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An investor term sheet and a shareholder agreement are both legal documents commonly used in the investment process of startups and businesses, but they serve different purposes. Here’s an overview of each, how they differ, and why they’re important.
Investor Term Sheet
Definition :
A term sheet is a non-binding agreement that outlines the basic terms and conditions of an investment deal between a startup and an investor. It serves as a blueprint for the final agreement and helps both parties ensure they are on the same page before moving forward.
Key Elements of a Term Sheet
Valuation: The pre-money and post-money valuation of the startup.
Investment Amount: How much the investor will invest.
Equity Ownership: Percentage of ownership the investor will receive in exchange for their investment.
Control Rights: Rights regarding decision-making power, board seats, and voting rights.
Liquidation Preference: Specifies the payout order in the event of a company sale or liquidation.
Anti-Dilution Rights: Protects investors from dilution if the company raises funds at a lower valuation in the future.
Exit Provisions: Conditions under which the investor can exit the investment
Purpose
• Outline key terms before drafting a detailed, binding contract.
• Clarify expectations on valuation, control, and ownership.
• Identify potential deal-breakers early in negotiations.
Binding Nature:
Most term sheets are non-binding, meaning they outline intent but are not legally enforceable. However, certain clauses, such as confidentiality or exclusivity, may be binding until a formal agreement is signed.
Shareholder Agreement
Definition :
A shareholder agreement is a binding legal document that governs the relationship between the shareholders of a company. It specifies the rights, obligations, and protections of each shareholder, including how the business is operated and managed.
Key Elements of a Shareholder Agreement
Shareholder Rights and Obligations: Defines voting rights, access to financial information, and responsibilities of each shareholder.
Board Composition and Decision Making: Details about board structure and authority, including how decisions are made and who has veto power.
Transfer of Shares: Conditions for transferring shares, including right of first refusal and buyback provisions.
Dividends: Defines if and how profits will be distributed among shareholders.
Exit Strategies: Outlines exit options, such as buyouts, sale of shares, or IPO conditions.
Dispute Resolution: Mechanisms for resolving disputes among shareholders, such as mediation or arbitration.
Purpose
• The shareholder agreement is designed to:
Define the relationship between shareholders and the company.
• Prevent disputes by providing clear guidelines on decision-making and operations.
• Protect minority shareholders by ensuring their rights are respected in decisions affecting the company.
Differences Between a Term Sheet and a Shareholder Agreement
Why Both Are Important
• The term sheet helps both parties understand and negotiate the basic terms of a deal without committing legally, allowing for revisions and negotiations.
• The shareholder agreement formalizes the ownership structure and rights after the investment is finalized, providing long-term governance for shareholders.
