Posted on May 23, 2012 by | 0 Comments
By Dug Campbell
Last time around, I looked at an investment deal that was reported to have been completed by text message. An extreme example perhaps but arguably an indication of things to come as the world accelerates towards widescale adoption of mobile platforms.
Back in the more mundane world of startup law, I thought that it might be useful to go all the way back to the start of the investment process. The pitch has gone well, you’ve shaken the hands of an investor who has confirmed interest in your business and now there is talk of a term sheet. So what do you need to know if the first time that you see a term sheet is the day that it arrives in your inbox?
Term Sheet? Heads of Terms? Letter of Intent? Ignore the title and focus on the purpose of the document – to reach clear agreement on the important terms. Fail to agree now and it will be a lot less painful (in time and money) for both sides to walk away now rather than waiting to hit a deal breaker later on.
But don’t make the mistake of ‘doing the deal’ on the term sheet itself. A simple letter can turn into War and Peace if both sides worry that leaving issues out of the Term Sheet indicates that they have conceded points. Clearly, you need to focus on key areas and can’t shy away from flagging up important points. But too much discussion at this stage can slow a deal down and incur more costs. Detailed negotiation at this stage can also sometimes act in one side’s favour. It usually helps to speak to someone who’s been through the process before to get a second opinion.
With an offer on the table and the onslaught of due diligence just around the corner, don’t be surprised to see a range of so-called ‘standard’ terms in the term sheet that you may not have discussed directly with the investor yet. I’ll touch on these in future posts – good/bad leaver provisions, tag/drag, information rights, board representation, service contracts and investor veto rights immediately spring to mind. The term sheet may flag up each point, rather than provide full details.
The term sheet should include a spreadsheet showing the split of shares before and after the investment. This should also show the agreed share valuation and the ‘fully-diluted’ position - put simply, the split if everyone who is entitled to exercise a right to receive shares chooses to do so. Common sense perhaps but it’s not unheard of for the cap table to highlight a misunderstanding – maybe the investor has agreed to fund the business in stages ('tranches') following milestones being achieved over time whereas you were expecting to get all the cash in one go.
These are simply conditions that have to be met before the investment goes ahead. You must be confident that you will be in a position to achieve them within the proposed timescales. For example, the term sheet may state that an investment won’t go ahead until the Company’s has secured Advance Assurance from HMRC that the investment falls within the scope of the EIS legislation.
Any investor will want to avoid a position where a founder walks away from the deal after a significant amount of time has been spent. Therefore, it’s common that the term sheet will require you to commit to working with them exclusively for a period of time. This works both ways - think carefully about the restrictions that you’re signing up to and where the business might end up if the deal falls apart by the time that the period of exclusivity expires. Will you have enough time to go out and search for replacement money? Remember - it's never the best time to negotiate is when you're on the brink.
In general, most provisions of the term sheet will not be legally enforceable although they will of course carry moral weight (for what it’s worth). There are certain specific exceptions with legal force however – most likely those dealing with confidentiality, abort costs and exclusivity provisions.
Often the term sheet will indicate an estimated completion date. Try your best to work to it as invariably any deal will take your mind off the most important part of your job – your business.
Many angel investors, it should be said, do not use term sheets. However, once you start dealing with VC’s, term sheets become far more commonplace as they are often an essential step for the VC who has to secure investment committee approval. My one tip? Dig into any provisions that you don’t understand. Now’s the time to try to get a feel for how ‘standard’ they actually are in practice.
What are your experiences of term sheets? For those that have been through the investment process, did you feel the time spent discussing a term sheet represented time well spent? Or did it just take too long and use up valuable time that could have been better spent on the deal itself? Feel free to jump in below with your thoughts.