Navigating SEIS and EIS: Risk-to-capital decoded
Navigating the world of SEIS/EIS is challenging, and predicting approval can be especially difficult with stipulations such as ‘risk-to-capital’. For...
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You've successfully pitched to investors, and now it's time to take the next steps and lock in that deal. This is where the term sheet comes in.
When you're raising investment for your company, the term sheet marks the beginning of turning conversations into commitments.
While “term sheet” is typically used for investment deals, they’re also called heads of terms, Letters of Intent, or Memoranda of Understanding.
A term sheet is a concise document that summarises the key terms of an investment. It's usually the first investment document you'll draft and is key in outlining the rest of your investment journey.
Whilst it's not legally binding, the term sheet sets the foundation for formal agreements that'll be signed subsequently, such as the shareholder’s agreement and articles of association.
A solid term sheet sets the tone for negotiations and keeps everyone aligned. It's the blueprint for the rest of your fundraising journey, so make sure it clearly outlines the investment details.
A well-crafted term sheet saves time, setting the stage for successful negotiations and streamlining the overall fundraising process.
An investment term sheet is often the first step in turning a business deal into reality.
You’ll encounter one in situations like:
A well-structured term sheet prevents surprises later on in the deal process. For example, if an investor wants specific voting rights or board seats, this will be specified in the term sheet and negotiated.
Similarly, if founders want to retain certain controls, stipulating them in the term sheet gives investors a chance to react.
Beyond aligning parties, term sheets also help create momentum in deals. Agreeing the main terms demonstrates that both sides are committed to moving forward.
When constructing your term sheet, there are key words, phrases, and clauses that you must understand in order to effectively set terms that work for you.
Let’s break down these essential elements so you can grasp their meaning and anticipate how they might impact your business in the long run.
The valuation outlined in your term sheet will directly influence how much of your company you’re offering to investors. By accurately valuing your business, you can confidently calculate the right amount of equity to allocate in exchange for investment.
There are two main types of company valuation:
Specifying which valuation type you're assessing, followed by a value that's representative of your business is key in maintaining ownership whilst still being attractive to investors.
Investors will usually receive between 5-20% per investment round, but this will vary depending on your business stage, financial situation, and the nature of investors. Use our free equity sharing calculator to help decipher how many shares to give to investors.
This clause helps you to shield investors from dilution, protecting their stake in the company as the business grows.
It essentially allows current investors to acquire newly issued shares ahead of a new funding round, acting as a safety net for investors who want to maintain their ownership stake throughout the company’s growth journey.
This not only benefits investors, but can also benefit founders who hold equity!
When it comes to selling the company, the terms set out around how the sale is handled can have a significant impact on both founders and investors.
Drag-along and tag-along rights are in place to ensure fair treatment for all shareholders during a potential exit or sale.
Both these clauses are often included in the term sheet to build a balanced approach to exits and sales. Drag-along rights protect investors by ensuring a streamlined exit, whilst tag-along rights safeguard minority shareholders by ensuring they aren’t left out of beneficial deals.
Investor consent rights define the areas where investors can exercise veto power over key decisions. While founders often retain significant control over day-to-day operations, investor consent rights ensure that investors have a say in major decisions that could impact their investment.
This clause, outlined in the term sheet, specifies which investors have consent rights and the types of decisions they can veto. Typically, these matters are critical to the business’ growth and may directly affect the investment returns.
For example, investor consent might apply to decisions like salary increases or taking on additional debt. However, it could extend to a broader range of business matters, including acquisitions or changes in the company’s direction.
This ensures that investors are protected and involved in decisions that could significantly influence their stake in the company.
*Keep in mind that while this is less commonly requested in funding rounds before Series B, it’s an important consideration as your business continues to grow!
Some investors, particularly those as part of VC firms, will request a board seat. This gives them the right to a say in some company decisions (inclusive of those not outlined in the investor consent clauses.)
VCs can offer valuable insights and advice when it comes to making key decisions, and so having members on your board is not always a drawback.
However, it is important to note that overloading your board with investors during term sheet negotiations will dilute your voice as a founder. Ensure that the decisions you make are in the interests of your company, rather than the investors.
Warranties are assurances provided by the founder to investors, confirming the accuracy of key details of the business. These are in place to give investors confidence in their investment.
They are defined in term sheets to set liability caps and floors to protect both parties from claims and unfair blame games.
Liability caps outline how much the founder should personally be liable for, should the company be misrepresented and warranties breached. Caps are in place to protect founders from unlimited liability.
On the other hand, liability floors establish the minimum claim threshold investors can pursue. This prevents trivial claims from disrupting the business, as only claims above the floor are viable.
Liquidation preferences determine who gets paid first when the company is sold or wound up. They're most common with preference shares and can dramatically change how proceeds are shared out.
Let's say you sell your company for £10 million, and investors put in £2 million originally. With a 1x preference, they get their £2 million back before the remaining £8 million is shared among all shareholders. With a 2x preference, they'd get £4 million first, leaving £6 million to split.
This is especially important if the company sells for less than expected. If you sell for just £1.5 million with a 1x preference, investors would get their full £2 million back first – meaning other shareholders get nothing.
Anti-dilution provisions protect investors if you raise money later at a lower valuation (called a 'down round'). These terms automatically issue extra shares to early investors to compensate for the drop in value.
For example, suppose an investor buys 20% of your company at a £5 million valuation.
If you later raise money at a £3 million valuation, anti-dilution provisions would issue them extra shares to maintain their investment's original value. This means other shareholders, including founders, get diluted more heavily.
These protections come in different strengths – from 'full ratchet' (the most aggressive) to 'broad-based weighted average' (more moderate). They're rare in early-stage deals but more common with larger VC investments.
Make sure you model out different scenarios to understand their potential impact before agreeing to them.
“It’s just a formality, we can rush through it.”
Wrong—your term sheet sets the tone for the remainder of the investment process. Get this right, and it should be smooth sailing. Rush this, and you may run into big issues with investors. Let it be the cornerstone of your overall funding strategy.
“Investors set the terms, and founders lose out.”
Founders can—and should—propose their own terms and protect their ownership. Setting the negotiation tone is key, and demonstrates confidence in future decisions.
“This is completely non-binding.”
Whilst it's true that mostly, term sheets are non-binding agreements, there may be clauses that are legally binding. Clauses such as confidentiality or exclusivity periods may be binding, and so you should always read the fine print!
The term sheet is a concise document that usually spans 4-5 pages, outlining the key terms and details of an investment. Unlike the extensive legal contracts and investment documents that follow, the term sheet is accessible and digestible, making it a powerful tool for negotiations.
The structure of a term sheet varies depending on the parties involved, but they generally share some common elements:
The basics:
Investor rights
Share terms
Founder protections
It may then mention any legal aspects (confidentiality and exclusivity clauses), and also discuss a timeframe for the remainder of the investment journey.
Now you have agreed on the term sheet, and it has been signed by investors. But what steps will you take next?
Now, it's the investor’s turn to look into your finances, and will perform extensive due diligence checks on your company.
Investors will want to thoroughly examine your financials, business documents, product, and all the key components that make up your overall business model.
With InVestd Raise, you have access to your own secure data room, so the documents investors need can be accessed at the click of a button.
Once the term sheet has been agreed upon, it’s time to formalise those terms into a legally binding structure. No matter the approach you take, the finalised documents should align closely with the agreed term sheet.
These subsequent documents are typically more detailed, diving into the finer points of your investment terms.
Depending on your business, you may encounter documents like shareholder agreements, share subscription letters, Advanced Subscription Agreements (ASAs), and deeds of adherence.
Navigating these next steps can feel overwhelming, but Vestd are here to help you determine exactly which investment documents you’ll need and when.
All investment documents have been agreed upon and signed. The funds are then transferred - congratulations, you have secured your investment!
Now it's time to grow your business in the way you set out to do.
With InVestd Raise, you can simplify every step of your fundraising journey, so you’re able to focus on growing your business without the hassle of complex admin.
But exactly how does InVestd Raise help?
With all the tools and expert support you need to navigate fundraising smoothly—InVestd Raise makes securing investment easier than ever.
Ready to transform your fundraising experience? Book a call today and see how InVestd Raise can help you secure funding without the headaches
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