Funding Rounds: Term Sheets and Investment Agreements

The legal framework

A funding round is a capital increase in which new investors subscribe for shares, sometimes of a new class, and in return the company receives cash. Company law is largely national in the EU, so the rules for a round depend on the country where the company is incorporated. EU law sets only a baseline, mainly for public limited companies: the Company Law Directive (EU) 2017/1132 requires shareholder approval for a capital increase and gives existing shareholders a pre-emption right, which they can set aside. Private companies are left to national law. In most countries the general meeting decides the capital increase, and existing shareholders normally have a preferential subscription right which the company waives or the shareholders set aside for the round. Countries differ on formalities, such as whether a notary is needed or a registry filing is enough.

Most of the commercial deal is not in company law but in contracts. The sequence is usually the same.

Term sheet. A short document that sets out the main terms. It is mostly non-binding, except for provisions such as confidentiality, exclusivity during the negotiation period and costs. It is the document to negotiate carefully, because later documents follow it.

Investment agreement (subscription agreement). Contains the subscription, the company's and founders' warranties, conditions precedent and the closing mechanics.

Shareholders' agreement. Governs the relationship after closing: governance, transfers of shares, exit and the position of the founders.

Articles of association. The agreed rights are reflected in the new articles as far as the applicable company law allows.

The terms that matter

• Valuation. The pre-money value is the value of the company before the investment. Adding the new money gives the post-money value. The investor's percentage is the new money divided by the post-money value. Whether an option pool is created before or after the round changes the real price for the existing shareholders.
• Liquidation preference. Decides who is paid first on an exit and whether the investor also shares in the remainder. It matters most at low exit values.
• Anti-dilution. Protects the investor if later shares are issued at a lower price. A weighted-average formula is more founder-friendly than a full ratchet.
• Governance and reserved matters. Board seats and a list of decisions that need the investor's consent, such as new financing, changes to the business plan or the sale of IP.
• Transfer provisions. Pre-emption rights, tag-along rights for minority holders and drag-along rights for a sale of the whole company.
• Vesting and leaver. Founder shares are earned over time. A good leaver and a bad leaver clause set the price at which departing founders must sell back.
• Employee incentives. Options, warrants or similar instruments are common, and their company and tax treatment is national.
• Exclusivity and conditions. The period in which the founders may not talk to others, and the conditions on which the investment depends, usually the outcome of due diligence.

In practice

A Ghent medtech start-up has developed a device with two founders and a university spin-off licence. An investor offers a term sheet for a seed round. The offer includes a 1x non-participating liquidation preference, weighted-average anti-dilution, a board seat and four years of vesting for the founders.

The founders' lawyer notes three points. The licence from the university is non-transferable without consent, which will matter on a future exit. One founder wrote the first firmware before the company existed and never signed an assignment. The option pool is created before the round, so it dilutes only the existing shareholders. They negotiate that the pool is partly counted after closing, and they sign the IP assignment and obtain the university's consent before due diligence begins, in a data room with a clear index.

At closing, the parties sign the investment agreement and the shareholders' agreement, and the capital increase is executed in the form the company's law requires (in some countries, before a notary). The first drafts of the agreements can be prepared from our clause library with our Document Studio and are reviewed and negotiated by a lawyer.

Public funding often runs next to the round. R&D grants and tax incentives reduce the amount that has to be raised and differ per country. You can read about valuation of your IP in How to Value an IP Portfolio.

Frequently asked questions

Is a term sheet binding?

Mostly not. The commercial terms are indicative, but confidentiality, exclusivity and cost clauses are usually binding. Investors can still withdraw after due diligence.

What is the difference between pre-money and post-money valuation?

Pre-money is the company's value before the new money comes in, and post-money includes it. A company valued at 8 million before a 2 million investment is worth 10 million post-money, and the investor holds 20%.

Why do investors ask for a shareholders' agreement as well as an investment agreement?

The investment agreement handles the subscription and the closing. The shareholders' agreement governs the relationship for as long as the investor stays, including exit, transfers and governance.

What do investors check first?

Ownership of the IP, the cap table, key contracts including change-of-control clauses, employment arrangements and compliance with data protection and sector rules.

How this connects

Our funding service prepares the company for a round and runs the legal work through to closing, with a structured data room for investor review.