Term Sheets: An Angel Investor's View

By Megan Maltby

 A term sheet is essentially a document that outlines the structure and conditions of an investment deal. It serves as a signal of the investor’s intent to provide financing and while non-binding, it often indicates that things are getting serious in the fundraising process. For the purposes of this post, I am not going to spend time explaining the structure and uses of a term sheet- that has been done before (see here, here, and here to start).

I want to focus this discussion on the angel investor’s view of a term sheet and the terms that are especially important for angels to consider. At FAN we negotiate the terms of each deal before our members ever see the company (this ensures quick financing and closing). Therefore, it is our responsibility to ensure that certain items are in place to protect our members’ interest and mitigate risk. I am going to break down those terms that we feel are most important for angels, and then provide a brief overview of how we approach the term sheet negotiation process.

Term

What is it?

Why is it important?

Price Protection/Anti-Dilution

The right of current shareholders to maintain their fractional ownership of a company by receiving a proportional number of shares of any future issue of common stock 

Protects investors' stake in the company in the case of a “down round.” Encourages the company to focus on growing value so that the provision never comes in to play.

Redemption

The right to demand under certain conditions that the company buys back its own shares from investors at a fixed price

This right protects investors in the event that an entrepreneur develops a “lifestyle” business, with no plans to exit and provide the investors with a return.

Right of First Refusal

Investors have the right to participate in future financings, and any changes to the capital structure will require the approval of a majority of investors in this round

The ROFR is designed to provide existing shareholders with priority rights to invest in future rounds and control which parties may own a significant number of shares in the company

Tag-Along Rights

Provides minority shareholders with the right to join a sales transaction- in the case that a majority shareholder sells their stake in the company

Ensures that a return can be provided to all of the shareholders- in particular it provides minority shareholders with the ability to capitalize on a deal put together by a larger shareholder

Board Creation

This condition usually requires the company to form a board within a specified time period, and may specify how the board is to be composed

Provides a mechanism for oversight/good governance

Information & Access Rights

Generally requires the company to cooperate with the investor in its due diligence work

Provides the investor with access to documents and information required to perform appropriate research and due diligence- thereby mitigating investor risk

While FAN’s main priority is to ensure investor rights are protected, the term sheet is always open for negotiation with the entrepreneur. As a result, our process typically works like this:

  • Begin with Standard FAN Term Sheet: includes those terms mentioned above.
  • Term Sheet is Customized: Details added such as valuation, share price, the ask etc.
  • Term Sheet is Issued: At FAN we issue term sheets only to those companies that we are very interested in funding. The due diligence is mostly complete and a determination has been made to move forward (Note that this differs according to the angel group/VC).
  • Review and Discussion: The entrepreneur reviews, and we then host a meeting or conference call where we answer the entrepreneur’s questions, explain terms more clearly, and allow for the entrepreneur to voice any concerns they have. It is a working process, whereby both parties are looking to protect their interests.
  • Term Sheet is Accepted/Denied: If accepted, the document is edited to reflect any changes agreed upon during the discussion and signed by both parties. Unfortunately, sometimes a deal will fall through because both parties could not agree to a compromised final term sheet. While FAN’s mandate is to protect the interests of our members- the angel investors- we endeavor to work with each entrepreneur individually to create a productive and supportive business partnership.

Interested in learning more? Our friends at the Angel Capital Association have a great archived webinar called “The Beginner’s Guide to Term Sheets”. Check it out HERE!