Significance Of Term Sheets For Founders
As more and more start-ups come into play, it is imperative for the entrepreneurs to understand the significance of negotiating the deal terms with an investor. Here, one cannot highlight the importance of the document governing the terms of the deal enough, known as the term sheets.
What are term sheets?
A term sheet is a nonbinding agreement that shows the basic terms and conditions of an investment. It serves as a prototype for more detailed & legally binding documents.
This document is crucial to attract venture capitalists (VCs) to fund enterprises. Ideally the term sheet should carefully spell out the company valuation, investment amount, percentage stake, voting rights, liquidation preference, anti-dilutive provisions and investor commitment.
The term sheet is essentially a framework or blueprint that ensures that the parties involved in a business transaction agree on most major aspects and minimises the likelihood of a misunderstanding or dispute.
What are the most common terms to look out for?
Most of the investors look for preference shares or special privileges over others. Most commonly it entails that in case of liquidation, the investors will get their money back before others.
Deal fees is basically the amount charged by VCs as a percentage of the deal. It includes legal and diligence fees and management or admin fees. However, the management fees is not charged to the company being invested in but from the limited partners of the VCs.
Angel investors, however, charge between 5%-10% as management fees to the company they invest in.
Incase of venture debt, this figure is around 1%-3% with an interest of over 15% over a 3-5 year period.
The investors expect a seat on the board in return for an investment most commonly at Series A of the funding round. However, there have been instances of investors for VCs to ask for handing over the seat to more qualified directors.
Founder vesting ensures a long-term buy-in of the founder. It is the time before the shares become the ownership of the founders. The most common layout of this scheme is vesting spread over 4 years with a 12-month cliff- i.e. a portion of shares become yours at the end of the first year after investment, steadily increasing over the remaining three years.
Most investors negotiate an exclusivity period most commonly around 4 weeks.
Some other common terms are ESG clauses, personal guarantees and right of first refusal.
With all this information marked out, it typically takes around 8-10 weeks to close a deal. However, with solo capitalists gaining prominence, these timelines get shortened further.
These term sheets are, hence, an important tool for founders of startups to negotiate the terms of the deal and avoiding bad VC experiences.
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We also give CFO services along with accounting and bookkeeping. All the data analysis is done, for our clients, to take decisions accordingly. Financial management is a daunting task as it encompasses all the departments and the whole company. Working with us enables our clients to have someone who has a clear understanding of their goals and has the expertise to help them achieve these goals and turn their dream into a reality.
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