Checklist term sheet negotiations
Guidance / checklist for (pre) seed term sheet talks with potential investors, January 2013
This guidance /checklist might be of assistance for founders of startups engaged in talks with potential (pre) seed investors in the Netherlands. For that reason, this checklist contains in fact the items you will typically see in a (pre) seed stage term sheet in the Netherlands. Much of it is based upon fairly standard US templates, but clearly there are typical differences. The list could be made more specific once it has been decided whether it will be an equity or (convertible) loan financing.
It should be noted that most angel investors / VC’s work with templates they always work with and feel comfortable about and sometimes are (very) reluctant to discuss as a starting point another template. Simple reasons, their templates are approved by investment committees and they are better able to play with the various parameters/wording options they have in their templates. Discuss such process carefully.
Start with the soft part, who are they, where do they typically invest in, how / why current portfolio, how do they manage their portfolio companies, etc. The first more essential discussion normally is on value, pre/post money, scope of investment, type of instruments (shares, convertibles).
a. Do you want the investor to be lead investor?
b. Be careful with shopping around with an offers, it’s a small world.
c. Particularly at seed stage, equal terms for equal investors are common.
2. Structure of financing
a. What is the aggregate max you are looking for at a fully diluted pre-money / post-money valuation?
b. Any milestones conditions asked by investor?
c.Any (un)allocated employee share option scheme to be taken into account?
d. (Convertible) common / preferred shares or convertible loan notes?
3. Conditions to close
a. Make sure you agree on the exact conditions to close, such as due diligence (what, how,
when), IP transfers and consents required from investment committees of the investor.
4. Estimated Closing Date
It is better to agree to a workable estimated closing date rather than constantly setting a new one.
5. Type of shares / instruments
a. Investors (typically VC’s) will ask for preferred shares, senior to (common) shares issued (to Founders), more favourable anti-dilution rights, liquidation preferences, etc. In some cases, these classes of shares are required in order for the investors to execute any (preferred) rights.
b. If not necessary in terms of cash flow/financing, do not grant preferred rights, nor more favourable anti-dilution rights. Liquidation preferences in the Netherlands are getting more in use, but are still limited to 1x or 2x the invested amount. Angel investors typically do not ask for liquidation preferences, unlike VC’s, which is simply based upon the difference in invested amounts and business model.
6. Important decisions
a. Investors will ask for approval rights for important board and shareholders’ decisions.
b. Try to work with annual budgets and investment schemes to be approved instead of any single decision approvals above certain thresholds.
7. Information rights
a. Avoid spending too much time on specific information required by investors. Investors normally just want your monthly balance sheet / loss & profit / cash flow projections, and each quarter/half year a comparison to your budget. Discuss what they want and manage expectations of what is possible at this stage.
a. Sometimes preference shares will be in place, to be converted into common shares upon a IPO or other occasion.
b. In case of loan notes:
i. pre/post money valuations are made to calculate the conversion rate;
ii. it is common to agree to discount rates; such rate goes up the longer it takes to
close a ‘qualified’ financing round;
iii. liquidation / sale of company or other qualified financing triggers automatically the conversion;
iv. Interest, typically around 7-8 % per annum not payable, but to be calculated in the conversion;
v. What will be the maturity date, ultimate date, extension, to either repay or convert, if not yet automatically converted.
9. Sale of the Company / Exit strategy
a. Drag along, best practice is a joint right for Founders and Investors, alternatively allowing tag along rights.
b. What is their exit strategy, in terms of time, minimal value, IPO focus, etc?
c. Important, does the investor have access to funding for next stage financing, will they require specific (new) conditions and/or approvals?
10. Restrictive covenants/undertakings (Founders)
a. Non-competition, non-solicitation;
b. Lock up / vesting / reverse vesting: understandable, but do not chain yourself; typically around 3 years, but not more than 5.
c. If there is a forced transfer, try to avoid transfer against nominal value / discounts, etc. If that will be asked, always include an arbitration clause that allows to choose for net asset value for instance.
11. Board of Directors
a. Appointment rights for investors?
b. If so, limit representation rights, allow ‘joining’ rights.
a. Required by investors; do not agree or limit it if you raise seed capital from multiple investors, but allow them equal terms and agree not to shop around.
a. Investors typically will try to have the Founders or the Company pay for all expenses. Do not agree. Agree to each party paying their own expenses and only corporate documents for the Company.
a. Ask which documents investor will require. Typically will be Investment Agreement (SPA), Shareholders Agreement (or Convertible Loan Agreement) and most of the times a condition precedent will be new management agreements / employment agreements with Founders / key personnel. Discuss who prepares the drafts. The more professional the investor, the more likely they will want their lawyer’s to prepare the drafts. In that case: let them pay.
Keep the drafts and terms confidential. Do not shop around by sharing confidential proposals.
16. Legal effect
a. Term sheets are non-binding, except for exclusivity, costs, confidentiality, governing law, arbitration clause.
For more information, contact Dave Dirks, email@example.com or @dave_dirks, partner M&A, Venture Capital, Certa Legal
This checklist is for informational purposes only and does not constitute advertising, a solicitation, or legal advice. Review of or use of this checklist does not constitute formation of an attorney-client relationship. Certa Legal Advocaten B.V. disclaims all liability with regard to use of this sample checklist. Readers of this checklist should not rely upon this document without seeking legal advice.