New startups are being registered in India each day and exciting ideas are evolving in the market at an incredible speed. People are diving into the wave of entrepreneurship with new ideas that are providing solutions to so many existing problems. Today, when many businesses are cash-strapped and operating on negative margins, raising funds from investors at an early stage is crucial for a startup to realise its goals. Angel investors and early-stage venture capitalists rarely show any interest in smaller enterprises. In this blog, we will discuss everything you need to know about a term sheet.
After raising funds for your company, it is important to realise the importance of a term sheet. A term sheet is basically a non-binding document of the shareholder agreement which covers all the terms and conditions of the proposed transaction between investors and promoters/co-founders.
What is a Term Sheet?
A term sheet is offered at the time of preliminary discussions. The term sheet identifies the most essential options, rights, and obligations of each of the parties. The term sheet is designed to express the party’s wishes and concerns in a way that is mutually satisfactory to all parties involved.
The preparation of this sheet is the first step toward the two parties’ agreement being finalised. It comprises all of the agreement’s key and critical points. It is, however, a non-binding agreement that does not obligate any parties, even if they sign it. It means that any of them, or both of them, can withdraw if they do not wish to continue.
Objectives of Term Sheet
The purpose of a term sheet is to address the major parts of the transactions without going into detail about every small question that a contract would cover. The term sheet establishes the framework for ensuring that the parties involved in a business transaction agree on the most important issues. It reduces the chances of miscommunication or unwanted conflict.
Inclusions of Term Sheet
A term sheet includes the following major points:
1. Parties’ Details
Details of the involved parties like name, registered office address, promoters’ etc. are included. This shall also include the details of all the investors investing during that specific round of fundraising.
2. Proposed Transaction
This is the main clause. This clause will include major details regarding the investment to be done by the investor. This also includes the following:
- The total amount of investment to be done by the investor(s)
- The type of shares to be issued
- The value at which each share is to be issued
- The holding of each investor in the company in lieu of the investment done
3. Board of Directors
While forming a board of directors may appear to be a necessary step, it is critical to put it on the term sheet. Appointing board members ensures that the company is structured like a company and that the correct people are on the board. Establishing board seats also enables the organisation to continue to disburse funding to all eligible parties as it grows.
4. Restrictive Transfer
While drafting the term sheet, it is also important to mention the restrictions on the transfer of shares, such as to whom the shares can or cannot be transferred, the details regarding when the shares shall be offered to the existing shareholders when the outgoing shareholder is trying to sell, etc. These are called the Right of First Offer (ROFO) and the Right of First Refusal (ROFR) and shall be clearly laid out in the Term Sheet.
5. Details Regarding the Voting Rights
The details regarding the voting rights should be mentioned in the term sheet. Details explaining the voting rights of the shareholders and the deadlock situation are included in the document.
6. Liquidation Preferences
Companies may also include the liquidation preference, which details how the proceeds from the sale of a company would be distributed to the investors.
7. Exit Options
The term sheet shall also include the details regarding the exit options for the investors like third party sale, drag along rights, qualified IPO etc.
8. Pre-emptive Rights
Pro-rata rights shall allow the investors to participate during the next fundraising round by the company. However, this is a right given to the investor and not an obligation. Thus, it is optional for the investor to opt for such rights.
The above-mentioned inclusions are not exhaustive. The term sheet always depends upon the transaction between the investors and promoters. The inclusions of the term sheet differ from transaction to transaction and the same is incorporated in the sheet.
The term sheet works as a brief document and the parties get a clear idea of how the further transaction will be. When any funding is raised, a lot of points need to be considered by an investor as well as by the promoters of the company. A good term sheet would help the parties to have a smooth transaction without any hurdles. If you’re looking for a reliable term sheet drafting service, look no further! Our team at Legalwiz.in has always been a helping hand to startups and companies for every legal assistance whenever required. Drop your details and we’ll connect with you soon!