What is a Term Sheet?
A Term Sheet summarises the key terms of a proposed equity investment by a Subscriber in a Company. It is often the first formal document exchanged between a social enterprise seeking capital and an investor willing to provide it - though a Confidentiality Agreement will usually have been signed at an earlier stage.
It generally records what the parties have agreed in principle, such as the amount of the investment, the price paid for shares, the governance structure, and any conditions that need to be satisfied before the deal completes.
Why is this important?
A Term Sheet may serve several purposes:
- Alignment: it ensures both parties are on the same page about the fundamental commercial terms before incurring the cost of preparing detailed legal documents.
- Efficiency: it provides instructions to the lawyers drafting the Subscription Agreement and Shareholders Agreement, reducing the scope for disagreement at the documentation stage.
- Commitment signal: although most of the Term Sheet is non-binding, signing it demonstrates a serious intention to proceed with the transaction to give the parties confidence to expend time and resources into undertaking more detailed due diligence.
- Protection: certain provisions of the Term Sheet - confidentiality, costs, governing law and media - are binding from the moment of signing, so that both parties are protected while the transaction is being negotiated.
- Leverage: the Term Sheet stage is often the point in the process where the social enterprise has the greatest opportunity to shape the commercial terms of the deal. Commercial terms not addressed at the Term Sheet stage can be more difficult to introduce once formal drafting begins, particularly where long-form documents are prepared on the investor's standard forms. If a particular term is important to your organisation, it is advisable to raise it at the Term Sheet stage rather than during documentation.
How does the Term Sheet relate to the other Toolkit documents?
In practice, the equity investment process for a social enterprise typically follows this sequence:
- Confidentiality agreement: before substantive discussions take place, the Company and the prospective investor will usually enter into a confidentiality agreement to protect commercially sensitive information shared during initial discussions and due diligence.
- Term Sheet (this template): once both parties are satisfied there is genuine interest in proceeding (ordinarily after conducting high-level due diligence), they negotiate and sign a non-binding Term Sheet recording the key commercial terms agreed in principle. The Term Sheet includes a binding confidentiality clause, which reinforces and may supplement the standalone confidentiality agreement.
- Due diligence: the investor undertakes comprehensive due diligence of the Company, such as verifying financials, legal contracts, intellectual property, operations and impact credentials. The confidentiality protections in both the standalone confidentiality agreement and the Term Sheet govern the investor's use and disclosure of information received during this process.
- Transaction documents: if due diligence is satisfactory and the conditions precedent are met, the parties prepare and execute the formal legal documents: a Subscription Agreement to give effect to the share issue, and a Shareholders Agreement governing the ongoing relationship between all shareholders after completion.
Who are the parties to the Term Sheet?
The parties are the Company (the social enterprise seeking investment) and the Subscriber (the investor).
The party referred to as the "Subscriber" in the Term Sheet is referred to as the "Subscriber" in the Subscription Agreement and will become a "Shareholder" under the Shareholders Agreement upon completion.
The template is drafted for a single subscriber. If there are multiple investors participating in the same round, the Term Sheet should be amended to reflect each subscriber's investment amount, shareholding percentage, and any differences in rights between them.
Is the Term Sheet legally binding?
Which parts are binding and which are not?
With the exception of certain specified provisions, the remainder of the Term Sheet is intended to be non-binding and indicative, and is not intended to create any legal relationship or binding contract between the parties. The provisions on governing law, costs, confidentiality, and media are legally binding and enforceable from the moment of signing.
Why is most of the Term Sheet non-binding?
This is standard market practice. The purpose of the Term Sheet is typically to record the parties' agreement in principle, rather than to create a binding obligation to complete the transaction. If due diligence reveals a material problem, or if the parties cannot agree on the detailed documentation, it is generally intended that either party may withdraw from the transaction without legal liability, subject to the binding obligations around confidentiality, costs, governing law and media. Parties should seek legal advice on their specific circumstances.
What does this mean in practice?
It is intended that, until the Subscription Agreement is formally executed, neither party is legally obligated to complete the investment. As drafted, the Term Sheet provides that no undertaking or representation will arise concerning the proposed transaction as a result of the subscriber undertaking due diligence, negotiations between the parties, or any action or inaction by a party on the assumption or expectation that the Subscription Agreement will be executed. Parties should seek legal advice to confirm this is effective in their jurisdiction and circumstances.
No undertaking or representation
This provision is intended to reinforce the non-binding nature of the Term Sheet by making clear that none of the ordinary steps of getting a deal done, conducting due diligence, negotiating the documents, or simply proceeding on the assumption that the deal will close, is intended to create any legal commitment on its own. Parties should obtain legal advice on whether this position is effective in their specific circumstances.
The investment
What is the investment?
As contemplated by the template, the subscriber will invest a specified dollar amount (the Subscription Price) for a specified number of ordinary shares in the Company, representing a specified percentage of the issued share capital of the Company.
The Subscription Price ÷ number of Subscription Shares equals the price per share, and the pre-money valuation + Subscription Price equals the post-money valuation.
What class of shares will be issued?
The template contemplates the issue of ordinary shares only. In many investment transactions, investors subscribe for preference shares carrying additional rights (such as a liquidation preference, anti-dilution protections, conversion rights, or preferential dividends). If the Company proposes to issue preference shares, the Term Sheet, Subscription Agreement and Shareholders Agreement will all need to be amended. Legal advice should be sought if preference shares or multiple share classes are relevant.
How is the Subscription Price determined?
The Term Sheet does not prescribe a valuation methodology; it simply records the agreed price. In practice, the Subscription Price will reflect the pre-money valuation agreed between the parties. For early-stage social enterprises, valuation can be complex and is often based on a combination of revenue forecasts, comparable transactions, and the social impact potential of the business. Parties should seek financial and legal advice on appropriate valuation methods for their specific circumstances.
Conditions precedent
Conditions precedent are the matters that must be satisfied (or waived) before the investment can complete.
As drafted, these may include items such as maintenance of social enterprise certification, satisfactory due diligence, no material adverse change, execution of the Subscription Agreement and Shareholders Agreement, and any required approvals. The parties should discuss and agree what conditions are appropriate for their specific transaction.
Due diligence
While it is common for the parties to undertake high-level due diligence so as to arrive at an in-principle agreement to enter into the Term Sheet, entry into the Subscription Agreement is typically subject to the Subscriber undertaking more comprehensive due diligence on the Company's business, finances, legal standing, operations and impact credentials before committing to the investment.
The template suggests a period of up to four weeks. This is a starting point, more complex transactions may require longer, while simpler transaction may require less. Parties should agree a realistic timeframe at the outset, having regard to the size and complexity of the Company's business.
Use of funds and the social mission
How must the investment funds be used?
The Subscription Price is required to be used for the agreed purpose and in line with the Company's Mission. The template also contemplates that the Company will report back on how the funds are used. This is intended to help ensure the investment is applied towards the Company's social aims, rather than on unrelated activities.
How are distributions limited?
Where the Company holds or is seeking social enterprise certification, dividends may be subject to a cap so that the total dividends declared in any period must not exceed the verified public benefit created by the Company over that same period. Parties should check the exact limits under the relevant certification framework and obtain legal advice as needed.
Governance and reserved matters
What governance rights does the investor get?
A shareholder holding more than 20% of the shares on issue will be entitled to appoint one director to the Board in accordance with the Shareholders Agreement. Critical business decisions (as set out in the Shareholders Agreement) will require approval by a Required Resolution of the Board.
The 20% threshold is a starting point and can be customised. It limits board appointment rights to significant investors. A lower threshold (for example 10%) would extend the right to smaller investors.
What are reserved matters?
Reserved matters are decisions so important they cannot be made by the Board or management alone. The Shareholders Agreement provides that critical business decisions may not be made without the requisite approval:
- Required Resolution of the Board (Part A matters): a resolution that needs approval from the majority of directors, but must also be agreed to by any major Shareholder Director. In practice, this gives any major Shareholder Director an effective veto over those key decisions.
- Special Resolution of shareholders (Part B matters): a resolution passed by shareholders holding 75% or more of the shares on issue. These matters require direct shareholder approval because they are generally considered so fundamental that board approval alone may not be sufficient.
The split between Part A and Part B matters, and the precise list in each, should be reviewed for each transaction.
Drag along and tag along rights
What are these rights, in plain terms?
Drag along and tag along rights both deal with what happens on a future sale of the Company, but they protect different people and pull in opposite directions:
- Drag along (a right of the majority): lets majority shareholders force minority shareholders to sell their shares as part of a full company sale, so a small holdout cannot block the deal and the buyer can acquire 100%.
- Tag along (a right of the minority): lets minority shareholders join where the majority shareholders wish to sell, allowing the minority to sell their shares on the same terms and not be left behind with a new owner they didn't choose.
How the thresholds in the template work
The template sets two separate percentage thresholds:
- 75% drag threshold: the drag along right can be exercised by shareholders holding at least 75% of the shares. A shareholder holding less than 25% may be required to sell if holders of 75% or more decide to sell the Company.
- 50% tag threshold: the shareholder's tag along right is only activated if 50% or more of the share capital is being sold. The minority can insist on being included once a sale reaches a change-of-control scale, but not for smaller sales below that level.
Both thresholds are starting points. Parties should choose thresholds that reflect the balance agreed between deal certainty for the majority and protection for the minority.
Why these are agreed at the Term Sheet stage
Drag and tag rights can significantly affect a shareholder's exit and the control of any future sale, so they are commercially important to both sides. Recording the headline thresholds in the Term Sheet ensures the parties are aligned on these points before the detailed drafting begins.
Warranties
What warranties does the Company give?
The Company will give customary warranties to the Subscriber, which are contained in Schedule 3 of the Subscription Agreement. These broadly confirm that the shares will be issued fully paid and free of encumbrances, that the Company has authority to enter into the deal, that no insolvency event has occurred, and that the business has been conducted in compliance with applicable laws. The parties may agree to include additional warranties specific to the Company's business or circumstances.
What are warranty qualifications and limitations?
The Company's warranties will typically be subject to standard limits, caps on how much can be claimed (often up to the Subscription Price), time limits for bringing claims, and minimum thresholds before a claim can be made. These protections are intended to help prevent disproportionate liability and are usually worked through in detail in the Subscription Agreement.
What warranties does the subscriber give?
The subscriber will be required to give customary warranties for a transaction of this nature. The subscriber's warranty about its status under the Corporations Act is important, it confirms that the subscriber is a "sophisticated" or "professional" investor (or is otherwise exempt from the disclosure requirements), which would generally mean the Company does not need to prepare a prospectus or product disclosure statement for the share issue.
Expiry
The Term Sheet includes an expiry date so that, if the transaction has not progressed to execution of the Subscription Agreement by the expiry date, the Term Sheet is intended to lapse and neither party is intended to have any further obligation (other than under the binding provisions, which continue to apply).
Parties should agree a realistic expiry date having regard to the time required for due diligence and document preparation. Expiry periods of 30 to 90 days are common.
Confidentiality
Neither party may disclose confidential information about the proposed transaction or the Company, except in limited agreed circumstances, for example, to professional advisers and employees on a need-to-know basis, for the purpose of negotiating the Subscription Agreement, or (in the subscriber's case) for the purpose of conducting due diligence.
This clause is binding from the moment the Term Sheet is signed and continues to protect both parties even if the transaction does not proceed. Where a standalone confidentiality agreement is already in place, check that the two operate consistently.
The post-completion capital structure
The Term Sheet attaches a pro forma capitalisation table (Schedule 1) showing the Company's share structure immediately after completion, who holds what, and in what proportions, once the new shares have been issued.
What does the Term Sheet deliberately not cover?
Some matters are not addressed in the Term Sheet but are dealt with in the Shareholders Agreement and/or the Subscription Agreement, including:
- Pre-emptive rights: on new issues and transfers.
- Default and its consequences.
- Dispute resolution procedures.
- Detailed information and reporting rights.
- Founder lock-up or vesting.
- Anti-dilution protections: relevant only if preference shares are issued; not addressed here as the transaction documents contemplate ordinary shares only.
- Non-competition or restraint provisions.
- Exclusivity: preventing the Company from engaging with other potential investors for a specified period.
If any of these matters are important to either party, they should be raised at the Term Sheet stage. Legal advice should be sought.
Download the template
The Term Sheet template is available to download below. Review with your legal adviser before use.