The following link takes you to a free Word template download of a sensibly balanced and founder friendly term sheet that is particularly suitable for raising an equity investment round which will qualify for tax relief pursuant to the Seed Enterprise Investment Scheme (“SEIS”):
A term sheet (traditionally known as ‘heads of terms’ in the UK) reflects the preliminary terms of a deal that have been agreed between parties. They are agreed and signed as a kind of pre-commitment before an investor will begin due diligence and more definitive and comprehensive legal documentation is negotiated and executed. The term sheet should just cover the commercial deal in principle. Its not worth getting into too much detail as the fine print should be reserved for negotiating the final legal agreements.
The main reasons why any successful transaction should start off with a good term sheet can be found here. A term sheet is not normally intended to create a legally binding contract (except for terms like confidentiality), but you still need to be careful as it can be difficult to get the other party to budge on a point once it is in writing and your bargaining position will be affected.
For larger investments involving more professional investors, then angels or VCs will usually produce their own term sheet in the first instance, although you should always seek to negotiate on their preferred terms. However, for smaller SEIS level investment rounds investors will often ask the founders to send them their suggested term sheet. This gives entrepreneurs an opportunity to produce a more ‘founder friendly’ term sheet, while taking care it is sufficiently balanced so as to entice and not put off investors.
Pre money and post money
Generally, the investor will agree with the company on a valuation for the company prior to the investment round. This “pre-money” valuation is then used to determine the price per share to be paid by the investor on completion of their investment in the company. The price per share is obtained by dividing the “pre-money” valuation by the fully diluted number of shares of the company immediately prior to completion. For these purposes, the fully diluted share capital of the company will generally include shares that are issued, shares allocated to any employee option pool and any other shares that the company could be required to issue through options, warrants or other convertible debt instruments.
Share option pool
In early stage investments, if the company does not have an employee share option plan (“ESOP”), the investor may insist that one is created. The intention is that the company’s employees are incentivised by allowing them to share in the financial rewards resulting from the success of the company. Generally the investor will require that the company has between 10% and 20% of the share capital of the company to be reserved in an ESOP creating an option pool.
Most SEIS investors will now make it a condition of the deal that before completion the company first receives advance assurance from HM Revenue & Customs that the company is a qualifying company for the purposes of raising funding pursuant to SEIS. You can watch a helpful video of the application process here from Steve Livingston: