Fundraising is a priority for any business owner. To raise funds, you need investors. Before investors hand over their money, a term sheet will be negotiated. But what is a term sheet?
A term sheet is a document listing the major conditions (terms) of a funding deal. The term sheet is not a legal promise to invest. However, future contracts will be built on the term sheet agreement.
Here are some notable term sheet conditions:
1. Pre-money and Post-Money valuation – How much is your business worth? How much equity are you giving up for the investment you’re getting?
2. Option Pool – This is a block of stock set aside for awards to future employees. Often the pool is created from the Pre-Money valuation, meaning the Founders pay for it through dilution. This is commonly called the “Option Pool Shuffle” after a classic blog post from Venture Hacks.
3. Liquidation Preference – This basically means an investor has dibs if the company is sold or goes out of business (a “liquidating event”). There are 3 common types: participating, participating with a cap, and non-participating. The link has examples of how each type works.
4. Board of Director Composition – Does the investor get a board seat at your company? Does the investor want independent directors to come on board? Board composition can determine if founders remain in control of the company.
5. Anti-Dilution – Protects an investor in a “down round” (i.e., the company issues future equity at a lower valuation than today). The price to convert preferred shares to common shares is adjusted downward. The investor therefore receives more shares at conversion and maintains more ownership.
See Funding Note for an expanded list of potential terms.