Mod note: this is for equity/converts/preferred and not anything else.
According to Investopedia, a term sheet is defined as a non-binding agreement setting forth the basic terms and conditions under which an investment will be made. A term sheet is supposed to serve as a template upon which the legal documents are developed. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is then drawn up.
A term sheet consists of many specific details. However, the investors care the most about very specific conditions. This article talks about the four most important conditions that the Investors care about.
1.Liquidation preference:
This right details the order in which investors get paid in the event of liquidation such as the sale of a company, etc. Liquidation preference helps protect the venture capitalists from losing money by making sure they get their initial investments back before other parties. Venture Capitalists are usually repaid before holders of common stock and before the company’s original owners and employees.
2.Dilution rights:
Anti-dilution rights are included as a clause that protects an investor from a substantial reduction in percentage ownership in a company due to the issuance by the company of additional shares to other entities. Investors are very concerned about the extent of control in the company and what effects do each rights have on their ownership. Similarly, investors include anti-dilution rights in the term sheet to ensure protection for their ownership rights.
3. Conversion rights:
These rights usually govern the timing/nature of conversion to common stock. These rights give the investor the right to force a company to replace the investor’s preferred shares or the lender’s debt with common shares at a preset conversion ratio. These rights help the investors in exercising their control over the company’s capital structure.
4. Protective provisions:
Protective provisions let preferred shareholders veto certain actions, such as selling the company or raising capital. These rights protect the preferred, who are minority shareholders, from unfair actions by the common majority. Venture Capitalists always want to retain a minority shareholder but at the same time, they want to ensure that they retain a controlling share. These protective provisions help their objective.
It can be concluded that the investors care about themselves the most. The investors include clauses that ensure their protection from the future actions of the company’s actions and the company’s capital structure and at the same time, the investors want to retain a controlling vote in the company they invested in to ensure the success of the company.
You forgot the most important part - Returns to Investor.
@"CAinPE" I left that one out as it is only after discussing the returns do the investors move on to Term Sheets. It is given that the returns have already been discussed about and hence, I did not consider including it in this list.
Why has this been frontpaged...?
One of our bloggers and her last post did well, so we thought we'd give her a shot at home page at a low traffic time (4am est)...
We realize for some people this will seem very basic, but remember the audience just isn't you and it can serve as an informative quick reminder for college students or analysts that have hedge fund/VC or PE interviews coming up...or is there some other issue?
I only ask because a) it's quite a specific area and b) it looks like a copy past from Investopedia.
Please clarify this is for equity/converts/preferred and not anything else.
Term Sheets can be and are used for everything from that to unsecured debt to bank loans, DIP financing and outright restructurings. The post above only deals with a very small subset of these.
To learn more about VC Term Sheets I recommend following the Foundry Group / Brad Feld's Blog http://www.feld.com/wp/
@"BatMasterson" Thank you for the suggestion. It is a great link.
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