Term Sheet Basics

A Term Sheet is a non-binding document outlining the basic terms and conditions under which an investment will be made. It is essentially a brief understanding between the founders and the potential investor(s). The document summarizes the key points of the commercial agreement set by both parties, before actually executing the definitive agreement(s) and initiating the time-consuming due diligence.  The primary purpose of executing a term sheet is for both parties to concur on the important terms by means of negotiations. Typically, the negotiations for term sheet(s) are not long and the number of iterations between the parties is limited. While term sheets vary for different companies, investors, and even between rounds, there are a few essential terms that should be kept in mind in any fundraising round as they are crucial and most importantly, negotiable.  What is a term sheet? How to draft a term sheet for investment? What are the key clauses in a term sheet? What is a non-binding term sheet? What is the format of a term sheet for venture capital? Here is a comprehensive guide to understanding term sheets for startup with a term sheet template that covers all the essential clauses. A term sheet is a document that outlines the terms and conditions of an investment deal, including the rights and obligations of the parties involved. It serves as a blueprint for the investment transaction and helps both parties to negotiate and finalize the details of the investment. The format of a term sheet for venture capital investment usually includes the following sections:

• Company details, including name, address, and incorporation date
• Investment details, including the amount, type of security, and valuation (if applicable)
• Management and board control, including the appointment of directors
• Liquidation preference, outlining how the proceeds of a sale or liquidation will be distributed
• Anti-dilution provisions, which protect the investor’s ownership percentage from being diluted
• Employee Stock Option pool, which is a percentage of the company’s equity reserved for employee stock options
• Pre-emptive rights, which allow the investors to maintain their ownership percentage by subscribing to new shares issued by the company

A non-binding term sheet signifies that the terms are subject to further negotiation and are not legally binding. This allows the parties to negotiate without the fear of being contractually bound. While drafting a term sheet, it is essential to seek legal counsel’s assistance to ensure compliance with applicable laws and regulations. Here is a term sheet template that covers all the essential clauses necessary for a successful investment negotiation:

[COMPANY NAME] [DATE]

Investor: _____________________ Investor Address: _____________________   Amount of Investment: ______________   Type of Security: __________________ Valuation: ______________________   Management and Board Control: ________________________   Liquidation Preference: _______________________________   Anti-Dilution Provisions: ______________________________   Option Pool: _______________________________________   Pre-emptive rights: __________________________________

This term sheet is non-binding and subject to further negotiation. Any investment will be subject to completion of legal due diligence and the execution of the definitive investment documents. This template serves as a starting point for drafting a term sheet. Ensure that all the terms and clauses are carefully negotiated and drafted to meet the specific needs of the company and the investor.

Exit rights

Achieving a successful exit from a company is the primary goal for most of the financial investors. While there are many routes via which an investor intends to obtain an exit, such as through an IPO, third-party sale or buy-back of their shares, there are other contractual mechanisms available such as a drag-along right and tag-along right which also aid in achieving the desired exit. A ‘drag along’ clause allows the investors to ‘drag’ the other shareholders into a joint sale of their shareholding too. Usually, if the investor is a minority shareholder it may become difficult to find a buyer for such shares, hence the investors usually demand a drag-along right to make the sale attractive for any buyer by offering a significant chunk of shareholding of the company. A tag-along provision is a clause that allows the investors to ‘tag-along with the promoters or group of shareholders if they find a buyer of their shares on the same terms and conditions. The term sheet is an important document and may create issues for the parties involved if it does not correctly reflect what has been agreed on or fails to deal with key terms which may lead to ambiguity and uncertainty over the exact nature of the relationship between the parties.

FAQs

Q: What is the difference between a term sheet and an agreement?

A: A term sheet is a non-binding preliminary document that outlines the basic terms and conditions of a proposed investment or transaction, while an agreement is a legally binding document that formalizes the terms of the transaction.

Q: Who prepares the term sheet?

A: Generally, the lead investor or the investor’s legal counsel prepares the term sheet.

Q: What is the purpose of a term sheet?

A: The purpose of a term sheet is to set out the key terms and conditions of a proposed investment or transaction so that both parties can negotiate and finalize the details of the investment.

Q: What happens after a term sheet is signed?

A: After a term sheet is signed, the parties will move towards preparing legal documentation such as an investment agreement or a shareholder’s agreement.

Q: Is the term sheet legally binding in India?

A: The term sheet is usually non-binding and is intended to serve as a framework for further negotiations. However, some clauses of the term sheet such as confidentiality and exclusivity clauses may be legally binding.

Q: What is the term sheet process?

A: The term sheet process involves negotiation and finalization of the key terms and conditions of an investment or transaction, followed by the preparation of legal documentation.

Q: Who signs a term sheet?

A: Generally, the lead investor, the other investors and the company sign the term sheet.

Q: Do term sheets have signatures?

A: Yes, term sheets are signed by the parties involved to indicate their agreement to the basic terms and conditions outlined in the document.

Q: What is a term sheet for a startup?

A: A term sheet for a startup is a preliminary document that outlines the basic terms and conditions of a proposed investment or transaction. It includes details such as investment amount, valuation, management participation, and liquidation preferences.

Q: How long does it take to make a term sheet?

A: The timeframe for preparation of a term sheet depends on the complexity of the proposed transaction and the negotiation process between the parties.

Q: What are the main clauses of a term sheet?

A: The main clauses of a term sheet include investment details, liquidation preferences, anti-dilution provisions, option pool, pre-emptive rights, board control, and confidentiality clauses.

Q: What is a term sheet in venture capital? What about private equity?

A: A term sheet in venture capital is a preliminary document that outlines the basic terms and conditions of a proposed investment. A term sheet in private equity serves the same purpose as a term sheet in venture capital, but it is specific to private equity transactions.