I’ve received a term sheet. What do I do next?

Receiving a term sheet can be a very exciting time as a founder – you have your vision for your business and investors have shown interest in it.

However, once you have received a term sheet, now things get serious. Having operated the business ‘your way’ up until now, this could be the time when certain aspects of your business could change, and you become more accountable to others.

In this edition of Ask the Expert, we set out what you should do as a founder once you have received a term sheet from an investor.

Step 1: Fully understand every single aspect of the term sheet

Unless you are a trained lawyer or have participated in hundreds of investments, the best way to do this is to seek expert legal advice from a lawyer with substantial experience in investments. You might say 'well as a law firm, of course you will say that', but if we had 0.001 of a Bitcoin for every time a company/founders had signed up to a term sheet inadvertently agreeing to things they did not understand, we would have retired a long time ago.

The term sheet sets out the basis on which they investor wants to proceed. Term sheets often contain jargon, sweeping ‘umbrella’ terminology or phrases such as ‘terms usual for a transaction of this nature’, which leaves a substantial chasm between how an investor might interpret these things and how a professional investor might interpret them. You signing the term sheet sets the direction for momentum of the investor, their internal team, their advisors, lawyers and accountants. Once this momentum is set it becomes very difficult to ‘change the deal’.

If you take your signed term sheet to a lawyer, it is likely that you will only discover you have agreed to something you didn’t mean to agree to once long form legal documents have been prepared and are explained to you by your lawyer. This is quite a way down the track and after the investor has spent significant time and professional fees in gearing things up to the terms in the term sheet.

If you take your term sheet to a lawyer before it has been signed, then they can help you understand the terms and the impact of the terms on you, your fellow founders and existing stakeholders. This is the right time to negotiate key terms with a full understanding of what has been proposed and how it might impact you.

Your lawyer should also help you to understand what you need to do with regard to your existing shareholders/investors- how to approach them about the investment, what prior rights they might have over an incoming investor, and how best to deal with those rights.

We are very successful at helping founders achieve a ‘fairer’ deal, whether that is better vesting terms or a reduced set of investor protections.

You should definitely watch the movies 'The Social Network' and 'The Founder', which are both great stories of when things have gone wrong!

Common terms sought by investors:

• seeking shares which have preferential rights over ordinary shareholders;
• anti-dilution mechanisms which mean they need to be issued additional shares at future fundraising rounds so there shareholding (but not the founders’ shareholdings) is protected;
• liquidation preferences which give the investor priority to get some or all their money back before other shareholders;
• veto rights over key decisions by or in respect of the company;
• reverse vesting of founder’s shareholdings, which means they won’t get potential full value for the shares if they leave for any reason within, say, a 2-4 year period;
• warranties about the state of affairs of the company;
• indemnities about ‘issues’ which the investor might identify in due diligence investigations of your company after the term sheet is signed (hidden in the term sheet under a generic term like 'customary indemnities'), such as e.g., defective company records, missed or incorrect filings, no records of ownership of key assets or intellectual property etc).

Step 2: Sign the term sheet and strap in for the process

If you can reach agreement with the investor on the terms of the investment and theses are reflected in the terms sheet, then you sign the term sheet.

Following signing of the term sheet, the terms of the investment will need to be brought to life in comprehensive legal documentation. You will have agreed with the investor in the term sheetwhose lawyers will initiate the drafts, usually the investor will like to take control. There will be an investment agreement and a new set of articles of association, and perhaps a disclosure letter or schedule if you need to make disclosures in respect of the warranties the investor is seeking.

The comprehensive legal documentation will be subject to some degree of negotiation and you should definitely seek expert legal advice from a lawyer with substantial experience in investments. The term sheet is the key terms, and there are definitely nuances to every single term, and ‘customary’ terms are open to potentially very wide interpretation by the drafting lawyer!

At the same time as the legal documentation is being prepared, the investor will start undertaking detailed due diligence investigations into your company’s legal and financial affairs. This needs to be done in an organised and controlled way, under the watchful eye of your lawyer. You may be asked to warrant certain information, and certain information might be proprietary- the deal isn’t done yet and you wouldn’t want your ‘secret ingredient’ being jeopardised.

Your lawyers will also need to prepare corporate authorisation, resolutions, any required consents and waivers, and be prepared to issue share certificates and deal with filings at Companies House and where applicable HMRC.

The time to do all this needs to be considered. Expect the process to take up a lot of your time each day, whether that is consulting with the investor, organising information or discussing the legal documents with your lawyers. Do not underestimate the amount of your time that will need to be devoted to the process.

Typically, an investment round will take a minimum of 4 weeks from signing the term sheet stage to completion of the investment, although this is highly variable and we usually say to allow for at least 6 weeks.

Step 3: Closing

This is when all of the legal documents are signed by all parties, the monies are received and the new shares issued to the investors.

Your lawyers should handle all of the process of issue of the shares and filings with the various registries.

Then it is time to crack on, use the investment and take your business to the next level!

If you want to take a closer look at term sheets, including how they evolve over different stages of funding rounds, you can read more about them in our FAQ article.

What next?

We were founded to advise founders and small and medium sized businesses with aspirations of growth. We have advised hundreds of founder teams and this is a core part of our expertise. Receiving a term sheet can be exciting but also daunting, so don’t be afraid to ask for advice. Our corporate lawyers can advise you and help you to navigate your next steps when receiving a term sheet. Call us on 0800 689 1700 or fill out the short enquiry form below and a member of the team will be in contact shortly.