12 June, 2023

When it comes to raising capital for your business, negotiating the terms of your fundraising is a critical step. A term sheet is a document that outlines the key terms and conditions of an investment, serving as a blueprint for the final investment agreement. Negotiating the term sheet is a crucial part of the fundraising process, as it sets the stage for the relationship between the company and its investors. Here are some key points to consider when negotiating your fundraising term sheet:

Valuation and Investment Amount

The valuation of your company and the amount of investment are central elements of the term sheet. Valuation determines the percentage of equity that the investor will receive in exchange for their investment. It's important to strike a balance between a fair valuation that reflects the company's potential and the investor's expectations. Negotiating the investment amount should also take into account the company's financial needs and growth plans.

Investor Rights and Control

The term sheet outlines the rights and control provisions that the investor will have in the company. These provisions may include board representation, voting rights, veto rights, and information rights. It's crucial to carefully review these provisions and ensure that they align with your long-term vision for the company. While investors will naturally seek a level of control to protect their investment, it's important to strike a balance that allows for the company's flexibility and decision-making autonomy.

Liquidation Preferences

Liquidation preferences determine how the proceeds from a sale or liquidation of the company are distributed among the investors and the founders. Negotiating liquidation preferences involves deciding whether investors have a preference over the founders in terms of recouping their investment. It's important to carefully consider the impact of different scenarios and prioritize a fair distribution of proceeds that aligns with the interests of both parties.

Raising Capital: Negotiating Your Fundraising Term Sheet

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Anti-Dilution Protection

Anti-dilution provisions protect investors from future dilution of their ownership stake in the company. These provisions come into play if the company raises additional capital at a lower valuation in the future. There are different types of anti-dilution protection, including full ratchet and weighted average. Negotiating anti-dilution provisions requires considering the potential impact on future fundraising rounds and the company's ability to attract new investors.

Exit Strategy

Your exit strategy will have an impact on the terms in the term sheet. These may include the rights of the investors in the event of an initial public offering (IPO) or acquisition, and some investors may insist on buyback options. Having a vision as to your likely exit strategy is important to align the investor's expectations with the company's long-term goals. It's also essential to have a clear understanding of the investor's desired timeline for exiting their investment and ensure it aligns with the company's growth trajectory.

Governing Law and Dispute Resolution

The term sheet should specify the governing law and dispute resolution mechanism for potential conflicts between the company and the investor. It's important to carefully consider the jurisdiction and applicable laws to ensure a fair and efficient resolution of disputes. Negotiating these provisions can help mitigate future disagreements and provide a framework for resolving conflicts in a mutually agreeable manner.

Milestones and Reporting

The term sheet may include milestones that the company is expected to achieve, as well as reporting requirements to keep the investor informed about the company's progress. Negotiating realistic milestones and reporting obligations is crucial to set clear expectations and foster a transparent relationship between the company and the investor, as well as to have certainty as to when an investor is obligated to invest additional funds.

In conclusion, negotiating your fundraising term sheet is a critical step in the capital-raising process. It's important to approach the negotiation with a clear understanding of your company's value, growth plans, and long-term vision. Collaborating with legal and financial advisors can provide valuable insights and guidance during the negotiation process. By carefully considering the various terms and provisions in the term sheet, you can work towards reaching a mutually beneficial agreement that sets the foundation for a successful investor-company partnership.

To learn more about best practices for negotiating a term sheet, join us on Wednesday, June 14th, for a webinar to learn how to negotiate the most important items in your Term Sheet—we'll cover everything described above, and more. Attendees will learn where to focus when negotiating a term sheet so they can protect their rights.

This webinar will be presented by Paul B. Johnson, Partner, Procopio. Paul helps entrepreneurs and their investors get companies formed, funded and sold, including initial formation of corporations and LLCs, negotiation of seed, early and mid-stage equity financings and buy and sell-side mergers and acquisitions. He is also adept at venture capital investments, public and private securities offering and compliance and general business counseling. Paul has also counseled some of San Diego’s most successful companies in Securities and Exchange Commission compliance and general corporate governance.

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