Term Sheet vs Shareholders Agreement (SHA): Don't Sign Without Reading

Funding is exciting. But legal documents can be overwhelming. Founders often confuse the Term Sheet with the final definitive agreements like the Shareholders Agreement (SHA) and Share Subscription Agreement (SSA).

Knowing the difference can save you from giving up too much control or equity too early.

1. The Term Sheet: The First Step

A Term Sheet is a bullet-point document outlining the material terms and conditions of a potential investment. It serves as a blueprint for the lawyers to draft the final agreements.

• Binding Clauses: Confidentiality, Exclusivity (No-Shop), and Governing Law.
• Non-Binding Clauses: Valuation, Investment Amount, Board Seats, Liquidation Preference.

2. Shareholders Agreement (SHA): The Final Deal

The SHA regulates the relationship between the company, the founders, and the investors. It details rights, obligations, and exit mechanics.

• Right of First Refusal (ROFR): If a founder wants to sell shares, existing investors get first dibs.
• Tag-Along Rights: If majority shareholders sell, minority shareholders can join the deal.
• Drag-Along Rights: Majority shareholders can force minority shareholders to sell during an exit.
• Anti-Dilution: Protects investors if the company raises funds at a lower valuation in the future.

3. Share Subscription Agreement (SSA)

While SHA defines relationship, SSA is purely about the issuance of shares. It records the payment of money and allotment of shares.

4. Common Pitfalls for Founders

• Ignoring "participating" liquidation preference: Investors get their money back PLUS a share of the remaining, reducing founder returns.
• Veto Rights: Giving investors veto power over day-to-day operational decisions instead of just strategic ones.
• Founder Vesting: Not negotiating fair vesting terms for their own shares (reverse vesting).

Frequently Asked Questions (FAQ)