Putting together a term sheet when raising money for your capital is a very important issue because you start a trend that leads to how you’re going to raise your money and how somebody thinks about you. Very often when you are dealing with various investors or investment groups or venture capital groups, what happens is they give you their sample term sheet which will state exactly what they want. You have to look very carefully when they do this to ensure the terms they have offered you are fair. You should talk to as many people as you can if you haven’t dealt with a term sheet before to make sure you can adjust those terms.
If you are drafting the term sheet, there are four key elements that you put into it. Do not get confused- a term sheet is not a sales tool. This sheet is intended to show how you are expected to put your money into the company. If you give someone a bad term sheet, it can kill a deal. If you give them a term sheet that has lots of open issues on it, it can leave those issues open for them to resolve rather than you. The key issues on a term sheet revolve around whether or not your investors know your business. However in terms of compensation, you’ll want to show as little as possible for the principles but enough for survival. If you do more than that, warn your investors ahead of time because a lot of the time it can turn them away.
The second element to a term sheet is your cap-table. This is how much stock each person owns. You want to make sure that the key people own enough stock to make it valuable. As a part of your cap-table, make sure to leave room for additional people to be added to the team. This is around 20% for most companies. When you are putting together the cap table, let people know you intend to bring in more management and you have stock available for them. It lowers the amount of stock you have for yourself, but it shows the investors that you know that is going to happen.
The third part of the terms sheet is how much valuation you are going to ask. Remember, if your beginning valuation is very low, by the time you raise all of the money you need, you aren’t going to own very much of your company. You want your valuation to be as high as possible.
The final piece is seeing if you can find term sheets your investors have done before. This will help you understand what they need and what they want. Look on the internet for deals they have done and take that into consideration when you are drafting a document that is asking them for money. Make sure that when you do your terms sheet, other people, who know what they are doing, look at it so that when you present it, it is not going to turn away investors, but rather rope them in. If your investors aren’t experienced, you have to do a very simple, careful term sheet that really explains to them what your business is. This will be very different than the type of term sheet you will draw for experienced investors or investment groups or venture capital groups.