Before You Pitch That Idea, Understand Valuations: How To Read An Investment Term Sheet

A term sheet in simple terms is the agreement an organization gets from investors while seeking funding. In this booklet, the investors discuss their interest and what they are bringing to the table. The owner of the company must be keen to clearly understand what the investors are after to avoid settling for a raw deal.

As we all know not all help is purely for the advancement of the company’s vision. Thereby, it is advisable in case someone does not clearly understand the terms in a term sheet to ask for guidance from a legal officer who will explain details clearly.

As explained earlier, the term sheet has different terms used to refer to assets in an organization. Investors are mainly attracted to a company because of its assets. In a term sheet, the word valuation means the value of the company in general. It is the net worth of the company.

There two types of valuation done while seeking funding. The valuation before an investor funds an organization is called pre-money. Pre-money means the company’s value has not changed its valuation. Post-money is the value of the business after funding. That means that the value of a business increases when investors invest in it. Below is a description.

If the pre-money value of a business is Ksh. 20 million and the post-money value is Ksh.25 million, this shows that the investors have invested Ksh. 5 million into the company. In percentage, the investors own 20 percent of the shares the company has.

The key element in this part is understanding that the higher the pre-money value of a company as compared to the post-money value; the higher the percentage stock ownership of the company the founders get to keep.

If the investors get the higher share they get power to make high-impact decisions to the company which can either build or destroy the company. Hence while reading the valuations of the company an individual should manage to understand the value of the company he is in charge of even after funding.

Another crucial part to look into is the cost of each share while seeking funding. The cost of a share that the founders buy and the cost per share that investors buy should differ. This is an area that has conflict of interest since both parties are looking out for their benefits.

There should be an agreement drawn for the cost of each share that will resolve the issue in a just manner that does not favor either the investors or the founders.
The board should have people who are representing each group’s interest with the group that has the highest shares represented fully. The representation should be done fairly so that there is fair representation of interests.

Also, there should be an agreement on the cost of a pre-investment share and the post-investment share. In that, the company agrees on the cost per share after the investor has pumped in some money in the company.

Since the valuation of the company has gone higher, the shares will of course become expensive thus there should be an agreement on how the profits should be shared and the costing of each share for the parties interested in buying.

A founder should check out on terms and conditions of the investors shares. If the shares belonging to investors are open for sale or not. This is so as some investors lock their shares even when other investors are ready to invest in the company.

On the issue of who gets paid first, the founder should have an agreement with the investors since some investors choose preferred shares that empower them to always get paid first despite the risks posed to the company. The dividends should as well be clearly stated the rate at which they are awarded.

Some investors can seek to get dividends even while it is an expense to the company. Therefore, it is advisable for a founder to understand that part as well. There is always a pool of share set aside in case a company runs bankrupt it acts as the insulation for the employees. These shares should be indicated who or how they are going to be arrived at.

Generally, a term sheet is not always good news for the company seeking funding. A founder who is seeking funding should have knowledge in all areas in regard to funding that can make him have losses rather than profits. If one is not conversant with the information on funding as stated earlier, it is safe to seek legal help to avoid financial losses. However, people who are ready to champion the growth of any organization under acceptable terms are a perfect opportunity for any company to blossom and reach its full potential.