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What information does a venture capital term sheet contain, and can you negotiate the terms?

LegacyFinancing & Credit

When a venture firm decides it is interested in investing in your company, it will present you with a term sheet, which is essentially an offer letter. This document outlines the proposed terms and conditions of the investment. While a number of the provisions in the term sheet may be "standard" (your experienced venture capital lawyer can tell you which ones) the terms are absolutely negotiable. But as is the case with all negotiations, you will only make progress if you have some leverage.

If you have gotten to this point without a good lawyer, now is the time to hire an experienced one with a background in venture capital financings. A legal advocate will be invaluable in wading through the legal terms and conditions. In addition, a lawyer with venture capital experience will often have experience working both sides of the table, so you can get insight into the thought process from the investor's perspective.

A term sheet usually outlines the following:

  • The valuation of the company: The venture firm will place a valuation on your company that is based on, among other things, comparisons to other companies in the marketplace and recent transactions.
  • The amount and timing of the investment: It typically takes 30 to 45 days to complete due diligence and negotiate and finalize the investment documents. Note that venture investors in early stage companies may want to stage their investment, with an obligation to make installment contributions only if certain pre-designated milestones are met.
  • The form of the investment by the venture capital investors: Venture capital investors often prefer to invest in convertible preferred stock. This gives them a preference over common shareholders in dividends and upon a sale of the company, and gives them the option of converting into common stock if the company is successful.
  • Non-solicitation. Most venture capital investors will insist on a lock-up period at the term sheet stage where the investors have a period of time (usually 30 to 45 days) to finish their due diligence and make the investment. During this time the company would be prohibited from accepting an investment or acquisition proposal from any other party.
  • Protective Provisions. A typical term sheet will include a list of significant actions that can't be done without the venture capitalist's approval. These include issuing stock that has rights or preferences senior or equal to the stock the venture capitalist is buying and selling the company.
  • The number of directors the venture investors can elect: The venture investors will often want the right to appoint a designated number of directors to the company's Board.
  • Vesting of the founders' stock: Venture investors may insist that all or a portion of the stock owned or to be owned by the founders and key employees vest (i.e., become "earned") in stages over a period of continued employment with the company.
  • * Price-based anti-dilution protection in connection with future sales of the company's stock: The venture capital investors will probably ask for some form of price-based anti-dilution protection, such that the price for your company's stock will be reduced if the company does a subsequent financing at a lower price.
  • Pre-emptive rights of the investors to purchase any future stock issuances on a priority basis. This allows the venture investors to maintain their percentage ownership of the company.