Overview of a Preference Shares Investment Term Sheet

What is a Preference Shares Investment Term Sheet?

Preference Shares Investment Term Sheet is a record of discussions between the founders of a business and an investor for a potential investment by preference shares. A Preference Shares Investment Term Sheet is not legally binding, except for confidentiality and exclusivity obligations (if applicable).

It is crucial that, at an early stage of the discussion, the parties have a good idea of the rights attached to (or any restrictions that apply to) the preference shares. Major rights that may be attached to preference shares include:

  • a fixed rate of dividend;
  • liquidation preference (i.e. getting paid ahead of other shareholders on any liquidation of the company), which could be a sum that represents an agreed rate of annual return on capital;
  • extra voting rights;
  • redemption right at a certain time or upon certain events;
  • conversion (into ordinary shares) at any time or upon certain events; and
  • anti-dilution protection (common choices are full ratchet, narrow based weighted average ratchet, and broad based weighted average ratchet).

Always bear in mind there is not a single set of rights or restrictions that is universal. Each provision is a matter of negotiation; therefore it is important for you to understand the provisions and to negotiate them with the counterparty where appropriate.

A Preference Shares Investment Term Sheet also sets out the parties’ preliminary thoughts on certain provisions to be included in a Shareholders’ Agreement, which will be executed at completion of the investment and which will protect the company’s or the shareholder’s interests.

Please note: investment by preference shares is highly sophisticated. If you are not familiar with how preference shares work or how this investment agreement operates, you must seek legal advice.

Key points included

  • Details of the subscription, including the amount of investment and percentage of shares to be issued;
  • Pre-money valuation and round size;
  • Cap table;
  • Rights and restrictions of the preference shares to be issued;
  • Expected timeframe for execution of the definitive agreement and completion of the subscription;
  • Board composition after completion;
  • Generic conditions precedent;
  • Reserved matters and other provisions in shareholders’ agreement;
  • Confidentiality; and
  • Exclusivity (if applicable).

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