Do We Have A Deal? Legal Expert Weighs In On Investor Term Sheets For Startups

It can be tempting to skip the term sheet and simply have your lawyer prepare the investment documents.

Aaron Sokoloff, Senior Associate at Procopio, Cory, Hargreaves & Savitch LLP; Source: Courtesy Photo
Aaron Sokoloff, Senior Associate at Procopio, Cory, Hargreaves & Savitch LLP; Source: Courtesy Photo

When a company appears to have an offer from a potential investor, it can be tempting to skip the term sheet and simply have your lawyer prepare the investment documents.

Although the term sheet can appear to be a “speed bump” on the way to getting a deal closed, it can also be an efficient way of clearing out issues and allowing the transaction to proceed efficiently, or identifying deal-breaking issues before too much time and money is invested.


Do you really have a deal?

You and the investor may appear to agree on the basic deal points (e.g. “investing $X at a valuation of $Y” or “investing in a convertible note for $X that converts at a cap $Y”), but you may be far apart on material business terms that you haven’t explicitly discussed.

This is particularly important to keep in mind in “seed” or angel deals, because there is more variation in what investors may consider standard or “market” terms when compared to venture capital deals.

The process of drafting a term sheet will force all parties to consider the full menu of key business terms. Thus, putting together a term sheet can help you figure out quickly whether there is a basic agreement or not, and isolate key business-level issues that need to be resolved.


Term sheets explained

While drafting and negotiating a term sheet involves some legal costs, it often saves money in the long run, because you can negotiate the key points in a short document (generally about 2 to 8 pages, depending on the deal).

By having your attorneys negotiate a few paragraphs of a term sheet, you can avoid having to pay them to negotiate pages and pages of definitive documents. 
Furthermore, if there is a fundamental disagreement that cannot be overcome, you will spend less time and money if you isolate this at the term sheet phase, rather than after a round of drafting and negotiation of the definitive documents.

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Even if all parties have discussed the business terms extensively, it still may be worth drafting a separate term sheet to memorialize the fundamental points.


The ’email’ term sheet

Often, deal terms will evolve over a series of emails, and the email thread may function as a sort of substitute term sheet. It’s easy to see why this occurs in practice, but using an email thread as a substitute for a term sheet can ultimately result in inefficiency and confusion, as it’s often unclear which parts of the thread reflect the final deal.

The parties may find themselves having to reconstruct an email conversation every time there is a new turn of the deal documents.

It can be a worthwhile investment to prepare a short term sheet to capture and summarize what was discussed over email, so as to confirm agreement and have a single reference point going forward.


When to skip the term sheet

Skipping the term sheet and going straight to definitive documents may work in situations where you are dealing with a friendly investor investing on simple terms, and there is a high level of confidence that the parties are in agreement on fundamental points, or if an existing investor is re-investing on terms that they are already familiar with.

There are also true emergency situations when a company literally does not have time for a preliminary document. 
However, in the majority of deals, it will make sense to start by coming to agreement on a term sheet, so as to put the rest of the transaction on a fast track to closing.

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This article has been edited and condensed.

Aaron Sokoloff, Senior Associate at Procopio, Cory, Hargreaves & Savitch LLP, counsels emerging growth companies and startups on corporate law, securities and financing (including venture and bridge financings), and mergers and acquisitions. Connect with @procopiolaw on Twitter.


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