What You Need to Know About Term Sheets
[IMG]http://sseblog.wordpress.com/files/2009/09/term-sheet-sum-lg.jpg[/IMG]Whether your goal as a startup is to form a standalone company that will last for generations or one that will eventually be bought out by someone else for millions of dollars, a request for information about your purchase conditions can come up any time. Whether it's a venture capitalist or a behemoth corporation that's asking, they'll likely hand over a term sheet outlining a tentative offer based on your perceived valuation and a number of other factors that go into a potential offer.
A term sheet is a relatively informal document outlining the terms and conditions of a sale, not a letter of intent (LOI) to purchase. It serves as a bulleted list of points that both parties and their attorneys can refer to while creating a formal contract or LOI, if negotiations get that far.
Startups often find themselves in negotiations with venture capitalists who require a term sheet early on in the negotiation process. "The temptation for the entrepreneur is to focus mostly on the overall valuation of the transaction," says [URL="http://www.businessweek.com/smallbiz/content/aug2008/sb20080815_418048.htm"]Business Week's Tom Taulli[/URL]. "But this can be fatal. Keep in mind that a term sheet has a variety of protective clauses for the VC that can significantly reduce the valuation for the entrepreneur. As a result, it's imperative to have an experienced attorney negotiate a term sheet with you."
One of the most important points of a term sheet include a company's valuation, a potential sticking point that has the potential to stall negotiations very quickly as [URL="http://www.techcrunch.com/2009/05/19/facebook-turns-down-8-billion-valuation-term-sheet-claims-2009-revenues-to-be-550-million/"]recently happened to Facebook[/URL]. A term sheet will also include information about upfront and legal fees the startup will be expected to pay, as well as details about liquidation and dividend preferences.
To get a sense of what a term sheet might look like as it relates to your company, try plugging some data into this [URL="http://www.wsgr.com/wsgr/Display.aspx?SectionName=practice/termsheet.htm"]term sheet generator[/URL]. Although it's designed for informational purposes only, it provides a lot of insight into what types of details go into a term sheet and what kinds of things are typically omitted.
[I]Flickr image courtesy of [URL="http://www.flickr.com/photos/crystalflickr/2162700587/"]Crystal[/URL].[/I]