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There are many critical issues that an entrepreneur needs to pay attention to when preparing a term sheet. One of critical issues that I would like to discuss here is the board structure and composition. The board of directors is responsible for hire & fire management and major financial and strategic decisions. Thus a term sheet should state clearly the structure of the board, the lists of decisions requiring board approval and the voting thresholds for taking action. Otherwise, later on there can be some conflicts about benefits and duties of board members.
I think pre-money valuation is not as important as what people think. If the investor has a strong background and connection in the industry that my startup is in, I am willing to offer more shares than the value calculated from pre-money valuation.
In my first startup, I and my co-founders negotiated the terms with our investor ourselves (without consulting anyone and none of us had any experiences about negotiating with investors). Later on, we found out that it was not a good strategy.
In the future, if I need to negotiate with investors, I will definitely get some advices in advance. I will talk with a lawyer to know which terms I should put in a term sheet and which terms I should avoid. However, I won’t let the lawyer negotiate directly with the investor, I think it will make the investor feel that I won’t respect him/her or I am suspicious about him/her. But before I sign the term sheet, I will definitely let my lawyer go through it.
In addition, I will also consult my friends who used to get funded from investors. I think it will be great to hear from people who went through this process.
According to me the most important section is the Valuation section. It is a combination of the company’s past and projected performance, and perceived value of the intellectual property. The valuation is a key figure, which will dictate how much capital you can expect to raise. It also dictates the size of the company’s pie, which is important when it comes to liquidation preferences.
The second important is Board of Directors. Investors would love to secure a board position so they can protect their investment. Personally, I would not like to give control of the board to investors.
The third important is Liquidation preferences. This is how the company’s pie eaten and by whom upon merger and acquisition. Investors will recoup their investment first and maybe even some multiple on top of this, and then shareholders will receive pay based on percent ownership in the company.
As an entrepreneur the most important element of the term sheet for me would be that the investors will definitely look for ways to exercise control. In other words, if protective provisions, board composition, and meetings are not aligned with my business objectives, then I’ve to very careful in signing the Term Sheet in order to avoid the negative consequences.
The compromise element would be to negotiate the outliers or unusual requests made by investors. For example, if investors are requesting some sort of fees or they want to have an audit of the firm, that would be acceptable and I can negotiate a deal on the fee and allow the firm to be audited.
At this moment, the least important element would be the “simultaneous deals”. I wouldn’t worry on that part, since I’ll not have a portfolio of businesses to start. But I would rate it differently, if I’ve a portfolio of products.
For me, as an entrepreneur, the Board Composition and Meetings sections is the most important element of the term sheet. They can effectively contemplate and change by their influence.
Besides, liquidation preference is also important provision as it may provides for favorable treatment of the investor if the company fails and is liquidated. Liquidation preference has a potentially huge impact on the payout to common stockholders, and should not be overlooked during negotiation.
