Startups and funding go hand-in-hand. First-time entrepreneurs are keen to bring angel investors and VC funds on board. That's when all the documentation and legalities come into the picture. Several entrepreneurs find it difficult to understand legal documents. One such document is the 'term sheet'.
What is Term Sheet?
A term sheet states that the founders and investors have reached a stage where they have a preliminary level of comfort with each other. It's a broad, in-principle agreement relating to the key deal terms, including the valuation of a startup.
The term sheet codifies the discussions and includes things the startup owner and investors have agreed to informally but not legally. Subsequent to the term sheet, there is a due diligence process and the parties eventually negotiate, agree upon, and sign the final agreement.
The signing of these definitive agreements is when a binding obligation to do the deal is formally created. However, term sheet does not create any obligations on the investor to invest or on the company to issue shares to that investor.
What does a Term Sheet contain?
Every business has different requirements and needs customised term sheet suitable to its investment model. A startup must consult startup lawyers in Delhi to get its term sheet drafted, who can include all the necessary details of who the investor is, name and identities of investors and founders, value of the company, investment amount, whether the investors will get a board seat, and information relating to veto rights.
Here is a list of the key terms of a term sheet that must be included by a lawyer:
1. Consideration for the money invested: A convertible note is a credit which has an option of getting converted into equity at a future date.
2. Type of stock given: The kind of stock allotted to the investor must be mentioned in the term sheet. The type of stock most favoured by investors is preferred shares which entitles them to vote and give an upper hand in case of liquidation.
3. Involvement of Board of Directors: Entrepreneurs limit the seats for investors in the Board of Directors. It becomes necessary to include the details of involvement of investors in board of directors of the company.
4. Prevention of Equity Dilution: This clause is added by lawyers to allow early investors the right to buy shares at the new, lower price, or otherwise maintain their existing ownership share must be included in the term sheet.
5. Tranches: Tranches means the different stages in which the investor wants to deliver the cash to the startup. The period of tranches must be specified in the venture capital term sheet as it reduces both the founders and investor's risk.
6. Right to buy shares back: This ‘right of first refusal’ allows existing owners to reclaim shares that are about to be sold to a new investor and prevent ownership division in company. Startup founders must get this option included by lawyers for themselves, and allow it for major investors. Venture capital investors normally insist on this option.
7. Investor liquidation priority: Investors want a contract preference to get their total investment back first in any company sale, to prevent founders who are struggling from deciding to sell at a loss. If the company is sold at a profit, liquidation preference can also help them be first in line to claim their profits. Smart investors will insist on this option.
To achieve maximum negotiating leverage, a startup must approach investors with term sheet drafted by experienced lawyers, keeping it as simple as possible, including all the common terms defined. MyAdvo connects you with the best startup lawyers in India for your business documentation. Email us at info@myadvo.in or call us at +919811782573.