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People often compare the founder and investor relationship to a marriage- both parties have high expectations going in and expect it to last forever (or, admittedly less romantic, at least a long-ish term). The term sheet is the prenuptial agreement in the marriage analogy- with similar benefits of setting expectations for the relationship and establishing a defined process if the parties need to part ways.
Specifically, a term sheet is a document that provides a skeleton outline of the terms an investor and an entrepreneur’s company use to reach agreement on a financial investment in the company. Generally, the term sheet includes provisions related to funding, corporate governance, and liquidation events.
Negotiating a term sheet is one of the most critical parts of the equity investment process; it defines the expectations between the investors and company, and can make the ensure alignment on the more difficult issues that may arise over the course of the relationship.
In this article, we’ll discuss some of the issues that commonly arise from the entrepreneur’s objectives, the investor’s objectives, and how to best ensure alignment between the competing interests.
Often the most negotiated provision, valuation of the company is where the parties to a term sheet negotiation usually start. It is critical to get the valuation correct from the start, as it helps determine what portion of the company the founder retains and many other terms are ultimately dependent on it.
Valuation has many competing calculation methods that are subject to fierce debate, often depending on the stage of the company, development of any underlying technology, paying customers, users acquired, and other metrics specific to the industry and business model.
Once a valuation is established, the respective objectives of the entrepreneur and the investor have to be considered and are discussed further in the next sections.
As a founder, your motives and goals are typically the following:
When negotiating a term sheet as a founder, consider the investor’s motives and goals:
Investors can use different methods and tools to make sure that the interests of founders and key management are aligned with the investors’ goals for the corporation:
Throughout the negotiation process, each side rarely achieves all of their objectives. If there is limited capital, then the investor will have the upper hand with the company. If there are competitive term sheets on the table, then the entrepreneur will win important negotiation points from the investors.
Hopefully, you have developed an appreciation for the competing interests and objectives of both parties to the term sheet negotiations.
We stand ready to review your business needs and help you achieve your business objectives in consultation with your lawyer at Lloyd & Mousilli.
Considering the importance of investment into the growth of your company, the following are suggested references for your review: