Venture Capital Term Sheet

A venture capital term sheet is the summary of deal terms a lead investor offers a startup before a priced equity round. It fixes the economics (how much is invested, at what valuation and for what class of shares) and the control terms (board seats, vetoes and information rights).

A common Canadian starting point is the model venture capital transaction documents of the Canadian Venture Capital and Private Equity Association (CVCA). They are Canadian versions of the US National Venture Capital Association (NVCA) forms, updated to track the NVCA's 2020 revisions. The CVCA term sheet groups each term under the document it will end up in:

• Articles of amendment creating the new class of preferred shares.
• A share purchase agreement, the investors' subscription agreement.
• An investors' rights agreement for information rights, pro rata rights and covenants.
• A voting agreement for board composition and the drag-along.
• A right of first refusal and co-sale agreement over shares of employees holding 1% or more.

Our guide to priced equity rounds vs. SAFEs explains how this differs from an earlier SAFE round.

Valuation and the option pool. The price per share is the agreed pre-money valuation divided by the fully diluted share count. Because the model counts the option pool in that count, the pool dilutes only the existing shareholders, and a bigger pool lowers their real pre-money value at the same headline number. Our pre-money vs. post-money valuation entry works through this option pool shuffle; the cap table shows whose percentage it reduces.

Converting instruments and the waterfall. SAFEs and notes usually convert at closing, and the SAFE and convertible note modeler shows their dilution. The liquidation preference and anti-dilution terms then decide who is paid what on a weak exit or after a down round.

Protective provisions are investor vetoes. In the CVCA model, while an agreed amount of the Class A Preferred remains outstanding, the company cannot take listed actions without the written consent of the Requisite Holders, a negotiated percentage of the preferred. The list covers:

• liquidating, dissolving or selling the company;
• amending the articles or by-laws, often limited to changes adverse to the preferred;
• issuing any security that does not rank junior to the preferred, or increasing the authorized preferred;
• redeeming shares or paying dividends, other than buying back departing employees' shares at cost;
• issuing digital tokens or cryptocurrency without board approval;
• creating debt above an agreed threshold; and
• holding shares in a subsidiary that is not wholly owned, or disposing of a subsidiary.

These sit on top of Ontario's Business Corporations Act (OBCA). Section 170 already gives each class a separate vote, by special resolution and even if its shares are otherwise non-voting, on amendments to the articles that change its rights. Protective provisions reach further, into decisions like borrowing that never touch the articles.

Other rights settled at this stage:

• Board seats. The voting agreement fixes who nominates each director, often including a Preferred Director whose approval is needed for listed board decisions.
• Information and pro rata rights. Major investors receive financial statements and budgets and can buy their share of future issuances, a contractual form of pre-emptive rights.
• Transfer and exit terms. A right of first refusal and co-sale right, and a drag-along requiring holders to support an approved sale.
• Founder and employee terms. Optional reverse vesting on founders' shares, options vesting 25% after one year and monthly for 36 months, IP assignments and one-year non-competes. Since October 25, 2021, section 67.2 of Ontario's Employment Standards Act, 2000 has made a non-compete with an employee void unless the employee is an executive, as that section defines it, or the sale-of-business exception applies; see our guide on whether non-competes are enforceable in Ontario.

The CVCA model draws the line in its opening paragraph. The no-shop and confidentiality provisions bind the company whether or not the financing closes. Nothing else binds until definitive agreements are signed, and the term sheet states that it is not a commitment to invest and is conditional on due diligence, qualifying the shares under securities laws, filing the articles of amendment and, if included, a legal opinion. The CVCA also notes that deal terms are often negotiated further before closing.

• No-shop. For a number of days the parties fill in, the company and the founders cannot solicit or encourage another offer for its shares, or for the company itself if the bracketed wording is kept, and must tell the investors about any approach.
• Confidentiality. The terms may be shared only with employees, shareholders, directors, advisers and other potential investors the lead investor accepts.
• Expiry and governing law. The offer lapses on a set date, and a named province's law governs.

Fee reimbursement is not on the binding list. The model has the company pay investor counsel's capped fees only if the round closes, so an investor who wants its fees covered on a failed deal must add that to the binding clauses. A letter of intent for a business acquisition draws the same line; our guide to LOIs, term sheets and purchase agreements compares the three documents.

1. Due diligence. Investors' counsel reviews the minute book, securities register, IP ownership, material contracts and every outstanding SAFE, note and option.
2. Definitive documents. Counsel (company counsel, in the CVCA default) drafts the share purchase agreement, articles of amendment and investor agreements.
3. Amending the articles. Creating the Class A Preferred amends the articles under section 168 of the OBCA, so the shareholders pass a special resolution, an affected existing class may also vote separately, and the corporation files articles of amendment, effective on the date in the certificate of amendment.
4. Issuing the shares. The shares need a prospectus exemption, usually the accredited investor exemption (in Ontario, section 73.3 of the Securities Act, with the conditions in section 2.3 of National Instrument 45-106) and a report on Form 45-106F1 filed within 10 days after the distribution. A qualifying company can use the private issuer exemption instead and file no report. At closing, SAFEs and notes convert, the board issues the shares, and the securities register and cap table are updated.

Lamba Law's startup financing practice reviews term sheets and runs these closings.

Yasmin Iqbal and Stefan Petrovic run a Markham construction-scheduling software company with $1.2 million in annual recurring revenue and $750,000 of SAFEs outstanding. A Toronto fund sends a CVCA-style term sheet: $3 million of Class A Preferred at a $12 million pre-money valuation, a 1x participating preference, a 12% unallocated option pool counted in the pre-money, two Preferred Directors on a five-person board and a 60-day no-shop.

Post-money is $15 million, so the fund will own 20%. The 12% pool is $1.8 million of post-money value taken entirely from existing holders, cutting their effective pre-money to $10.2 million.

Because the no-shop binds on signing, the founders negotiate first. The pool falls to 8%, lifting the effective pre-money to $10.8 million; the preference becomes 1x non-participating; the board becomes two founder nominees, one Preferred Director and one jointly approved independent; and the no-shop drops to 45 days. The fund keeps its protective provisions but raises the debt veto threshold to $500,000 so the company can use its bank line.

Diligence finds a former contractor who never assigned his code, and the company obtains an IP assignment before closing. The round closes in nine weeks, with a special resolution, articles of amendment and, under the accredited investor exemption, a Form 45-106F1 filed within 10 days.