

Term Sheets 101
November 23, 2020
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4 min read
Once an investment opportunity is analyzed, negotiations is an important next phase in many private M&A transactions. A term sheet is created precisely for this purpose. It contains the material terms and conditions of the agreement. Although the term sheet is non-binding in practice, it acts as a starting point for both parties to discuss and eventually, agree to. Here are the most important items of a term sheet:¹
¹Sources: US National Venture Capital Association, Harvard Business School

Type of Financing
Startup founders do not always offer common equity as the investment instrument for venture capital investors. Here are other widely-used instruments:
Notes and Other Credit Facilities are debt arrangements that guarantee payments based on a fixed interest rate, and which take precedence over equity. Convertible notes are a form of interest-bearing debt that allows the investor to convert the instrument into equity sometime in the future and upon satisfying predetermined and negotiated conditions.
Simple Agreement for Future Equity (SAFE) Notes allows for seed investments without interest rates or maturity dates. Like an option or warrant, it allows the investor to buy shares in a future round.
Preferred shares are a form of equity ownership with a fixed dividend rate. Deals of this kind typically specify participation and cumulative features. In early-stage financing, preferred shares usually come with a conversion feature into a fixed number of ordinary shares upon the fulfillment of certain conditions.

Valuation Matters
Valuation is an important consideration not only to fix the price, but for investors to determine their ownership interests after the investment.
Pre-Money Valuation is the monetary value of the company prior to investment. The most common methods used in startup valuation include (1) market multiples such as the standard earnings multiple method, (2) discounted cash flow, (3) cost-to-duplicate, and (4) comparables.
Post-Money Valuation, on the other hand, is the sum of the pre-money valuation and the amount invested. Thus, if a startup company has a pre-money value of $1,000,000 and it received investments of $250,000, then it
will have a post-money value of $1,250,000.
Other terminologies include up, down, and flat rounds, which are all used to compare the value of the current financing round relative to the previous round. For example, a flat round means that the shares issued at the current financing round are at the same valuation as the previous round.
