The term sheet is the most important document that a founder may ever sign. It governs the key terms of a deal between a startup and its investors.
Yet many founders sign term sheets not knowing how the terms and stipulations measure up to other term sheets being issued in the market. That’s particularly important given that term sheets can be a founders’ downfall.
“There is a lot of information asymmetry on both sides when it comes to term sheets. When founders get a term sheet from a VC, it’s hard to know whether that term sheet is fair. I’ve found when negotiating deals that investors also sometimes think their house term sheet is ‘market’ but often there are areas and clauses where they are not leading to deals being lost,” says Glen Waters, founder and head of PwC Raise | Ventures.
PwC Raise, the arm of the professional services giant that works with startups and scaleups, has published one of only a few sources of data on what a ‘market’ — or ‘standard’ — term sheet looks like in Europe right now.
The team compiled data from 187 rounds from seed to Series C+ in 2020. The data covers deals with VCs, family offices, corporate VCs and EIS/VCT funds (UK schemes that encourage individuals to invest in private companies). The data doesn’t say what the 'best' term sheet is as that varies by investor and by company, but just what the most common terms are.
We’ve grouped things by some of the major clauses and areas that come up on a term sheet, with a brief explanation for each. Anyone looking for a good template, check this out from Y Combinator.
Valuation determines how valuable an investor, founder or employee’s stake in the business is and how much they get on exit. Investors talk about valuations in terms of pre- and post-money. Pre-money is the valuation before the new investment. Post-money is equal to the pre-money valuation plus the amount of the new investment.
71% of seed-stage deals had a pre-money valuation of less than £5m. The range of Series A pre-money valuations was more varied — 55% were in the range of £5 to £14.9m. 64% of Series B companies were in the range of £50m to £599m.
An option pool is a number of shares set aside to offer to future hires, and the survey showed that this was a feature in nearly all term sheets.
- 84% of term sheets created an option pool. It’s usually in the founders’ favour to calculate the pool post-money, meaning that new investors have to accept some dilution.
- In 46.5% of cases, the pool was created post-money, meaning the company and investors get equally diluted by the creation.
- In 45% of cases where the pool was created in the post-money valuation or a mixture of pre and post, the size of the pool was 10% or higher. Interestingly, option pools in the US tend to be much bigger, and this metric will be an interesting one to watch for clues about European founder appetites to give equity incentives, and operator incentives to take them over cash.
Downside protection for investors
Many times investors write in some sort of downside protection for themselves, and the PwC survey bore that out.
73% of term sheets had some form of preferred shares in the term sheet, which means those shareholders receive money back on investment before other investors or the founders.
Of those term sheets with some form of preferred shares, 71% were non-participating. This is usually seen as the most friendly for both founders and investors compared to participating preferred. We won’t go into the difference here, but there are many good explanations out there.
Of those term sheets with a non-participating preferred structure, 96.9% of them had a 1.0x liquidation multiple. This means if the company is sold or merged with another company, the preferred shareholders get back exactly the amount they invested before money is paid out to more junior shareholders. Founders obviously want the lowest possible multiple.
These clauses protect investors from dilution in case the company received investment at a lower investment the next round (a down round). But anti-dilution clauses can also be tricky if they involve founders giving up shares to investors to make sure their shares don’t get diluted.
- 43% of term sheets had anti-dilution clauses. That number was 63% for term sheets signed with VCs.
Board of directors
A term sheet usually includes stipulations about board structure and voting. VCs are incentivised to have a representative on the board (more sceptical writers might say it’s also an ego thing), while founders want to maintain balance between investor-friendly and founder-friendly members as the company scales. Some investors argue VCs should give their seats up to qualified, independent directors who can contribute more practical expertise and help diversify the board.
95% of deals included investor appointments to the board.
35% of term sheets gave the investor the right to appoint an investment director; and 40% gave the investor the right to appoint a non-voting, observer member in addition to the investment director.
69.5% of term sheets did not specify a minimum shareholding required for an investor to hold a board seat, making it easier for smaller investors — such as angels — to serve on the board.
These clauses let big shareholders or groups of shareholders ‘drag’ minority shareholders into a sale of the whole business.
95% of term sheets included a drag-along clause.