It started out as a passing thought. A business idea you believed might just work. Now you have a potential co-founder and it’s starting to look like that idea could become a reality. What should you do next? Is it too early to make your plans for the business and your developing partnership official? Should you write something down?
Surely we only need a handshake?
Maybe you’ve been friends for years, or you are long standing colleagues. Maybe you have been introduced by someone each of you trusts. You are both taking a risk in the business and each other. You feel confident a handshake and each other’s word is enough.
But what happens if your idea hits a speed bump? What if your new business partner sidesteps something you thought they had agreed they would do? Were you clear about what you were each bringing to the table and what you would get in return? Did you talk about what would happen if the idea wasn’t as successful as you hoped? How about going as far as covering how you might break up?
The brutal truth is that the start-up graveyard is filled with businesses that failed because going into business with someone is hard work. The uncertainties and challenges that any start-up brings can be too big a test for even the strongest of friendships. It is a truism that it is always easier to agree how to behave if something goes wrong whilst everyone still likes each other (and is sure they always will).
Put simply, having something written down (even in the form of a basic agreement) can help prevent a conflict ending a business.
An agreement? That sounds expensive and time consuming?
You want to get stuck into the business and bringing your idea to life. You don’t want to be bogged down negotiating an agreement. And you want to channel the little money you have managed to pull together into launching the business.
We get that. And we know that the idea of a legal agreement means, for most people, lots of complicated and expensive paperwork.
But it is not possible to overstate the value to an early stage company of thinking through and writing down the key things you all agree about the way you will set up and run your business together, and how you plan to deal with any challenges that present themselves along the way.
A Term Sheet might offer an affordable short-term solution.
What is a Term Sheet?
A Term Sheet (sometimes called a Memorandum of Understanding, MOU or Heads of Terms) sets out the key benefits and obligations of the parties in user-friendly language. It normally also includes some standard legal language about things like confidentiality, resolution of disputes and ownership of intellectual property. Generally, a Term Sheet will state that the parties will enter into a full agreement in future as, essentially, a Term Sheet is the skeleton on which a fully-fleshed out agreement would be built.
But if it’s only Term Sheet, do we need to do what it says?
It is a common misconception that Term Sheets are not legally binding. Generally speaking, a binding contract is created if the parties to it make promises to each other and those promises have some value. This means that a Term Sheet which captures the contributions you and your co-founder(s) agree make to your business will likely be binding unless the Term Sheet clearly states that is not your intention.
If you are serious about the business and have thought things through, you likely want the Term Sheet to be binding. In fact, knowing it will be should encourage you all to think very carefully about what you commit to. Putting things in writing will help you to have the difficult conversations (like how many shares each person gets in the business and when) that you might otherwise avoid.
We have a signed Term Sheet. Now what?
You have a legally binding Term Sheet and have saved yourselves the time and cost of entering a full agreement. You have bought yourself some time to test the waters and see how things progress, whilst protecting yourselves and your idea. What happens next?
If it never takes off, you haven’t invested a load of energy and cash on paper destined for the shredder. But you do have a structure that will help you dissolve things amicably.
We would never recommend you run your business on a Term Sheet forever. If the business progresses (for example you set up a company), you will want to put in place a full Founders’ Agreement. The conversations you had to create the Term Sheet should make that next step easier to achieve and less expensive.
Click here to generate your ScaleUp Founders’ Term Sheet.
Ready for the next step?
If you already have your Term Sheet and/or are ready to take the next step, click here to generate your ScaleUp Founders’ Agreement.