Negotiating an Investment Term Sheet
In the current challenging times, many businesses will want to close investment rounds quickly and efficiently so that they can get back to building the business. With that in mind, below are our top tips to successfully negotiate an investor term sheet.
- IDENTIFY KEY ISSUES: Identify the meaningful terms which will have a significant impact on you and your business and work hard at negotiating those points.
- NEGOTIATE: If you agree a term sheet without negotiation, you may lose credibility with the investor and it may be difficult to negotiate changes at a later date. But, don’t negotiate every point as you risk losing focus on the end goal and may appear inexperienced.
- FOCUS: Focus on the key points for you and your business. Recognise what is non-negotiable and when to move on. Key terms for negotiation often include:
- Valuation and Dilution: Clarify the basis of the valuation before committing to a specific share price –understand the different implications of a pre- or post-money valuation and a valuation based on issued or fully diluted share capital (e.g. the impact of including the option pool in the fully diluted pre-money valuation). It may be better to accept a lower valuation from an investor who is aligned with the business goals than a higher valuation from a less compatible investor.
- Investor Rights: Investor consent rights and Board representation can have a significant impact on business strategy and operations. Strike a workable balance - investor consents should be limited to the most important matters (e.g. sale of the business, amendments to the constitutional documents) while investor director consents should be for operational matters (e.g. major expenditure, changes to the business plan and key hires). Work collaboratively with the investor to identify a Board appointee who is compatible with other directors and has the relevant skills and expertise.
- Leavers and Vesting: The circumstances in which a founder or other key shareholder may be required to sell his/her shares and the sale price are particularly sensitive. Points for negotiation include the triggers for compulsory share transfers, the definitions of “good leavers” and “bad leavers” and the share transfer price. Similarly, if founders’ shares are subject to a vesting schedule, the timeframes and acceleration triggers are worthy of negotiation.
- Warranties: Liability for breach of the warranties should be capped –typically, for the company, to the amount of investment and for the founders, a multiple of annual salary.
- Liquidation Preference. A liquidation preference setting out the return that an investor receives on a sale may have a significant impact on the founders’ return. Understand the implications and prepare worked examples of the proposed liquidation preference on exit values. This is often a key point in US venture deals.
- Anti-dilution Protection: Investor protections from future sales shares at a lower valuation typically involve an award of additional shares to make up for the dilution suffered by the investor as a result of the down round. Different formulae can have significant implications for the founders and should be understood and negotiated as needed. This is often a key point in larger UK and in US venture deals.
- TAKE ADVICE: This is by no means an exhaustive list of investment terms and there may be specific issues of concern in each situation. Consult with a lawyer experienced in early stage investments to help identify the most important issues for the success of your business.