Whether you’re a start-up founder, a seasoned entrepreneur or an Investor – you’re likely to have encountered term sheets in your career. But what exactly is a term sheet and what needs to be considered when you strive to achieve them?
This post will answer many questions around term sheets and you’ll learn what exactly what they mean for all parties involved. You will also find a checklist outlining the documentation start-up founders need to present and Investors expect to see to achieve a term sheet from Investors.
What is a Term Sheet?
A term sheet is a non legally binding document that is created to show Investor intent by listing investment details and terms such investment levels, shares, exclusivity, roles, jurisdiction and confidentiality.
Term sheet goals
- Encourage all parties to focus on the important commercial issues in the early stages of transaction.
- Let all parties openly address any problems or misunderstandings.
- Allow key legal principles to be settled, which in turn can be used as a framework for drafting the more complex legally binding transactional documents.
- Outline conditions which need to be satisfied before binding.
- Provide an outline of the process to due diligence.
- Show a timetable for negotiation and completion of the transaction.
- Make clear any binding elements agreed between all parties.
What’s included in a Term Sheet?
- Company details, shareholders and director names.
- Valuation of the company and the amount that the company hopes to raise.
- Information about rights for Investors.
- Any rights for particular founders or Investors to remain as directors.
- Information about “reserved rights” for Investors in respect of major business decisions.
- Details around what the funding will be spent on.
- Any restrictions on the activities of the founders.
- A summary of the rights relating to the issue and transfer of shares.
- Explanation of what happens when the company is sold or wound up.
Term Sheet Failures
Term sheets always have the potential to fall through. In an article for TechCrunch about the ways in which term sheets fail to amount to money in the bank, Jonathan Friedman explains the three main reasons for a term sheet falling through.
Rushed Term Sheets
In general, before any term sheets are offered, a VC would have already examined your business from all angles. But this doesn’t mean to say that usual protocol isn’t rushed or pushed through faster, especially if there is competition from other Investors who are interested in your company and looking for a great deal.
This results in VCs sending you a pre-term sheet due diligence to you after your term sheet is signed to speed up the process. Sadly for the start-up, this means there is a higher chance of the Investor backing out post-term sheet.
Term Sheet Drafts
When a VC is interested in funding a company, especially if there is potential for a great deal, they may offer a term sheet before that company officially decides to seek capital. This draft term sheet is a rough outline with very little commitment. If they receive too much push back from you they will move on.
Not all is lost though. Start-ups can use this outside interest in their favour.
” In cases where extra runway is desired, you can leverage the social signalling this term sheet represents to raise a quick internal extension round from your existing investor base, positioning this as a chance for them to invest more at a lower valuation before other term sheets come in.” – Jonathan Friedman
The Honeymoon Term Sheet
So you have a great business, you’ve found product market fit and Investors are interested in your start-up. VCs often (and should always) fall in love with your business, it’s values and solution to the dysfunction that you’ve discovered.
As mentioned previously, a pre-term sheet could be on the table but they may be looking at your business through rose tinted spectacles.
Once that “honeymoon phase” passes, and a deeper analysis into your business is conducted, they may discover red flags that significantly change their mind or perception of the proposed deal.
If this happens to your start-up it’s very important to receive clear feedback on why they have decided to pull the plug on your funding. You need to be proactive and prevent this happening with future VCs.
Documents Investors Need To See To Give You Your Term Sheets
We’ve compiled a checklist of documents to prepare any SaaS leader before approaching Investors to avoid common fundraising pitfalls. Use this list to check your documents against or download a printable PDF to ensure you have everything you need for VCs.
- Pitch email – a short paragraph describing your company with bullet points telling the Investor your best growth metrics. These can show anything from traction and customers to existing investors and market share.
- Pitch Deck* – the length of your presentation varies depending on what round of funding you are seeking. Quick research online shows that the average Pitch Deck size does not go below 14 slides. Also be clear about the amount of funding you need and where/how it will be used in your business.
- Product/Service demo – communicate what your business aims to achieve in a compelling way that includes the Investors.Historic quarterly financials including P&L, BS and cash flow statements.
- Existing customer information and contracts (for your top customers).
- SaaS Metrics.
- Growth projections and financial models – in particular the model you used to create the projections.
- Tax Returns.
- All legal documents.
- A schedule of any personal assets you’re willing to use for a guarantee.
*Tip: If you don’t have an in-house design team or access to a designer, you may want to consider hiring a team who specifically specialize in producing Pitch Decks for VCs.
Why Are These Documents So Important?
For an Investor to part with their money they need to know what’s in it for them – they need to be able to understand a company’s assets, liabilities and financial accounts so it’s important that you can present these on demand, and most importantly, they are correct.
Errors in financial documentation or being unable to supply financial papers when asked will of course play against you in front of Investors. Alejandro Cremades writes in an article for Forbes that the most important slides in a Pitch Deck are the financials.
He writes “investors spent 23.2 seconds viewing the financials slide. That’s more than double the time spent on ‘Problem’ and ‘Solution’ slides”. With this level of attention paid to your numbers, the financial slides must be backed up with adequate documentation as proof.
Here are some points for you to consider that may save you from fundraising errors thus failing to secure the term sheets you need to grow:
- Find an alternative to tracking your financials in Excel. Consider syncing your business accounts with accounting software such as Freshbooks, Quickbooks, KashFlow or Xero – most of which offer freemium accounts.
- Fully understand your numbers. Presenting financials that don’t match up will lead Investors to question your business acumen.
- If you have an investment roadmap, make sure the financials match up.
- Consider allowing a financial professional to look at your documents. You may be capable of crossing the Ts and dotting the Is but following this advice allows for a fresh pair of financial savvy eyes to look over your work and perhaps catch an error before it’s presented to Investors.
- Ensure that any customer contracts you share are signed by both parties – don’t present any pending contracts.
- Use testimonials or quotes from customers who have continuously renewed their contract or subscription. Not only does this show their loyalty to your product or service – their endorsement is delivered with more clout.
Providing enough information for your Investor is important for a multitude of reasons. Not only will it help attract them to offer you a term sheet, it will start to build a close Investor/start-up relationship of transparency and depth. They want your business to be a success as much as you do, so allowing them access to your documents is another tool for them to help you succeed.
The documents listed above won’t be asked for at the same time – but having them ready, or a plan in place to collect them together, is important to have and execute.
Have we missed any documents from our list – are there any additional documents that you have used previously to secure investment? Please leave a comment below to help other SaaS leaders achieve those term sheets.