In the early stages of growing a business, one of the most significant hurdles you will experience is securing the funding you need to move forward.
Venture capital (VC) can be a valuable solution for start-ups or scale-ups during this stage, enabling them to secure the finance they need to grow, in conjunction with helpful guidance that shapes the future of the business.
However, venture capital is very selective. The majority of businesses will be rejected, with a reported success rate of only one in 2000. If you want to stand any chance, you need to undergo a process, which starts with highlighting your value to an appropriate VC firm and ideally ends with being accepted for funding.
Part of this process will include receiving a term sheet from the venture capitalist you are working with. If you haven’t experienced venture capital before, you may be asking what this term sheet means and how it influences the funding you will receive.
This blog defines a term sheet in venture capital and what to do when you receive one.
What is a term sheet?
A term sheet is a non-binding document provided to a business by a venture capital firm. It dictates the potential agreement that will be formed between the two sides once a formal deal is made. It will be used to draft further documentation during the process, acting as a blueprint for what comes next in the relationship between your business and the VC.
It is not an official agreement for funding itself, though it’s generally a good sign that the firm is interested in your company if you receive one.
When you receive a term sheet, you and the VC are not legally committed to the agreement laid out. This means it’s a good time to shape the contract you would like to have, especially if there are any terms you’re not satisfied with. In this sense, the sheet can be the starting point for the negotiation process. It should also alert you to what to expect when working with a venture capitalist so that you can prepare your business accordingly.
What’s included?
A term sheet will typically include specific conditions that the venture capital firm expects you to meet before offering any investment. These are known as the ‘conditions precedent’.
It’s crucial that you take note of these to make sure your business can comply and if you are happy to do so. This will also help you to understand what next steps you might need to take to proceed.
The term sheet will also contain information regarding the assets owned by your company, the initial purchase price and any other factors that may affect the cost of any deal made. There are may be additional critical information, such as voting rights, timeframes for investment, liquidation preferences, stake percentages and so on.
Finally, the sheet will have a timeframe for response – essentially, a deadline for when your company must come back to the VC firm with your agreement or any feedback.
What effect does the term sheet have?
The main purpose of the term sheet is that it will shape the agreement between your company and the VC firm moving forward. Accordingly, it will also be used as the basis for other understandings relating to the arrangement.
One example of this is the Subscription Agreement, which details the investment round, including how many shares and of what kind have been undertaken by the venture capitalists, payment terms and any other conditions that have been set. This could include representations and warranties, which is where the business owner sets out any issues that they believe shareholders should know before investing.
It will also shape the Investors’ Rights Agreement, which will contain information of any investors’ rights, including voting, consent, protections, board representation, and non-compete restrictions. These same provisions will typically be carried forward if you pursue further funding rounds, making it essential to get them right.
The term sheet will generally affect what your company must do during the investment relationship and what you will receive in return. Due to this, it’s vital to form a deal that both parties are happy with, helping you get the funding you need under suitable conditions and enabling the investors to meet their criteria.
What comes after?
Once you have received and had time to digest the term sheet, it needs to be agreed by all parties (including the VC firm, any other investors and you). If you have any feedback, you will need to go back to the VC firm to negotiate this until you come to an agreement.
The agreed document will then be used to draft other documents.
After you have met the pre-conditions outlined in the term sheet and the VC raises the funding for your business, you will get a formal agreement that you must sign to form the official relationship. At this point, your venture capital journey will have kickstarted – and you can look forward to receiving funding and hands-on advice.
Conclusion
Receiving a term sheet is a significant milestone in your bid to secure venture capital for your business.
By understanding what the term sheet means for the long-term agreement, you can make sure you come to a deal that suits all parties involved and gets you the funding you need to meet your goals.
If you are interested in pursuing venture capital for your business, we can explain the process and point you towards the right contacts to progress your journey.
Get in touch today to find out how we can progress you on your funding journey.