Term Sheet Transparency

TL;DR congratulations, you’ve received a term sheet for your funding round 🎉 But what now? In this post, we share our standard term sheet together with guidance on the key terms and what to look out for 👀

Be Careful

First, a warning…

One page term sheets are positioned as simple, but in reality they save (hide?) the details until after you have signed them and entered exclusivity. At this point you have little leverage to negotiate.

If your investor insists on a one page term sheet, and the important terms aren’t crystal clear, ask to see the template long form legal documents before signing the term sheet so you know what’s coming next.

Initial Steps

There are two initial steps founders should take to prepare for a term sheet negotiation:

• Do your research by reading posts like this one so that you are familiar with the concepts used, have formed a view on any terms you plan to negotiate, and understand where market practice puts the parameters
• Hire a lawyer who understands venture capital — your family lawyer, or somebody who only does large M&A deals you know from university, will end up wasting time, running up costs and causing frustration

Our Term Sheet

Here’s our template term sheet that we use as the starting point for every investment we make. It’s based on the BVCA standard documents with a couple of modifications explained later on in this post. It’s intended to be fair and balanced to minimise the time spent going back and forth, and we include enough detail so that all the material points are covered up front.

Key Terms & What To Look Out For

• ESOP: the employee share option pool enables early hires to be incentivised by granting them ownership in the company. 10% is standard in the UK and Europe, and this is the level we set. Since the ESOP will be (fully or partially) re-set at subsequent rounds, founders shouldn’t accept higher than 10% unless they know they will need it for upcoming hires.
• Conditions to Closing: our only conditions to closing are legal, on the basis we still need to check the company is correctly setup and agree long form documents before we can close. Be cautious if there is a long list of other conditions as this could mean that the offer is not as solid as it looks and the investor might be building in optionality (i.e. a reason to get out of the deal later on if they want to). Push back on the investor to either negotiate out the other conditions or agree exactly how they will be satisfied and the timeline for doing so.
• Exit Provisions and Distributions: you should expect — and accept — a 1x non-participating preference, but no more. Early stage venture is about ensuring alignment between founders and investors, not financial engineering, so push back on any participating preference or more than 1x. Some good background reading on how preferences work here.
• Drag Along: this can be an emotive term — alongside any terms that give investors control over your company— but, to be clear, the drag can only be activated if the founders want to sell. In this scenario, it’s useful to include in case you have shareholders that you cannot contact or who are otherwise obstructive during an exit process (although it’s best to stay in regular contact and keep them onside so the drag isn’t needed).
• Important Decisions: taking external investment means that you are no longer entirely in control of your company. The list of decisions requiring either investor director or investor majority (shareholder) consent is set out in the Appendix. Avoid signing a term sheet without seeing a list of these decisions. If you haven’t already, this is the moment you should take extensive references on your potential investor. More important than the legal terms is how your investor will behave once the funds have been wired. You can’t do too many references.

One common misconception is that including these Important Decisions will slow the company down — that’s the last thing we want to do. We discuss and approve very quickly (usually hours) and often informally (via WhatsApp).

• Board of Directors: our view is that boards are a positive for companies, even at the early stages. The agenda, format and cadence will evolve over time, but it’s good practice to get together on a regular basis. The key question for founders is — do I want this person on my board? This should be a key part of your decision making process. It’s also important not to bloat the board early on so ‘one director per round’ is a sensible yardstick after applying, of course, any round specific details (for example, this wouldn’t typically work with two investors writing equal sized cheques and co-leading your round). Tie observer rights to maintaining a certain shareholding % so they drop off over time unless they maintain their ownership in the company.
• Founder Vesting: founders are now very familiar with this concept and understand that it’s to protect everybody in the company, not just the VCs. When co-founders breakup, vesting makes it possible for that to be an equitable process allowing the company to survive (without vesting, one co-founder leaving with 50% of the shares after 12 months kills the company). Make sure you fully understand the Bad Leaver / Good Leaver definitions and then layer on top your references and your relationship with the investor. Bad Leaver looks, well, bad, so ensure they can be objectively ascertained and that triggering them is within your control. (Note that we have voluntary resignation within 24 months as a Bad Leaver event because, ultimately, we are investing in the founders to be there for the long term and believe this better aligns all of the founders and the investors.)

• Restrictive Covenants and Founder Undertakings: the starting point here is an absolute prohibition on work outside, but we make exceptions where it makes sense — for example, some of our healthtech founders continued to work in a clinical setting for a day a week. If this is relevant for you, speak to the investor and see if you can agree a carve out rather than assuming it won’t work or doing it in secret!
• Documentation and Warranties: the whole process around warranties and disclosure feels stressful for founders, but remember: (1) investors just want to make sure they know everything they can about the company around key topics like employment, IP and disputes and this is the legal process to do that; and (2) investors are very, very unlikely to ever sue the company they have invested in.
• Expenses: you should expect the lead investor to have their legal fees covered, with other investors covering their own costs. No other expenses or fees should be charged by the investor as every pound should be going into growing the company. Push back on all fees other than legal fees specifically for the investment round.
• Expiry: investors should give you a minimum of a week to finalise and sign a term sheet. Shorter time periods are often referred to as ‘exploding terms sheets’ designed to put pressure on founders. If the deal is right for you and your company, take it; if it’s not, don’t.
• Exclusivity: entering exclusivity should be a positive step— founders have agreed to proceed with their chosen investor whilst the investor has agreed to prioritise their resources to get the investment closed (and, in our case, has final Investment Committee approval to proceed). This is how it works in many (perhaps most) cases, but remember that exclusivity locks you out from talking to other investors so only sign once you are sure your lead is the right fit for you. Also check whether any further Investment Committee approvals are required — this can often catch founders out with convoluted, multi-step processes making it unclear if the investment is actually approved or not.
• Non-binding Effect and Jurisdiction: a reminder that term sheets are not binding and we do hear about term sheets being pulled after founders have invested considerable time in a process. Protect yourself by doing your references (yes, this is the third time it’s been mentioned for good reason) and ensuring that you negotiate out or have absolute clarity on any conditions as mentioned above.

You made it!

Just one more term to cover:

• ❌Anti-dilution provisions ❌: some investors include anti-dilution provisions to protect themselves in the event of a down round (and it’s included in the standard BVCA terms). Since we believe that founders and investors should be aligned — and building together — we don’t include them in our term sheet. If things aren’t going well, we’ll figure out the best financing options together rather than relying on a contractual right to put ourselves first.

Questions?

You can reach me on chris@playfair.vc or any of the social channels below.

Thank you Emily Townsend and Andrew Davis at Goodwin for their input and ongoing counsel.

If you’re a founder at the very earliest stages of building your company, you can pitch the Playfair team here or find me on social (LinkedIn, Twitter, TikTok)

You can follow the Playfair team on LinkedIn, Twitter, Forbes, Vimeo and here on Medium.