivity and fees.

  • DON’T avoid difficult issues (such as leaver provisions).

  • DON’T go into a level of detail that is best left to the eventual Investment Agreement.

  • DON’T assume the “non binding” nature means you can renegotiate further down the line.

Oblivious or obvious?

So - were you oblivious to all of this? Or was this all obvious? If you’ve taken investment in your business and have a tip that might help another entrepreneur, please let them know in the comments below.

Next week, we'll move on to the next blog in the series, “Diligence – what’s due?” In the meantime, please get in touch via any of the usual channels if you’d like to discuss the investment process.

Kenny    (@Kenny_Mumford)

Claire    (@Claire_Corbin)

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