Whether seeking to obtain financing, negotiating the purchase of real property, or entering into a partnership, most small business owners will encounter term sheets at some point. In its most basic form, a term sheet is a non-binding document that sets forth the material terms and conditions of a business agreement. It then serves as a blueprint for drafting the final contract.
The Benefits of Term Sheets
When negotiating a complex business deal, a term sheet ensures that everyone is literally on the same page because key terms are outlined in bullet points. It also ensures that the parties have reached an understanding of at least the key elements involved in the deal before they spend additional time and resources to reach a formal legal agreement.
“…term sheets are often an essential part of securing financing…”
While the parties are generally not bound to the elements of the agreement laid out in the term sheet, there are often two aspects of the document that are specifically stated to be legally binding. For instance, term sheets may contain non-disclosure provisions that require the parties to keep the negotiations confidential. Term sheets may also contain exclusivity provisions that prevent the one or both parties from negotiating with other potential business partners for a specified period of time. The provisions are intended to prevent businesses from using the term sheet to negotiate a better deal with someone else.
The Role of Terms Sheets in Start-Up Funding
For new and growing businesses, term sheets are often an essential part of securing financing. Even though they are intended to be stripped down versions of the final agreement, term sheets can still be overwhelming for first-time entrepreneurs.
While the entire document should be carefully negotiated, below are some key provisions to watch out for when meeting with venture capital (VC) firms and other potential investors:
Valuation: Determining the price per share is clearly one of the most important terms. However, entrepreneurs should remember that a higher price is not always best. In some cases, agreeing to a slightly lower price can result in more favorable investment terms. In addition, start-ups should be cognizant of the impact a high valuation can have on successive rounds of financing.
Liquidation Preference: This provision determines the division of proceeds between shareholders (common and preferred) should the company be later liquidated via a sale, merger, etc. In essence, the liquidation preference dictates which parties get paid first and how much. Prior to agreeing to any liquidation preference, it is imperative to do the math to determine how much the venture capital funders and the company founders will receive under each scenario.
Vesting Schedules: Term sheets may be used to establish a vesting schedule for stock and/or options held by company management, employees, and even those held by founders. VC’s often seek to negotiate for the founders to re-vest their equity over time, it is important that all founders are on the same page in terms of stock allocation and vesting, i.e. monthly vesting over a period of years. Other issues to address include what happens if one of the founders leaves the company due to resignation, termination, or even death/incapacitation; in addition, there may be potential negative tax consequences to be considered in the event of re-vesting.
Board Structure: Board composition and structure is another key issue addressed in a term sheet with investors. While bringing in outsiders is often essential to growing a business, founders should be mindful of how this will impact the day-to-day operations of the business. Key issues to consider include the skill sets of board members, what decisions will require board approval, and voting procedures.
While term sheets can be headache-inducing for small business owners, experienced lawyers are well-versed in how to negotiate and document complex business transactions. Therefore, it is advisable to consult with experienced counsel early in the process rather than simply relying on your attorney to draft the final contract.
Dissolving Your Business: Essential Legal Steps to Protect Your Interests
If you’re considering closing your business, it’s crucial to understand that simply shutting your doors does not end your legal obligations. Unless you formally dissolve your business, it continues to exist in the eyes of the law—leaving you exposed to ongoing liabilities such as taxes, compliance violations, and potential lawsuits. Dissolving a business can seem […]
The Role of Corporate Restructuring in Mergers & Acquisitions
Contrary to what many people think, corporate restructuring isn’t all doom and gloom. Revamping a company’s organizational structure, corporate hierarchy, or operations procedures can help keep your business competitive. This is particularly true during challenging times. Corporate restructuring plays a critical role in modern business strategy. It helps companies adapt quickly to market changes. Following […]
Crypto Enforcement: A Former Prosecutor’s Warning to Criminals and the Public
Cryptocurrency intimidates most people. The reason is straightforward. People fear what they do not understand. When confusion sets in, the common reaction is either to ignore the subject entirely or to mistrust it. For years, that is exactly how most of the public and even many in law enforcement treated cryptocurrency. However, such apprehension changed […]
Understanding Chattel Paper: A Key Component in Secured Transactions
Using chattel paper to obtain a security interest in personal property is a powerful tool. It can ensure lenders have a legal claim on collateral ranging from inventory to intellectual property. To reduce risk and protect your legal rights, businesses and lenders should understand the legal framework. This framework governs the creation, sale, and enforcement […]
For years, digital assets operated in a legal gray area, a frontier where innovation outpaced the reach of regulators and law enforcement. In this early “Wild West” phase of finance, crypto startups thrived under minimal oversight. That era, however, is coming to an end. The importance of crypto compliance has become paramount as cryptocurrency has […]
Supreme Court and Title VII: Implications for Reverse Discrimination
Earlier this month, the U.S. Supreme Court issued a decision in Ames v. Ohio Department of Youth Services vitiating the so-called “background circumstances” test required by half of federal circuit courts.1 The background circumstances test required majority group plaintiffs pleading discrimination under Title VII of the Civil Rights Act to meet a heightened pleading standard […]
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Sign up to get the latest from our attorneys!
Explore What Matters Most to You.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!
