If the initial Due Diligence has gone well, the investor will put a term sheet on the table. The term sheet lays out the investor's terms for making an investment. Term sheets generally state that they are non- binding documents. In other words, nothing is official until you close the round by signing the formal, legal documents (see "Closing an Investment").
Try to get More than One
The objective is to get term sheets from multiple VCs, if you can (although one is always better than none!) If you get more than one, you have much more leverage to negotiate terms
More Reading
There are excellent blog posts on Term Sheets in our Tag Cloud
Example
In Downloads, (a subscriber area - read more) we've included a typical term sheet that you might receive from a venture capitalist. Here are the background assumptions (the same assumptions we used in the Capital Structure example):
- The pre-money valuation is $4 million
- The investment amount is $3 million
- The post-money valuation is $3 million plus $4 million, or a total of $7 million
- The investors will own three sevenths (3/7) or roughly 42.85714% of the stock (that's their $3 million investment divided by the $7 million total corporate value).
- The option pool was agreed to amount to 25%. That leaves 32.142857% for the founders.
- So the founders' 1 million shares represent 32.142857% of the company's stock, which (on paper, at least) implies a value of 32.142857% of $7 million dollars or $2.25 million.
- That means that the stock is priced at $2.25 per share (1 million shares divided into a value of $2.25 million)
- So a $3 million investment means the investors are purchasing 1,333,333 shares of stock ($2.25 times 1,333,333 is $3 million)
- The option pool is 25% of the stock, so that equals 777,778 shares
- To summarize, the "Cap Table" looks like the following:
- Common shares: 1,000,000
- Option pool: 777,778
- Series A Preferred: 1,333,333
- Total shares: 3,111,111