Our Open Approach To Term Sheets
TL;DR The investment terms we offer are intended to ensure long lasting alignment with our founders and be fairly balanced. We actively avoid short term thinking, complex financial engineering and a nickel-and-dime mindset.
Waiting to receive a term sheet is an anxiety inducing time. And when it finally lands in your inbox, initial excitement can quickly be replaced by the frustration that comes with reviewing several pages of complex legal jargon.
The problem is that legals are generally opaque and tedious. I should know, I was a lawyer for a decade before escaping the greyness. They also feel very different from the friendly and collaborative conversations that led to the term sheet being issued. In the worst case, they can delay (or derail) a deal.
Avoiding this legal quagmire is in everybody’s interest. Whilst instructing a lawyer who is familiar with venture deals is a major help (and using a lawyer who isn’t can be a disaster), founders equipping themselves with some knowledge about what to expect is also key to getting smoothly to closing.
Last month Mountside Ventures and LandscapeVC released Demystifying Venture Capital Term Sheets, a guide aimed at founders raising an institutional round. It surveyed 200+ VCs to understand market terms and is a great starting point when figuring out what to expect — and what’s on- or off- market — when that first term sheet drops into your inbox.
Whilst there is broad consensus on some terms, there is significant deviation on others. This reflects the changing nature of venture capital firms in the UK and the different structures and incentives that are in place. It also shows that in some ways venture capital has lost its way, as I wrote in Forbes recently.
Before reading the rest of this post, I’d encourage you to check out the guide.
At Playfair we’ve always recognised that behind every deck is a dream and work hard to treat every founder as we would wish to be treated. This extends to the way we think about investment terms and manage the legal process.
In the rest of this post, I’m going to break down all the terms in our term sheet, starting with the big ones that are likely of most interest to founders:
We fundamentally believe in being economically aligned with our founders and enabling all investors in a round to invest on the same terms, taking advantage of S/EIS (if applicable).
Complex preference stacks create unintended consequences and perverse incentives so we are strongly against them.
Our approach is to invest in ordinary shares with a 1x non-participating preference that is S/EIS qualifying.
Leading deals and board involvement
We’ve always advocated the benefits of a strong cap table where every investor brings value to the table. This means we love working with other funds and angels to bring together the best possible round. We do see value in having a properly constituted board from early on, but caution against having too many people around the table, especially if it’s not clear what they bring.
We’re not precious about whether we lead, co-lead or coinvest. Where we lead or co-lead, a director or observer seat helps bring early rigour to the business which will put the company on the best footing for growth and future fundraising.
Transaction/deal and monitoring fees are entirely inappropriate in early stage venture capital where every pound counts and increases the chances of a company being successful.
Legal fees paid by the company to lead investor should be kept to a minimum.
We will never charge transaction/deal or monitoring fees.
Our legal fees are capped and kept low by using an experienced firm outside of London and by doing much of the legal work including due diligence ourselves. On average, our legal fees will be 0.25-0.5% of the round.
At the early stages, we are investing in people. Founder vesting is in place to provide a clear economic incentive for the key people in the company to stay working in the company. And it’s not just a protection for investors, but for co-founders too — if one of them leaves and a replacement is needed, the unvested equity will be required to incentivise the new joiner.
Our approach is a four year vesting period with a one year cliff.
Share options are a powerful tool for recruitment and retention. We work closely with founders to align the option pool with the hiring plan, baking in some headroom/contingency for additional or more expensive hires.
A 10% ESOP is standard to ensure there is capacity to grow and offer the right incentives to the team. We have flexed lower where key hires are already in place.
The above terms were the main ones reviewed in the Mountside / Landscape guide. For completeness — and perhaps because being a lawyer never fully leaves you 😭— here are the rest of the terms include in our term sheet:
- Pre-emption rights: these enable us and others investors in the round to maintain their shareholding percentage on a new issue of shares by subscribing for a pro rata amount
- Right of first refusal: if shares are being transferred (sold) by any shareholder, the existing shareholders have a right to buy them first before they can be offered to a third party. This keeps things in the ‘family’
- Drag along/tag along/co-sale: all similar mechanisms that ensure when the founders / investor majority want to sell, all the other shareholders will sell too (without these you may not be able to deliver 100% of the shares to a purchaser which is a big problem)
- Information rights: we require information, including management accounts, from the company on a regular basis. It’s not onerous as the company should be producing this information anyway
- Important decisions: certain decisions require the approval of the investor director (if appointed) or an investor majority. The intention here is not to interfere with the day-to-day running of the company, but to have input into material decisions (e.g. a decision to acquire another company)
- Warranties: warranties are statements of fact that the founders will give about the company and run alongside our due diligence process to make sure we have a complete picture of what we are investing in
- Restrictive covenants/founder undertakings: founders will enter into new service agreements (unless the existing ones are sufficient) and agree standard non-compete and non-solicitation provisions for the benefit of the company as well as an undertaking to work 100% on the business (this doesn’t prevent charitable interests, mentoring, hobbies, etc. :))
- Expiry: the offer in a term sheet is available for acceptance for a limited period. This varies on a deal-by-deal basis depending on round dynamics
- Exclusivity: like the expiry period, this varies on a deal-by-deal basis
Our approach is to get all the important elements on the table and agreed at term sheet stage so there are no surprises when we get to the long form legal documents (Investment Agreement and Article of Association) — this is in the best interests of both founders and investors.
A Final Comment
There is an increasing trend in the market to overly simplify term sheets by replacing detailed terms with loose language like ‘customary terms will be included in the long form documentation’.
It may seem appealing — and optically the term sheet looks less dense — but the problem with this approach is that it merely defers discussion about important terms until later on.
If there are certain terms that are important to you as a founder, make sure you have clarity on these before you sign the term sheet.