By Jacoline Loewen, EMDA Director and Director, Loewen & Partners Inc.
A term sheet is just a stepping stone towards an actual deal.
Exempt Market Dealers negotiating the term sheet with private
equity or venture capital (VC) investors need to alert business
owners that most investors will load term sheets with pre-conditions
to financing as well as escape clauses in their favour.
In rushing to the finishing line, clients must be made aware
of the potential bear traps with term sheets to be understood and
avoided. Here is a list to share with your client, the business owner:
The private equity investor will want to include the “no shop”
clause, which means that you cannot show the business to other
investors while this investor is humming and hawing whether to
buy in as partners.
The investor may justify keeping you on the hook, saying “All
of our partners need to see you.” Do not go for this justification;
find out the fund’s approval process.
Forty days of being exclusive to one fund is the longest
you need. Sixty days is too long to be out of the market looking
Some private equity investors say, “I want my legal fees paid,
even if I don’t get the deal closed.” This is not the norm and you
should push back against including this in the term sheet.
If they are included, there should be a cap on legal expenses
at a fixed amount. Do not leave the amount open-ended.
An investor should be kept motivated to close the deal if
they know they have limited time to have sole rights to examine
your business and that they must bear the costs of their own
You need to make sure that the results of due diligence are
confidential. The confidentiality clause protects the assets of
your company. It must apply to both parties and must protect
customer trade secrets. The investor cannot reveal the results to
anyone as they could poison the market.
The investor says, “I bet on you and your team and if you
leave, then I’m paralyzed. Your shares should be surrendered.”
Clauses for founders to sell back their shares if they leave the
company are critical to define upfront. The period for exercise of
shares should be short, not an open-ended time and it should be
Investors may try to put the non-compete clause into the
term sheet, rather than in the employment contract because it
adds more teeth. The non-compete does not apply to the investor
due to their broad focus across different parts of the value chain
in one market. In other words, if it was dating, if you break up you
are not allowed to date but the investor can.
In the early meetings, the onus is upon you to look at the
private equity or VC investor’s portfolio of companies. Ask yourself
if any of those portfolio companies could take your ideas and
use them to your detriment. As you know, investors on boards
of competitors have a fiduciary duty to report information that
they learn about your company. Some investors may even meet
you for an information gathering session to glean competitive
information for their gain.
One hint: If VC investors are using their Blackberry, then
they are more likely to invest. If the VC investors are paying full
attention, the meeting is more likely to be a fishing expedition
rather than to invest in your company!
For more information contact:
When Negotiating the Term Sheet