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How do you create a winning term sheet?

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A term sheet is a document that outlines the key terms and conditions of a proposed investment deal between a startup and a venture capital (VC) firm. It is not a legally binding contract, but rather a way to align expectations and negotiate the final agreement. A winning term sheet is one that balances the interests of both parties and reflects the value and potential of the startup. In this article, you will learn how to create a winning term sheet by following these six steps:

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Anuraag Guptaa

Board Member | Mentor-Investor | President & CEO | Listed Unicorn, Pre-IPO Soonicorns | Harvard Business School |…
Roshaan Narkedayy ↗?

Investments | Public Market | Growth Investor ??

1 Understand the basics

Before you start drafting a term sheet, you need to understand the basic elements and terminology that are commonly used in VC deals. These include the valuation, the amount and type of funding, the equity and dilution, the governance and control, the liquidation preferences, the vesting and employee incentives, the anti-dilution and preemptive rights, and the exit clauses. You also need to be familiar with the different types of term sheets, such as the convertible note, the SAFE, and the priced round, and how they differ in terms of risk and reward for both sides.

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Michael Deem

Managing Partner | Private Equity | Venture Capitalist | Life Sciences | AI
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The key points on your term sheet will be amount of raise, valuation, rights, preferences, restrictions, vesting, control, confidentiality, and conditions to close. The amount of raise is the money that you are seeking to fund your company. The valuation determines the fraction of your company that you will be selling. Vesting can come up in investor-friendly term sheets. And control will be determined by the rights and restrictions as well as the composition of the board of directors.

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2 Do your research

To create a winning term sheet, you need to do your homework and gather as much information as possible about the startup, the market, the competitors, and the investors. You need to conduct a thorough due diligence process to verify the facts and figures presented by the startup, and to identify any red flags or issues that might affect the deal. You also need to analyze the market size, growth, trends, and opportunities, and how the startup fits into the landscape. Moreover, you need to research the VC firm's track record, portfolio, strategy, and preferences, and how they match with your goals and vision.

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Michael Deem

Managing Partner | Private Equity | Venture Capitalist | Life Sciences | AI
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The valuation of the company should be roughly in line with current comparables. What have been the valuations in the last year of companies at roughly the same stage in the niche of this company? Whether the term sheet will be founder friendly or investor friendly depends on the VC firm, the market, competition for the deal, and stature of the founders.

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3 Negotiate the valuation

One of the most critical and contentious aspects of a term sheet is the valuation, which is the estimated worth of the startup based on various factors, such as the traction, the team, the product, the revenue, and the potential. The valuation determines how much equity the VC firm will get in exchange for their investment, and how much dilution the founders and existing shareholders will face. To negotiate a fair and realistic valuation, you need to use multiple methods and sources, such as comparables, multiples, discounted cash flow, and market approach, and be ready to justify your assumptions and expectations.

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Anuraag Guptaa

Board Member | Mentor-Investor | President & CEO | Listed Unicorn, Pre-IPO Soonicorns | Harvard Business School | MBA-NYU Stern, LSE, HEC | Author Igniting Minds with a Million Views | Incubating CEOs Gurukul
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Here are key insights: 1. Fair Valuation: Determine a fair valuation that reflects the startup's current standing and potential, while ensuring a good ROI. 2. Clear Terms: Spell out all terms clearly, including investment amount, equity stake, voting rights, and liquidation preferences. 3. Founder-Friendly Terms: While protecting your investment, avoid overly restrictive conditions that could stifle the founders’ motivation. 4. Flexibility for Future Funding: Structure the term sheet to accommodate future funding rounds without overly diluting existing stakeholders. 5. Milestones and Tranches: Consider linking funding to the achievement of specific milestones, offering protection to investors while motivating founders.

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4 Balance the terms

Another important aspect of a term sheet is the terms, which are the clauses and provisions that govern the relationship and rights of the startup and the VC firm. The terms can have a significant impact on the future outcomes and scenarios of the deal, such as the decision-making power, the distribution of returns, the protection from downside risk, and the exit options. To balance the terms, you need to prioritize the ones that matter most to you, and be willing to compromise on the ones that are less essential. You also need to understand the trade-offs and implications of each term, and how they affect the valuation and the alignment of interests.

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Anuraag Guptaa

Board Member | Mentor-Investor | President & CEO | Listed Unicorn, Pre-IPO Soonicorns | Harvard Business School | MBA-NYU Stern, LSE, HEC | Author Igniting Minds with a Million Views | Incubating CEOs Gurukul
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Continued... 6. Exit Strategy: Include reasonable terms regarding exit strategies, considering both IPO and acquisition scenarios. 7. Governance and Reporting: Outline governance structures and reporting requirements while providing empowerment and agility. 8. Alignment with Goals: Ensure that the term sheet aligns with the long-term goals of both the VC firm and the startup, fostering a partnership rather than just a financial transaction. 9. Legal Compliance: Ensure the term sheet adheres to all legal and regulatory requirements. 10. Negotiation Room: Be prepared to negotiate and make reasonable adjustments.

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Roshaan Narkedayy ↗?

Investments | Public Market | Growth Investor ??
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Use clear and straightforward language to avoid ambiguity. Ensure that the terms are easily understandable by all parties involved. Ambiguity can lead to misunderstandings down the line.

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Michael Deem

Managing Partner | Private Equity | Venture Capitalist | Life Sciences | AI
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What aspects are important to the founder? What aspects are customary or important to the VC firm? A good deal is where most of the terms that are important to both sides have been met.

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5 Review and revise

Once you have drafted a term sheet, you need to review and revise it carefully before presenting it to the other party. You need to check for any errors, inconsistencies, ambiguities, or gaps that might cause confusion or disputes later on. You also need to make sure that the term sheet is clear, concise, and comprehensive, and that it covers all the relevant and necessary aspects of the deal. You may want to consult with a lawyer, an accountant, or a mentor to get a second opinion and feedback on your term sheet, and to ensure that it complies with the legal and regulatory requirements.

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Michael Deem

Managing Partner | Private Equity | Venture Capitalist | Life Sciences | AI
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Most likely, there has been quite a bit of negotiation between the company and VC firm before a term sheet is presented. With experienced founders, the process can be quite efficient. Depending on the timing and competition for the deal, some revision of the term sheet might be necessary. With first time founders, it may take more time to bring the expectations of everybody into line with the market.

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6 Communicate and close

The final step of creating a winning term sheet is to communicate and close the deal with the other party. You need to present your term sheet in a professional and persuasive manner, and highlight the benefits and value proposition of your offer. You also need to be prepared to answer any questions, objections, or concerns that might arise, and to negotiate and resolve any differences or issues that might emerge. You need to be flexible and respectful, but also confident and assertive, and aim for a win-win outcome. Once you reach an agreement, you need to sign the term sheet and proceed to the next stage of the deal process, which is the legal documentation and closing.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Roshaan Narkedayy ↗?

Investments | Public Market | Growth Investor ??
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Outline the proposed exit strategy, including scenarios such as acquisition or initial public offering (IPO). Clarify the rights and obligations of both parties in the event of a liquidity event.

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How do you create a winning term sheet?

1

2

3

4

5

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7

1 Understand the basics

2 Do your research

3 Negotiate the valuation

4 Balance the terms

5 Review and revise

6 Communicate and close

7 Here’s what else to consider

Venture Capital

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How do you create a winning term sheet?

1

2

3

4

5

6

7

1 Understand the basics

2 Do your research

3 Negotiate the valuation

4 Balance the terms

5 Review and revise

6 Communicate and close

7 Here’s what else to consider

Venture Capital

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