Signing a term sheet without consulting an attorney
This is the seventh post of Mistakes Founders Make, a series of blog posts that shine light on legal mistakes that startups commonly make and attorneys have to fix. Keep in mind that the post sacrifices detail for simplicity and is for informational purposes only. It should not be taken as advice — whether legal, tax, or other — and does not create an attorney-client relationship.
Just the basics
A startup signs a term sheet without consulting a knowledgeable attorney first. Although largely non-binding, the term sheet sets the tone for all the steps that follow up until closing — the deal documents must reflect and respect the terms in the term sheet. So, while your attorney still has some leeway in negotiating the documents, they’re confined to what you agreed to.
Medium, and I say this just because you can always walk away from the deal (probably not without damaging your reputation, depending on how far into the process you are). Assuming you decide not to walk away, then the problem can be pretty bad, depending on the actual terms you’ve agreed to and are bound by.
Make it a habit to have a quick check-in with competent startup counsel at significant points in your journey, especially before signing documents. Also, keep your legal documents complete and organized in one place – something Corpora can help you with.Talk with a knowledgeable attorney about your term sheet. A quick glance and a thirty minute call can go a long way in saving you fees, delays, and a headache.
What's a "term sheet"?
A term sheet usually comes up in a priced round, such as Series Seed. It lays out the main terms of the priced round, such as the amount of money being invested, the valuation at which the investment is made, the type of stock that will be issued, and legal terms such as investors’ rights and anti-dilution provisions. For context, a term sheet is normally 2-3 pages long for an early-stage round.
Why is it important?
The purpose of a term sheet is for the startup and the investor(s) to come to agreement on the high-level terms of the round before lawyers spend a whole lot of time drafting and negotiating the main transaction documents. It makes sure that everyone is on the same page as to the major terms of the deal.
Is the term sheet binding?
Normally, no, unless it explicitly says so. For example, the term sheet may block the startup from shopping around for better deals for a period after the term sheet is signed, commonly around 30-45 days.
If the term sheet is not binding, what's the big deal about it?
This is where the priced round journey begins. All the actions that come after the term sheet is signed must reflect and respect what’s written in the term sheet. As an unwritten rule, term sheets are not renegotiated after they’re signed. You live with what you’ve agreed to in the term sheet through the closing of the round… or you walk away from it. No doubt, you can attempt renegotiating it, but it bears a high risk of damaging your reputation… if not botching the deal altogether.
So, after the term sheet is signed, my attorney's hands are tied?
Yes and no.
Yes in the sense that the attorney cannot go against what’s explicitly stated in the term sheet. If you’ve agreed to “full ratchet” anti-dilution protection (why would you??), then your attorney cannot go ahead and provide broad-based weighted average anti-dilution protection in your restated charter.
However, the deal isn’t done just because the term sheet is signed. It’s not a straight line from term sheet to closing, which is why priced rounds sometimes take a couple months or more to close. For example, the term sheet can have broad wording, such as “customary protective provisions” — what that actually means will often be heavily negotiated between your and the investor’s counsel. These are pockets where your attorney still has wiggle room.
I might as well have someone knowledgeable take a look before I sign the term sheet, huh?
100%. With a quick glance, an astute attorney can help you understand what’s reasonable and acceptable and what are the red flags that must be pushed back on. Your attorney would actually be thankful to you for involving them early in the process.
Stepan Khzrtian is a corporate attorney with over 10 years of experience helping startups with their legal needs, including corporate formation, financing rounds, equity issuances, personnel matters, contracts, acquisitions, and intellectual property. His clients have ranged from pre-seed to pre-IPO companies. He is the co-founder and CEO of Corpora, Inc.