Commitment Letters from Investors

Getting a venture capitalist (VC) or a business angel to put money in your enterprise is only the first step. Closing the deal is really the most difficult part of the whole process. You can take months or even years just to get the important piece of agreement to get the money from your investors. The first document which the entrepreneur will see is the term sheet. Here are some guidelines to what needs to be include in the term sheet. Of course, as an important rule, get a lawyer friend to help you out.

Investors and VCs have different methods to make a committment in financing a team to do their startup. The easiest is to issue a commitment letter. Depending on the investor, not all tend to issue a commitment letter. In some cases, they have a verbal agreement and subsequently draw up legal documents that, in turn, close on the investment on the basis of the verbal understanding. Do note that in Singapore, verbal agreements are legally binding.

Some investors adopt a one page “term sheet” that outlines the important points of the deal. It is in this situation that you need professionals with experience. You need the lawyers for the legal mambo jumbo and the business people for business language. So, we identify some key features which the entrepreneurs need to look out in the commitment letters.

1. The most critical items in this piece of paper are (i) amount of equity owned by founders, managers and investors and (ii) type of investment. For example, here is a sample statement: “1. The investor company will make a junior subordinated loan (“the Loan”) of S$200K for 1.5 years at an interest rate of 10% per annum, paid monthly on the first of each month.”
2. The collateral for any loan or external aspects to the loan that will be taken up by the investor.
3. The conditions of the investment, whether they can be good or bad. We will explore this in detail in future articles when we go through a term sheet on our own.
4. Representations made by the entrepreneur to induce the investor to invest in his or her company.
5. The conditions on which the commitment was made to the entrepreneur. This is important when it comes to decision making for the management team. A word of caution is that it might be good for the investor to get their hands dirty, but do not let them end up micro-manage the management team.

So, don’t think that getting the investors with beautiful presentations is the “be-all, end-all” situation. You need to start learning how to close the deal.

References:
[1] Venture Capital Investing by David and Laura Gladstone.
[2] The Power of Unfair Advantage, by John Nesheim.