TERM SHEET AND SHAREHOLDERS AGREEMENT

A term sheet and a shareholders' agreement are both critical documents in the context of business financing and governance, particularly in startup environments. Each serves a specific purpose and plays a key role in defining the relationship between investors and company founders or shareholders.

Term Sheet

Definition:

A term sheet is a non-binding agreement setting forth the basic terms and conditions under which an investment will be made. It serves as a template to develop more detailed, legally binding documents.

Key Elements:

Valuation of the Company: It outlines the pre-money and post-money valuation.

Investment Amount: The total amount of money being invested.

Type of Security Offered: Such as common stock, preferred stock, or convertible notes.

Liquidation Preference: How the proceeds will be distributed in the event of a sale of the company.

Voting Rights: Specify any special voting rights attached to the investment.

Anti-dilution Provisions: Protects investors from dilution in future financing rounds.

Board Composition: Describes changes to the board of directors post-investment.

Dividend Policy: Terms regarding the payment of dividends to shareholders.

Drag-Along and Tag-Along Rights: Rights that protect majority and minority shareholders, respectively, in the sale of the company.

Employee Stock Options: Details about the stock options pool for employees.

Purpose:

The term sheet simplifies the process of investment by outlining key terms and conditions before drafting more complex documents. It is usually non-binding, except for certain provisions like confidentiality and exclusivity.

Shareholders' Agreement

Definition:

A shareholders' agreement is a legally binding contract that outlines the rights, responsibilities, liabilities, and obligations of shareholders within a company.

Shareholding Structure:

Details of the shares held by each shareholder.

Governance: How the company will be governed, including the appointment of directors and the conduct of board and shareholder meetings.

Rights and Obligations of Shareholders: Includes rights to dividends, rights to participate in company management, etc.

Pre-emptive Rights: Right of first refusal given to existing shareholders to buy new shares before the company offers them to external parties.

Transfer of Shares: Provisions regulating the sale or transfer of shares, including any restrictions on share transfers.

Dispute Resolution Mechanisms: Procedures for handling disputes among shareholders.

Exit Strategy: Provisions for the sale of the company or the sale of shares by individual shareholders.

Drag-Along and Tag-Along Rights: Similar to those in the term sheet but legally binding.

Confidentiality Clauses: Obligations of shareholders to keep certain information confidential.

Non-compete and Non-solicit Clauses: Restrictions on shareholders’ activities outside the company.

Purpose:

The shareholders' agreement is critical for the long-term governance and control of a company. It provides a framework for managing relationships among shareholders and outlines how critical decisions are made.

Differences and Importance

Stage: A term sheet is often drafted earlier in the investment process, usually when investors agree to fund a company. The shareholders' agreement is created later after the investment terms are thoroughly negotiated and agreed upon.

Legality: The term sheet is generally non-binding (except for specific clauses), while a shareholders' agreement is a binding contract.

Detail and Scope: Shareholders' agreements are typically more detailed and cover a broader range of issues than term sheets.

Both documents are essential in investment negotiations and the ongoing management of a company, providing clarity and legal grounding for the relationship between investors and the company.