First State Angels Fund: Terms Sheet is next step
by Sam Waltz
Creating “the terms sheet” that captures the important variables in a prospective capital-quality business transaction – an investment, a loan, an acquisition or sale, a merger – is one of the most important variables in “papering the deal,” prospective early-stage investors were told by the First State Angels Fund, a budding new Delaware early-stage investment group.
“The terms sheet is the “˜next step’ after the preliminary discussions, after expressions of interest in “˜doing a deal’ and after preliminary valuations,” Michael J. Kelley, founding partner of the ARC Angel Fund, told the new group, staffed by Pedro Moore of the Delaware Innovation Fund.
“Its purpose is to establish a framework for further documentation,” Kelley told the group in mid-July at the New Castle County Chamber offices. “Not that you have to have lawyers involved, but it sets the key economic terms and provides guidance to legal professionals when you get them involved.”
“The more detail in the terms sheet, the easier the work with the lawyers. You can get more done without spending the money on the lawyers,” he said.
But, while it may seem like terms sheets are a bit of a do-it-yourself project for smaller entities and investments, “as deals get larger, intermediaries play a larger role in helping negotiate the term sheet. Often the company will provide the term sheet,” Kelley added. RLS Associates, founded 1986 and headquartered in suburban Wilmington, is Delaware’s oldest and largest “intermediary” in such transactional work.
Nevertheless, none of that means that investors and enterprise founders are “off the hook” to be prepared to know the terms sheet. Among the topics that Kelley said the terms sheet may want to address are:
- Exceptions to its non-binding nature
- Corporate entity: e.g., corporation or LLC
- Financial instrument: common stock vs. preferred stock vs. convertible debt
- “Conversion discounts” for convertible debt, as well as payback provisions
- Confidentiality: who the Investor(s) can talk with about it
- Governance: any special provisions in a board role
- Valuation and the “cap table”
- Amount of the capital raise, and equity involved
- Preference(s) for a future raise, e.g., B round
- Information rights, e.g., access to ongoing business financials and details
- “Rights:” distinctions, if any, between “major investors” and “minor investors.”
Kelley discouraged the creation of what he called an “investment LLC,” that is, an entity vehicle created by a group of investors who pool their investment capital into a single ownership. “Creating the investment LLC just creates headaches, tax returns you have to file, paperwork, that someone has to administer it, and all that,” he said.
“The terms sheet is not a binding document, most of the time,” he added. Kelley sent the prospective investors to www.FELD.com/Archives/Category/Term-Sheet to learn more about preparing one.
Editor’s Note: Sam Waltz, who is a principal in his own firm Sam Waltz & Associates Strategic Capital & Business Counsel, has enjoyed an affiliation with RLS Associates for over a decade.