Bringing an investor into a startup: what should the term sheet and investment agreement cover?

The term sheet organises the future transaction

A term sheet records the principal assumptions before detailed documents are prepared. It should cover the investment amount and form, valuation, post-round cap table, investor rights, governance, founder obligations, closing conditions and exit principles.

A term sheet may be largely non-binding, but that should never be assumed. Confidentiality, exclusivity, costs and governing-law clauses are often intended to bind the parties. The document should state the status of each part clearly.

Pre-money and post-money valuation affect founder dilution

Pre-money valuation is the value of the company before the investment; post-money valuation includes it. The distinction directly affects the equity percentage obtained by the investor.

The calculation must consider not only existing shares but also the planned employee option pool, options and other instruments that may convert into equity.

If the investor requires the option pool to be created before its investment, the economic cost is borne mainly by the existing shareholders. The term sheet should therefore define the denominator used for every percentage.

An investment does not always mean only new shares

Funds may be paid to the company in exchange for newly issued shares. Founders may also sell some of their existing shares to the investor, or both routes may be combined.

The amount financing the company must be separated from any amount paid to existing shareholders. The documents should also state how the new money may be used and whether a material budget change requires investor consent.

Liquidation preference determines payment priority

A liquidation preference may give the investor priority to receive an agreed amount on a company sale, liquidation or another defined event.

The clause should specify the triggering events, the preference multiple, whether the investor also participates in the remaining proceeds, how prior distributions are treated and what happens when the exit value is lower than expected.

Worked examples are essential. Founders may otherwise retain a high nominal percentage but receive a much smaller portion of the proceeds at a particular exit value.

Anti-dilution protects the investor in a down round

An anti-dilution clause can increase the investor’s economic entitlement if a later issue takes place at a lower price.

The protection depends on the formula and exceptions. Common carve-outs include employee incentive schemes, conversion of pre-agreed instruments and shares issued as consideration for an acquisition.

The documents should also establish who bears the economic effect and which corporate actions are required to implement the adjustment.

Reserved matters may give the investor a veto

An investor may seek consent rights over new issues, material debt, sales of key assets, changes in business, related-party transactions, budgets, management appointments and dividends.

The list should protect the investor without paralysing daily operations. Financial thresholds, response deadlines and an agreed consequence of silence can preserve that balance.

Founders may be subject to vesting

The investor may require founders to remain involved for a defined period. The documents can permit the repurchase of part of a founder’s shares if they leave before vesting is complete.

Departure for reasons outside the founder’s control should be distinguished from a breach or voluntary early exit. The consequences should be tied to precisely defined good-leaver and bad-leaver events.

Before the round, the company should also establish a clean chain of title to code, trade marks, domains, databases and other core intellectual property.

Exit rules should be agreed before the investment

The shareholders’ agreement may regulate rights of first refusal, tag-along, drag-along and the company-sale process.

Key points include the drag threshold, minimum sale terms, shareholder liability to the buyer, allocation of transaction costs, cooperation with due diligence and whether a partial sale may be required.

Well-designed exit rules reduce the risk of one shareholder blocking an attractive deal or being forced to accept disproportionate liability.