Term Sheet for Angel Investment/Pre-Series A
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Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies and investors. He has worked on 70+ convertible note financings as both investor and company counsel. The information on this page should not be construed as legal advice. |
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Convertible notes are the preferred instrument for early stage investments under $1 million. Companies are able to raise funds at a relatively low cost by deferring the negotiation and complexity of a priced round until a later time. Although convertible note transaction documents are simple enough that no term sheet may be required, they are often used to discuss the terms of the deal.
If used, a convertible note term sheet will usually contain the following terms:
A. Aggregate Amount of the Round
Investors may want to know certain terms of the round, including the maximum amount of notes that will be sold. Often times, important decisions like whether a note: (i) may be prepaid, (ii) amendments to the note or purchase agreement will be allowed, or (iii) investors will convert to equity upon a sale or at the maturity date (if conversion has not happened before the maturity date) are made by a majority in interest of the noteholders. Investors might want to know what portion of the overall interests they represent.
B. Interest
As a convertible note is a loan with the opportunity to convert to equity, normal terms of a loan apply, including the interest rate.
C. Discount Rate
Because convertible notes are designed to defer investment negotiations to a later stage, the noteholder which will receive the future instrument should receive something better than the future deal terms to account for their earlier investment. This is accomplished, in large part, by the discounted price that the noteholder's loan will convert to the equity being offered in the next round at.
D. Price Cap
Since an investor will own less of the company at conversion the higher the valuation of the company goes, there is usually a cap on the conversion price based on a valuation of the company. This essentially amounts to an agreement between the company and investor that if the company achieves a higher than expected pre-money valuation at the converting investment round, that the noteholder won't suffer from that success.
E. Maturity Date
The maturity date is the date which the loan becomes due. The maturity date in California could be influenced by the California Finance Lenders Law.
F. Optional Conversion Upon Maturity
Since a company that has not been able to raise money by the maturity date may not be in a position to repay the loan, and since it would be in the mutually bad interests of the investor and company to force repayment when the company is not able to repay, there are often times mechanics for what happens in this occurence. A common option is for an optional conversion by the noteholder to Common Stock.
G. Sale of the Company
Although rare, the company could be sold prior to reaching the maturity date or converting the note to equity. In such a case, the note should articulate what happens. In most cases, the note provides the option (either the noteholder's indivdual option or at the majority in interest of the noteholders) to elect repayment of the loan (principal amount + interest) or conversion to the company's Common Stock at a pre-set valuation. Sometimes the repayment option will have a premium (e.g., 1.5X repayment or conversion). Alternatively, there might be a premium multiple payout for a sale (e.g., if the company sells for >$5 million --> (principal + interest X 2); >$10 million --> (principal + interest X 3)...)