What’s in a term sheet? Understanding the key commercial agreement that sets up your capital raise

Knowing market practice and key documentation will strengthen your business and relationship with investors

Over the past decade, nothing has been more celebrated in the Australian start-up eco-system than a successful capital raise. Closing a funding round signifies both a validation of the founder’s vision, as well as a commitment of critical funds necessary to realise it. 

At the start of this journey is a term sheet – a non-binding document that establishes the specific conditions and arrangements of the investor’s commitment of capital. A key message we always try to get across to the founders that we act for is that the deal is done in the term sheet. While it is possible to walk back from positions in the long-form, legally binding documents, doing so will cost you time, money, and likely some goodwill with your investor.

Term sheets are filled with insider jargon and market practice. Investors will be highly familiar with the key concepts, but it can be overwhelming and a little intimidating for a first-time founder to navigate.

Here we demystify some of the common terminology used to help founders engage in term sheet discussions with confidence.

Do you get to sleep at night?

An increasing trend we have noticed in venture capital term sheet is founders giving warranties personally. Warranties are a series of statements about the company that the investor relies on when investing. If a statement is untrue, the investor can seek compensation. The question is, who do they seek compensation from? In Australia, it is unusual for founders to give personal warranties and any personal liability of the founders should be limited to a commercially reasonable level.

A final thought

A company’s capacity to negotiate the conditions in a term sheet is of course linked to bargaining power – ie, whether demand for the company’s equity gives it the ability to require certain terms and push back on others. It’s also linked to the style and approach of investors in their relationships with Founders and the monitoring of their portfolio companies. Either way, having a clear understanding of the fundamentals of your term sheet, the range of market practice, and the different levers that can be pulled can really help you understand your choices and strike a deal that sets your business – relationship with investors – on a course for success.

We are always happy to chat with founders approaching the fundraising process and give insights on what to expect. If you think that would help, get in touch.