A term sheet is a business document whose purpose is to outline the terms and conditions that have been reached upon in a business agreement.
Execution of a term sheet serves as a green light for the legal counsel involved in the business agreement to commence the preparations of the final agreement. It is therefore prudent to note that a term sheet only serves as a guide upon which the legal counsel comes up with the terms and conditions of a final agreement. As such, a term sheet may not necessarily be binding but mostly only tends to highlight the conditions prevailing a particular business transaction. In other words, a term sheet can only be viewed to be a contract to the extent that: It requires the parties involved to keep all negotiations taking place as confidential information and tends to forbid an enterprise from finding other buyers for a certain period of time. Therefore, a term sheet is deemed not to contain any legal force whatsoever and only tends to outline the various key parameters pertaining to an investment. These are:
- stock purchase
- investor rights agreement
- company valuation
- voting agreement
- certificate of incorporation
The typical terms of a Term sheet will usually depend on the parties involved. Therefore, assuming that a venture capitalist aims to invest in a company X, some of the typical factors that he or she will include in the term sheet include the type of share, the company valuation and the dividend rights among a host of other factors.
- With regard to the type of share, the investor most often goes for certain class of shares that are mostly not similar to those held by the founders of the company and others. One of the reasons for this is that the venture capitalist usually invests larger sums of money as compared to the founders of that company whose major investments are time and idea.
- The company valuation will also be a crucial factor to be included in the term sheet. The reasoning behind this is that there ought to be a determination of the price per share that is to be paid by the venture capitalist once the new investment round is complete.
- Regarding the dividend rights, most venture capitalist investors are always interested in investing in companies that are at a growth phase that is considered intense. This means that the investor will be more interested in a company that reinvests its dividends as opposed to paying the dividends to the shareholders. This is because the investor is likely to get a higher rate of investment (ROI) from such a company. Therefore, the venture capitalist considers dividend rights as a typical term to be included in the term sheet.
There are numerous other terms that are featured in the term sheet but more often than not, these terms are usually left to the discretion of the particular parties involved in formulating the business agreement.