Guide To Term Sheets

Contracts form the cornerstone for businesses. However, contracts can take a long time to create. What if there was a shortcut that allowed you to see all of the main terms of the agreement before reviewing the entire contract? 

That is what term sheets are for. This outline provides important details about an agreement and serves as a cheat sheet for all parties involved. Term sheets are often used to help raise startup capital for a burgeoning business. They may include key points about an investment offer in the company and are followed up with later with more detailed paperwork. 

For assistance in drafting term sheets and business contracts, consider contacting a business lawyer at the Schwab & Gasparini offices in Syracuse at (315) 422-1333, in Albany at (518) 591-4664, or in White Plains and Hudson Valley at (914)304-4353.

What Is a Term Sheet? 

A term sheet summarizes the basic terms of an agreement, often used in venture capital contexts. Carnegie Mellon University describes a term sheet as a short document that states an intended investment in a company and reflects the agreed-on valuation of the company, the investment amount, and the ownership interest the investor will receive for their investment. 

The term sheet itself is not a binding agreement. Instead, it references the terms that are included in a separate agreement. Once the parties agree on the basic terms on the term sheet, they can begin crafting a contract incorporating these terms and including additional details and provisions. 

Common Uses of Term Sheets

The Small Business Administration recognizes term sheets as an integral way small businesses can obtain venture capital to start or expand their business. However, term sheets are used in other capacities, including:

• Mergers
• Acquisitions
• Commercial real estate development
• Mortgage agreements
• Long-term debt agreements
• Seed round investments
• Series A round investments
• Convertible note rounds

Each type of transaction involves a different set of terms and processes.

Benefits of Having a Term Sheet

Term sheets can help simplify the drafting of a contract. The parties can agree on the basic terms to include on the term sheet and finish the rest of the contract. This can allow the parties to reach a tentative agreement sooner in the process so they can each rely on it. Additionally, term sheets can help avoid misunderstandings and prevent disputes. If the parties are unable to reach an agreement regarding the terms to include in the term sheet, they can back away from the deal before it becomes binding. 

Common Terms Included in Term Sheets

The contents of a term sheet will differ depending on the type of business involved. In general, however, some terms commonly included in this document are:

Valuation of the Business 

One of the most important terms included in a term sheet is the value of the business. The term sheet may include a formula or methodology used to determine the business's value. The valuation term may also list the pre-money and post-money valuations. 

Investment Amount

The term sheet will typically list the amount the company seeks in investments. This may indicate the amount they expect from the particular investment and the entire amount the business seeks from all investors. 

Ownership Interest

The term sheet will indicate the percentage the investor will receive in exchange for their investment and may also include additional terms about how this percentage is calculated. An employee equity pool that reserves shares for employees can dramatically impact the price of company shares. The investor may also want to include additional provisions to prevent dilution of their shares.

Investor Rights

Term sheets may also include information about the investor's rights, including economic rights and control rights, including:

• Their right to receive their investment back before others in case of an exit event, such as the sale of the business or a merger and acquisition 
• The right to invest in a future round of financing so their share is not diluted
• The right to a price adjustment to protect against dilution
• The right to have a board seat
• Veto rights for certain decisions that might impact their investment
• The right to block future financing rounds 
• The right of first refusal on stock transfers 
• Drag-along rights, which ensure that a large stockholder does not prevent a desired sale

Liquidation Preference 

There may be a term regarding how the business will be liquidated. Liquidation terms may give a preference to certain investors over others, often weighted in proportion to the size of their investments. 

Other Provisions

Term sheets may contain other provisions, such as:

• Valuation caps, which specify when convertible notes can be converted to equity
• Information on the assets of the company 
• Contingencies that may affect the price
• A timeframe to respond to the offer
• The amount and timing of net income distributions
• No-shop agreements that prevent the business from seeking investors from third parties

The specific terms in a term sheet depend on the specific agreement. An experienced contract lawyer with Schwab & Gasparini can help determine appropriate terms to include in term sheets and negotiate them. 

How Do You Structure a Term Sheet?

The overall structure of a term sheet may include the following elements:

• A provision that states the terms are not legally binding but an indication that the parties agree to continue to negotiate a deal
• A summary of the material terms the parties have agreed to
• Clear language regarding the terms included in the sheet
• Language regarding how long the investor must remain vested
• A signature by both parties that formally signifies the parties' intention to enter into a later formal agreement
• A timeline of when the investor or business is expected to take action and what that action is

Contact a Knowledgeable Business Lawyer for Assistance 

If you would like assistance in creating a term sheet that clearly expresses the terms on which the parties have arrived at a tentative agreement, or if you need assistance in negotiating these terms, a business lawyer can help. Consider contacting the business contract team at Schwab & Gasparini by calling our offices in Syracuse at (315) 422-1333, Albany at (518) 591-4664, or in White Plains and the Hudson Valley at (914) 304-4353We can review your situation, explain your legal options, and prepare documents that clearly communicate the desired terms. 

Mon Aug 21 2023, 12:00am