Probably one of the things I have found that many of my fellow angel investors enjoy even less than analyzing the financial model of a company they are contemplating investing in (see my last post ) is diving into the Term Sheet. A term sheet is a document that lays out the key terms of a proposed investment. Once those key terms have been negotiated and the term sheet is executed by both parties, it serves as the basis for drafting the other documents which comprise the legal closing documents in a transaction.
At a recent meeting, one of colleagues made the comment that term sheets are like country western songs – you know those soulful ballads that bemoan the difficult breakup, the secrets never shared, the soulmate you trusted who walked away and left behind a pile of debt…… When you make an angel investment you are not only entering into a financial transaction, you are entering into a relationship with the CEO/founders/management team. If you have been investing in this sector for awhile, it is likely you have made at least one investment that did not turn out as planned! Another way to think about the term sheet is a kind of “pre-nup” for angel investing. Clearly if you don’t really believe that a particular investment has the potential to be a good partnership over time, you probably shouldn’t make the investment.
Term sheets cover four main areas:
- Economics: What is the valuation of the investment you are contemplating, and how will the proceeds be distributed upon exit.
- Control: What are the voting provisions and what control can shareholders and Board members exercise over management
- Value Protection: What information is the company required to provide to investors. What are your rights when there is a follow-on round and what provisions are in place to protect you from a “down round”.
- Liquidity: What are the redemption provisions and how are you able to participate in sale of the company or an IPO.
Over the next few weeks, I will cover some of the specific provisions of term sheets that impact early stage investors. Also check out the sources referenced below.
Term Sheets and Valuations – A Line by Line Look at the Intricacies of Term Sheets and Valuations by author Alex Wilmerding – recommended by a colleague at Golden Seeds.