TERM SHEETS: 3 THINGS THAT YOU SHOULD PAY ATTENTION TO

You have been bootstrapping your start-up and finally believe it is time to get some investors on board, You get a chance to pitch your idea to some VCs/Angels and you nail it! By the time you are done with your pitch, they are mesmerized and all of them head over to you to give you their business cards and schedule a meeting on how they can fund you for a stake in your amazing business.

However, before the deal is done, the investor usually shares with you a Term Sheet which is a form of 'trailer' of your 'box office' agreement, and structures the investment. They want to know whether you accept the terms or not, do you?

Here are some key sections to look out for in the Term Sheet as a Founder;

1?Valuation

This clause describes how investors will assess the value of your business which in turn determines how much they invest in it. It is critical to take note of both the pre-money and post-money appraisals on the term sheet. While?pre-money valuation is the value of the company before the investment, post-money valuation is the sum of pre-money valuation and the investment received.

Depending on how "hot" your start-up is you may have the capacity to negotiate the terms of the Term Sheet or not, however, as a founder, it is important to try and make sure both your short-term and long-term interests are protected in the clauses.

This will involve ensuring there is balance and your company is properly valued to ensure your ownership is not diluted in the case of under-valuation or you are pressured to live by impossible expectations in the case of over-valuation.

1. Investor Rights

Investors use Term Sheets to protect themselves, which means unless you pay close attention to your interests you might end up short-changed as a founder. Investor rights vary depending on the type of business you are in and the type of investors you have, it is always a good idea to seek the guidance of a lawyer to ensure that you enter into a fair bargain.

For example, sometimes investors have anti-dilution rights which allows them to maintain the same ownership percentage in the business even when you issue new shares to other people - including future investors. Whereas this makes most investors feel safe and willing to invest in your start-up, it can also be limiting in terms of the quality and number of shares you can give fresh investors.

Another example is when investors insert the Right of first refusal (ROFR) clauses in the Term Sheet. This entitles them to get priority when you want to issue new shares before you can offer them to someone else. This can be very limiting because if they decide to buy all the shares that you issue, you may not have room to onboard new investors who may bring in fresh ideas and a fresh perspective to your business.

1. Redemption Rights

This clause should be flagged in any term sheet because it is a particularly dangerous one for startups.?Redemption rights?give investors the ability to demand that a company repurchase their shares at a pre-agreed-upon price within a set time frame. This is dangerous because if a start-up faces a rough financial patch within the agreed-upon time, investors can demand their money back and make it even harder for the startup to survive.

In conclusion, whereas getting investors interested in funding your start-up is exciting before you get the matching t-shirts to post on LinkedIn, take some time to carefully evaluate the terms of the investment against your short-term and long-term goals to ensure that you are not given a raw deal that you will regret later along the road.

The writer is a lawyer who specializes in offering legal services to people in technology, you can reach him through?[email protected]