The journey from term sheet to long-form documents, i.e. shareholders’ agreement (“SHA”)
and articles of association (“Articles”), is a critical inflection point for companies (and
investors alike). What begins as a short summary of commercial intent ultimately crystallises
into lengthy binding terms that govern economic, control and exit rights for (potentially)
years to come.
This article unpacks some of the core elements found in venture capital term sheets,
considers their practical effects, and examines how they might be reflected in the long-form
investment documents.
At the outset, it is important to note that not all term sheet provisions carry the same legal
weight. Exclusivity, confidentiality, and allocation of costs are typically binding upon signing
of a term sheet. The commercial terms discussed below represent non-binding statements of
intent, conditional on due diligence, board and shareholder approvals, and execution of
long-form investment documents.
Liquidation Preferences
Liquidation preferences determine the order and amount that investors (preferred
shareholders) receive on an exit before distributions are made to ordinary shareholders. A
“1x non-participating” preference (which is most common) entitles investors to the higher of
their original investment or their pro-rata share of exit proceeds. A “1x participating”
preference allows investors to recover their investment first, then share remaining proceeds
pro-rata with ordinary shareholders (also known as “double-dipping”). It should be noted
that each preference multiple added to the liquidation preference stack will reduce the
proceeds ultimately available to the ordinary shareholders (i.e. founders and employees).
Anti-Dilution
Anti-dilution provisions protect the economic value of an investor’s shareholding if the
company raises a future round at lower valuation than what the investor invested at (also
known as a “down round”). The most common mechanism for achieving this is by issuing
“bonus shares” to the protected investors, thereby preserving (to an extent) their economic
position notwithstanding the down round. Various anti-dilution ratchet formulas can be
used, the most common (and the most founder-friendly) being the broad-based weighed
average formula.
Option Pool
The share option pool will either be established on a pre-money basis (diluting existing
shareholders only and therefore preferred by new investors) or a post-money basis (diluting
existing shareholders and new investor shareholders proportionately). Investors typically
require option pools to cover 12–18 months of future hires, comprising up to 10-15% of the
company’s fully diluted share capital. If the company has an existing option pool that is
insufficient, then the term sheet may specify a “top-up” to accommodate future hires.
Board Composition
Typically, lead investors have the right to appoint a director to the company’s board, while
non-lead investors will appoint board observers. It should be noted that whilst directors and
observers are entitled to receive the same board materials and may both attend and speak at
meetings, observers do not have voting rights on board matters. Crucially, directors are
subject to directors’ duties, while observers are not. A typical Series A board might comprise two founders, and one investor director. If an even number of directors are appointed to a board, a future deadlock can be avoided by appointing a chairperson with a casting vote (noting that an existing director may be appointed as chairperson, thereby effectively holding two votes).
Consent Rights
Investor consent rights (also known as “reserved matters”) require investor approval for
certain milestone company decisions. Typically, decisions that relate to ongoing
management of the company (e.g. hiring senior staff, taking on debt etc.) require the consent
of the investor-appointed director, while less frequent, more fundamental decisions (e.g.
issuing new shares, amending the Articles) will require approval from the investor in its
capacity as a shareholder. Take care to limit the breadth and depth of the reserved matters to
so that they provide sufficient control to the investor(s) without stifling management’s daily
running of the business.
Information Rights
Information rights grant investors access to regular management accounts, annual audited
financials, budgets, and a right of audit access. Such rights are typically limited to a handful
of “major investors” who might not necessarily have the right to be represented on the board.
Care should be taken to ensure that reporting obligations are not unduly burdensome for the
company and that adequate time is afforded for the preparation of the relevant
documentation.
Leaver Provisions
Leaver provisions govern what happens to a founder’s (or sometimes key employee’s) shares
when they leave the company. The number of shares that a leaver may retain (or receive
economic value for) depends on “when” and “why” they are departing. The “when” variable
turns on the fact that the leaver’s shares are subject to vesting over a specified period,
typically 4 years from the relevant investment. For example, at the 2-year mark, half of the
leaver’s shares will be “vested”, and the other half will be “unvested”. The “why” variable
turns on the reason for their departure. “Good leaver” status (departure due to death,
disability, termination without cause or any other reason that are not “Bad Leaver” reasons)
typically allows a leaver to retain their vested shares (and give up their unvested shares).
“Bad leaver” status (departure due to gross misconduct, termination for cause or breach of
non-compete/restrictive covenants and sometimes resignation) typically requires the leaver
to give up all their shares (vested and unvested).
Drag-Along
Drag-along rights enable a group of shareholders (typically a majority with investor consent)
to compel all other shareholders to sell their shares on the same terms, thereby preventing
minority shareholders from blocking an exit. Founders and investors may want to negotiate
control mechanisms to avoid being “dragged” into a “bad deal”, e.g. such that drag-along
provisions cannot be triggered within a certain period from an investment round or where
the exit share price is lower than a certain value.
Tag-Along
Tag-along rights serve to protect minority shareholders in a scenario where the majority
shareholders sell their shares without facilitating the same liquidity for the minority
shareholders (e.g. by not invoking the drag-along provisions). For example, if a third-party buyer is willing and able to purchase a majority of the shares in the company, the minority shareholders are able to “tag-along” and require the buyer to purchase all of the shares in the company.
Pre-Emption
Pre-emption rights give shareholders the right to subscribe for new shares or purchase
existing shares before they are offered to third-party investors/buyers. Take note that it is
common practice for only a handful of existing shareholders (e.g. major investors) to have
rights of pre-emption and that such rights may be waived without the consent of all such
major investors (e.g. by a majority of the major investors).
Other Key Takeaways
Navigating the journey from term sheet to completion can be treacherous. In-house teams
would benefit from having all or some of the following resources to hand when reviewing
term sheets and negotiating long-form documents:
- A term sheet mark-up guide (similar to this article) with negotiation notes, flagging
market, founder-favourable, and investor-favourable positions. - A capitalisation table (in Excel format) that models shareholdings on a fully diluted basis, liquidation preferences and dilution across funding rounds. There are many online resources for to help with this, or we at Bird & Bird LLP can also advise.
- A market standard set of investment documents to use as a benchmark when negotiating long-form documents. The BVCA model documents (revised in 2025) are available free of charge and serve as a reliable market-standard starting point for this.
If you would like to discuss any of the above topics in further detail (or anything term-sheet related that is not addressed in this article), please contact Albert Mennen (Albert.Mennen@twobirds.com) at Bird & Bird LLP, or any other member of the Bird & Bird LLP corporate team.
This article was written by Albert Mennen, Senior Associate at Bird & Bird
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