Overview of the Term Sheet

At this point during the negotiation process the entrepreneur and investor discuss the major issues surrounding the transaction. The term sheet is the result of initial negotiation and agreement between the parties regarding the funding transaction. Term sheet negotiations begin once the investor and entrepreneur are serious about consummating an equity investment deal. The term sheet is not binding, as parties want to retain the ability to negotiate further or withdraw from the deal if market conditions change or due diligence reveals some previously unanticipated realities about the target business venture.

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The most common elements negotiated in the term sheet include:

• Business Valuation
• Resulting Capital Structure (E.g., Size of Option Pool)
• Type of Security (E.g., Preferred Convertible shares with Participation Rights and a Liquidation Preference)
• Conversion Rights
• Anti-Dilution Protection (and Carve Outs)
  • Broad and Narrow-based
  • Weighted-Average
  • Full Ratchet
• Preemptive Rights
• Redemption Rights
• Registration Rights
• Information Rights
• Voting Rights
• Dividend Rights
• Board Seats or Observer Rights

The parties often agreement to several binding provisions, including exclusivity and confidentiality of negotiations and responsibility for legal fees if the transaction is consummated. Investors want exclusivity in their negotiations and non-disclosure of the terms sheets in order to prevent a competitive situation for the funding deal. While the term sheet is generally not binding, these terms provide the foundation for the agreement. Once these terms are decided they are rarely changed at a later stage of the transaction. Each party then depends upon counsel in strategizing, negotiating, and finalizing these and other ancillary terms of the agreement.

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