Venture capital heads of terms (term sheets)
A Term Sheet is a document which outlines the key financial and other terms of a proposed investment (see Key documentation). Investors use a Term Sheet as a basis for drafting the investment documents. With the exception of certain clauses – commonly those dealing with confidentiality, exclusivity and sometimes costs – provisions of a Term Sheet are not usually intended to be legally binding. In addition to being subject to negotiation of the legal documentation, a Term Sheet will usually contain certain conditions which need to be met before the investment is completed and these are known as conditions precedent.
If a company seeks to raise venture capital in the UK the principal documents needed for an
investment round are generally a Subscription Agreement, a Shareholders' or Investors' Rights Agreement (frequently these are combined into a single Subscription and Shareholders' Agreement or Investment Agreement and Articles of Association (see Key documentation). The provisions of a Term Sheet will be included in these documents.
The Subscription Agreement will usually contain details of the investment round, including number and class of shares subscribed for, payment terms and representations and warranties about the condition of the company. These representations and warranties will be qualified by a disclosure letter and supporting documents that specifically set out any issues that the founders believe the investors should know prior to the completion of the investment.
A Shareholders' or Investors' Rights Agreement will usually contain investor protections, including consent rights, rights to board representation and non-compete restrictions (see Key terms of the Investment Agreement). The provisions in this Agreement will hopefully be used as the basis for corresponding provisions on subsequent funding rounds. The Articles of Association will include the rights attaching to the various share classes, the procedures for the issue and transfer of shares and the holding of shareholder and board meetings (see the Key Terms of the Articles of Association).
Some of the protective provisions in the Shareholders' Agreement may instead be contained (or indeed) repeated in the Articles of Association. The decision to include terms in one or both of these documents may be jurisdiction-specific, based primarily on company law restrictions (e.g. some Continental European jurisdictions limit the rights that can be attached to clauses in the Articles of Association), enforceability concerns (the investor protections can be difficult to enforce in some Continental European jurisdictions) and confidentiality concerns (Articles of Association typically must be filed as a public document with a relevant company registry while the other investment documents can often be kept confidential).
A venture capital investment round is usually led by one venture capital firm. That firm will put together a syndicate either before or after the Term Sheet is agreed and then co-ordinate the syndicate until the round is completed. The syndicate will usually comprise some or all of the existing investors and some new ones, one of whom will typically lead the round.
Once agreed by all parties, lawyers use the Term Sheet as a basis for drafting the
investment documents. The more detailed the Term Sheet, hopefully the fewer the issues which will need to be agreed during the drafting process. The process can be complex and working with lawyers who are familiar with venture capital transactions is recommended in order to minimise both timeframe and costs.
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