Equity Financing for Businesses: Term Sheets + Convertible and SAFE Notes
Learn about term sheets and equity financing when businesses are either pre-revenue or don’t have enough recurring revenue to inform evaluation.
What Are Term Sheets?
A term sheet is a document that outlines the basic terms and conditions of a priced equity route. It serves as a roadmap for negotiations and lays out the key elements that will be included in a final agreement.
It typically includes critical information, such as the amount of funding or investment, the valuation of the company or asset, the type of security or equity being offered, the rights and obligations of each party, and any conditions or contingencies that must be met before the agreement can be finalized.
Term sheets are usually nonbinding, meaning they do not create a legal obligation for either party to complete the transaction. However, a term sheet is vital for clarifying expectations and ensuring that both parties are on the same page before moving forward with a more formal agreement.
Once a term sheet has been agreed upon, the parties can move forward with due diligence in finalizing the transaction, using the term sheet as a guide for negotiating the finer details of the agreement.
How Pre-Revenue or Poor Revenue Affects Evaluation
So, what happens when businesses are either prerevenue or don’t have enough recurring revenue to inform evaluation? Investors or founders can suggest either convertible notes or SAFE notes.
Convertible notes are a type of short-term debt instrument that can be converted into equity in a company at a later date, usually upon the occurrence of a priced funding route. Startups commonly use them to raise capital during the early stages, as they allow for flexibility in terms of determining the valuation of the company at the time of investment.
SAFE — Simple Agreement for Future Equity — notes are a type of financial instrument also commonly used by startups to raise capital during the early stages. Similar to convertible notes, they’re structured as a loan, but instead of accruing interest and having a maturity date, they entitle the investor to a future equity stake in the company.
The conversion of the note typically occurs at certain events, such as a priced equity round or an acquisition.
Where to Find Convertible and SAFE Notes
You can find these documents in several online resources, including Y Combinator, a famous incubator. They provide a widely used SAFE document that’s free for download.
Legal platforms like Clerky or Gust Launch provide legal and financial support for startups, including access to legal documents and templates. Cooley and Goodwin Procter are startup-friendly law firms, where Cooley, in particular, offers Cooley Go — a website that provides legal resources and templates for startups.
In summary, equity financing is an excellent option for businesses looking to fund growth and expansion. It is important to carefully consider the terms of the investment and ensure the valuation is fair and realistic. With the right approach, equity financing can provide the resources needed to take a business to its next growth stage.
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