How to negotiate a Term Sheet under French law?

YOUR START-UP’S PITCH DECK AND BUSINESS PLAN ARE READY AND UP TO DATE? YOUR INVESTOR MEETING WENT WELL, AND YOU’LL SOON BE RECEIVING A TERM SHEET? ALSO KNOWN AS A LETTER OF INTENT, THIS IS ONE OF THE FIRST DOCUMENTS SIGNED WHEN RAISING FUNDS. IT CONTAINS A SUMMARY OF THE MAIN LEGAL AND FINANCIAL TERMS OF THE INVESTMENT. WHAT CLAUSES SHOULD IT INCLUDE? WHAT ARE THE LEGAL IMPLICATIONS? WE’LL HELP YOU MAKE SENSE OF IT ALL, AND SECURE YOUR OPERATIONS!

What clauses should the Term Sheet contain?

What is the purpose of the term sheet? Summarize in writing the main terms and conditions of the agreement you are potentially going to conclude with the investor, through various clauses:

Clauses in the investment agreement and shareholders’ agreement

The letter of intent sets out the terms and conditions of the investors’ entry into your capital, which will be set out in the corporate documentation and the shareholders’ agreement:

• the identity of the parties (including information about the company and its shareholders);
• the amount of the planned investment, and the valuation of the start-up before and after the operation;
• the terms and conditions of the investment (cash or in-kind, existence of BSA Ratchet or not, pool of BSPCE, etc.);
• minimum and/or maximum duration of negotiations ;
• whether or not the letter of intent is binding (generally non-binding);
• a confidentiality clause;
• applicable law and place of jurisdiction ;
• a cap table before and after the investment operation.

The main terms and conditions of the future shareholders ‘ agreement must also be included:

• a list of important decisions, for which the prior agreement and/or consultation of the investor will be mandatory – formalized by the creation of a board or strategic committee;
• supervision of share transfers (pre-emption rights, approval rights, lock-up clauses, joint exit rights, joint obligation rights, etc.);
• financial provisions relating to profit sharing – preferential liquidation clause ;
• exit clauses governing the early departure of shareholders ;
• provisions relating to corporate governance (composition of the Board of Directors, appointment of the Chairman and Chief Executive Officer, strategic decisions, etc.);
• investors’ preferential rights where applicable ;
• founders’ commitment and good/bad leaver agreements ;
• intellectual property rights clause ;
• non-competition clause, no poaching, no solicitation.

Good to know: The more complete the Term Sheet, the faster you’ll move towards completion. Conversely, the more concise it is, the more it will require clarification during subsequent negotiations.

To find out more, read our article on the founding partners’ agreement.

Obligations of the parties to the fund-raising agreement

The document sets out the obligations of each party within the framework of the fundraising, namely the clauses :

• confidentiality (prohibiting disclosure to third parties of the contents of the term sheet and the progress of negotiations);
• information (your company undertakes to provide the investor with all information required to complete the investment project);
• the conditions required to bring the investment project to fruition (legal and financial audits, regulatory approvals, etc.);
• the exclusivity clause (prohibiting any negotiation or conclusion with another person, and any act that may hinder the completion of the transaction).

In practice, the letter of intent will also contain a provisional timetable for the various stages.

What are the consequences for key personnel?

The investor may negotiate the retention, departure or modification of working conditions for a category of your startup’s staff. In this case, you can discuss it during the Term Sheet negotiation phase.

In practice, professional investors often provide management packages for key personnel (chairman, managing directors, etc.) to encourage them to invest more in the start-up.

Who signs the Term sheet?

The Term Sheet must be signed by the company and any major shareholders. In practice, the term sheet is signed by the corporate officer or a proxy, the founders of the start-up who intend to participate in the transaction, and the existing investors.

What are the legal issues involved in Term Sheet?

The wording of the letter of intent is relatively free. The parties can therefore formalize it themselves, on the basis of a term sheet template, for example. In practice, it will usually be the equity investor who sends this document to your start-up. But it is wiser to have it drawn up by lawyers, who will assess whether it is more or less binding.
The good thing about this is that it shows you what you already agree on. You can insert specific clauses (confidentiality clause, etc.), and define the points to be negotiated later with the investor.

In principle, the letter of intent has no contractual value, and is therefore not binding (non-binding term sheet). Why is this an advantage? This is because it allows you to demonstrate your mutual willingness to raise funds, without committing to a contract. This is possible, provided that the non-binding nature of the document is clearly stated. So be careful to avoid, for example, inserting overly precise performance conditions.

The acquirer may also make the completion of the transaction subject to certain legal conditions (authorization from certain authorities) or contractual conditions (prior authorization from certain shareholders, non-implementation of certain prohibited transactions, obtaining bank financing, non-identification of blocking elements following audits). It is therefore in your interest to provide the best possible framework for the most decisive conditions for carrying out the operation.

What precautions can you take to protect your liability?

In principle, Term Sheet participants are free to break off negotiations without incurring liability. However, the parties must be careful not to break off talks in an abusive manner.

Exchanges taking place within the framework of a Term Sheet are subject to article 1112 of the French Civil Code, which stipulates that the conduct and termination of pre-contractual negotiations are free and must satisfy the imperatives of good faith.

When can you be held liable?

If you start or continue negotiations when you have no intention of concluding the transfer contract, and are merely seeking information, you may well incur liability.

Judges consider that there is abuse in the exercise of the right to break off talks when the person breaking off is motivated by an intention to harm (Civ. 1re, April 12, 1976) or when he has acted with blamable lightness (Civ. 3e, June 15, 2017). The main consideration is the existence of talks that are sufficiently advanced to give one party the legitimate belief that the other is about to conclude (Com., April 22, 1997). Conversely, fault is ruled out when the breach occurred at a time when the parties were still assessing the risks and opportunities of the planned contract (Com., January 12, 1999).

More specifically, when discussions are still at an early stage, you can terminate them without having to justify a legitimate reason for termination (Civ. 1re, December 20, 2012). On the other hand, when negotiations are more advanced, the person who terminates the contract must justify a legitimate reason for doing so in order for the termination not to be considered culpable (Com. July 11, 2000).

So what’s the risk?

The penalty takes the form of damages. Article 1112 paragraph 2 of the French Civil Code specifies that compensation for loss cannot be intended to compensate for the loss of benefits expected from the non-concluded contract, nor for the loss of opportunity to obtain such benefits.

More concretely, only losses incurred, i.e. costs incurred (consultancy fees, study costs, expert appraisal costs, auditing costs, legal fees, etc.) give rise to compensation. On the other hand, lost profits, and in particular the loss of an opportunity to conclude the contract, are not eligible for compensation.

Successfully negotiating your term sheet as part of the fund-raising process is essential. This document is part of the investment documentation, so it’s a good idea to train yourself to understand its key terms.

If you would like us to help you negotiate your term sheet, or if you have any questions after reading this article, please do not hesitate to contact us.