Term Sheet Meaning
A term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment. It is a non-binding contract, which neither of the parties is bound to obey. The document is shared at the very onset of the transaction deal.
The format of a term sheet is such that it contains all the points that the two parties, especially the investors, need to be aware of before spending on equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company's balance sheet.. It includes all required investment details, including issuer information, valuation terms, amount, and other information. It, thus, ensures the parties know what to expect once they begin their collective journey.
Table of contents
- A term sheet is a non-binding document containing all investment details to avoid further misunderstandings.
- It is similar to an LOI (Letter of Intent) or MoU (Memorandum of Understanding) that clarifies multiple aspects of a deal to all parties involved.
- As a no-shop agreement, it restricts target companies from having another set of investors for fundraising purposes for a specific period.
- Business information, type of security, valuation, investment amount, liquidation preference, percentage stake, voting rights, etc., are the most important aspects to be covered in a term sheet.
Term Sheet Explained
A term sheet discusses the major conditions for the parties to decide whether to get into a transaction deal. Moving into a term sheet investment contract ensures no misunderstanding exists in the future between the parties involved. It is similar to a letter of intentLetter Of IntentA letter of intent, also known as LOI, is a preliminary contract containing key terms of a prospective business deal between two or more parties. It is common in business transactions, for example, the sale, purchase, merger, or formation of a joint venture. (LOI) or Memorandum of Understanding (MoU)Memorandum Of Understanding (MoU)A memorandum of understanding (MOU) is an initial level of consent shown by the involved parties in a document to proceed with certain mutually agreed objectives. For example, two countries sign an MOU to outline the terms of their upcoming trade partnership terms.. These are non-binding documents featuring the terms for the parties to go through before they enter into merger & acquisition (M&A) or other deals.
A private equityPrivate EquityPrivate equity (PE) refers to a financing approach where companies acquire funds from firms or accredited investors instead of stock markets provider identifies a few target companies that require to raise funds. Then, it goes through their business model, studies the business plan, and performs due diligenceDue DiligenceDue diligence is a thorough examination of information and strict adherence to the applicable rules and regulations. It ensures asset protection as well as the avoidance of malpractices and conflicts.. After shortlisting, they conduct the necessary discussions and negotiations before finalizing the target company. Once a private equity fund provider decides which company to invest in, the term sheet comes into the scene.
Preparing this sheet is the first step towards finalizing the deal between the two parties. It contains all the essential and critical points of the agreement. However, it is a non-binding document that does not become an obligation for any parties, even if they sign it. It means either of them or both can back out if they do not feel like proceeding further.
The contract plays a crucial role in entrepreneurship. It is because investors need to know where they would be investing and how much returns they should expect. In addition, the contract acts as a no-shop agreement, restricting the target company’s relationship with other investors. As per this feature of the term sheet for investors, the target company cannot involve in another round of fundraising for a specific time range.
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Format of Term Sheet
The term sheet template used in different sectors might differ. However, there are a few points that the agreement never fails to cover. Here is a list of clauses that are necessarily found within a term sheet for investors:
1. Business Information
This section includes the name of the parties involved. It should name the business seeking capital and the interested investor.
2. Security Type
This segment identifies the type of security offered and the price per share of that security. The types of assetsTypes Of AssetsAssets are the resources owned by individuals, companies, or governments expected to generate future cash flows over a long period. There are broadly three types of asset distribution: 1. Based on convertibility (current and non-current assets), 2. Physical existence (tangible and intangible assets), 3. Usage (operating and non-operating assets) available include equity, preference sharesPreference SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation., warrants, etc. It is the initial deal term, which is determined between the private equity provider and target company.
This clause mentions the price per share for the target company. As preferred sharesPreferred SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation. have more attractive terms, they are preferred over equity by investors. Finally, the section provides information on the pre-money and post-money valuations of the company. The pre-money valuation is based on the number of outstanding sharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet. before the financing is done. The post-money valuation, on the contrary, is done based on the number of shares outstanding post-financing.
The document should mention the amount of investment. Most of the time, the verbally discussed amount is negotiated greatly. As a result, the parties might get confused regarding the actual amount expected as an investment. Thus, specifying the amount clearly to avoid further confusion is a must.
5. Liquidation Preference
This section specifies the liquidation details. The liquidation preferenceLiquidation PreferenceLiquidation preference is a clause that states the order of payment from the realization of assets in case of liquidation. It usually protects secured debt, trade creditors, other liabilities, and then preference and equity share holders. is proportional to the amount invested. Therefore, it might be equal to or a multiple of the amount invested. This multiple can be thrice to five times the invested amount.
6. Stake in Percentage
It is the portion of the term sheet template that identifies what investors own in return for their investment. For example, if the percentage stake of company A is 25%, it will signify the investor’s ownership of the company. Based on the number of investors or the distribution of the rest 75% equity, A might have the chance of becoming the largest shareholderShareholderA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares. of the company.
7. Voting Rights
Based on the share of investment investors make, they get an opportunity to enjoy voting rights in the company. This section helps investors know the extent to which they can participate in the decision-making process of the company. When they have a say in the company, it makes investors more confident about choosing to help that particular company raise funds and capital.
- Investor commitment: It contains details about what is expected from investors’ end. The section includes information specifically on when the investors would have to remain vested.
- Founder’s obligation: This section displays the liabilities and responsibilities of the founder towards the venture.
- Time frame: Investors can take to go through the document properly. As a result, they can utilize the allowed time to decide whether to proceed with the investment.
- Non-disclosure requirements: This clause lets both the parties know the confidentiality required to maintain the deal once they sign it.
- Closing Date: This specifies the date of closure, which is normally a few days after the due diligence is accomplished.
Example of Term Sheet
The following term sheet example in the form of a template has been shared. It shows what the contract looks like and the necessary information it contains.
Frequently Asked Questions (FAQs)
It is a non-binding contract signed between two parties before they offer and accept investments to raise funds and capital, respectively, for a venture. Involving in the agreement is the first step towards beginning a collective journey of an investor and a company, especially a startup. Moreover, the contract contains all details concerning the investment, from who is the issuer and receiver to what liquidation preference it offers, etc.
No, it is not legally binding. As a result, even after the parties sign the document, they will have no obligation to obey the clauses. In short, either or both of them can step back from honoring the agreement if they do not wish to continue.
In the context of private equity, a term sheet is defined as a non-binding contract that a private equity provider involves with a target company. Thus, it requires investment to raise capital to take its business venture forward.
This has been a Guide to Term Sheets & features. Here we discuss the format & check an example of what a sample term sheet investment template looks like. You may learn more about Private Equity from the following articles –
- Redeemable Preference SharesRedeemable Preference SharesRedeemable preference shares are those shares where the issuer of the share has the right to redeem the shares within 20 years of the issuance at pre-determined price mentioned in the prospectus at the time of issuance of preference shares. Before redeeming such shares the issuer shall assure that redeemable preference shares are paid up in full and all the conditions specified at the time of issuance are fulfilled.
- Private Equity in IndiaPrivate Equity In IndiaThe top private equity firms in India are - ICICI Venture Fund Management, Kotak Private Equity Group, Chryscapital, Blackstone Group, India Value Fund, Ascent Capital, Everstone Capital.
- Private Equity vs. Hedge Fund
- Types of Alternative Investments