A term sheet is a non-binding agreement between the founder and the investor that contains the basic terms and conditions of the investment. It serves as the foundation for the ultimate binding agreement between the parties. A term sheet is generally used by entrepreneurs and startups to invite investors. It is also used by commercial real estate developers for mergers, acquisitions and long term borrowings.
The Term sheet contains all the major clauses of a definitive agreement and states in a concise form what the investor looks for from the startup in return for his investment.
All the essentials of the Term Sheet can be divided into the following five parts:
- Deal Basics
- Transaction Economics
- Governance & Oversight
- Investor Rights
- Liquidation & Exit rights
The term sheet begins with a brief introduction to the parties and a list of the legally binding clauses. The term sheet’s fundamental information includes the Company name, the investor, the existing shareholders and investors (if any), the promoter/founder, and the company’s key personnel.
The agreement’s financial component is covered next. The Type of Security that the investor is choosing to invest in the enterprise, is listed as a part of transaction economics. Investors can generally choose between two types of securities. Either an equity investment or a debt investment is possible. Investors who choose to participate in equity have the choice of Compulsorily Convertible Preference Shares (CCPS), Convertible Notes, or Equity Shares. The investor may have options like Debentures, Bonds, or Grant if he decides to invest in debt. Based on his investment, the investor shall be entitled to dividends or interest, the rates of which are decided in the agreement. Along with the percentage shares in the business after the investment, the term sheet then includes the Investment Amount, which is the sum that the investors are investing. The agreement also specifies the after-investment, or “post money valuation” of the company.
As a part of governance and oversight, The investor can dictate the constitution of the Board of Directors and give guidelines for the ESOP Pool. The business receiving the investor’s investment must provide all pertinent information and grant the rights outlined in the contract. The company is obligated to fulfill the Conditions Precedent to the agreement to sign the agreement and a list of Conditions Subsequent to receive the full investment amount. The Company must agree on a Closing Date for the agreement, which may be either after the requirements are met or after the definitive agreement has been signed. Even a list of protective rights, including the investors’ affirmative voting rights, is included in the term sheet.
As he invests in the enterprise, the investor is looking for certain privileges. They include a variety of rights that prevent the company from doing actions that can jeopardize the investment and necessitate that the founders get the investor’s consent. The Information Rights provision stipulates that the Investor is also entitled to receive quarterly and yearly fiscal reports as agreed in the definitive agreement. The borrowing company involved in a financial transaction will provide Representations and warranties as a way to satisfy the investor to invest. But if the Company’s representation is no longer true, the contract’s penalties can be enforced by the investor. The Lock in & Vesting clause restricts the key person’s ability to sell or transfer any of the company’s assets, including his shares. The Right to First Offer (ROFO) and Right to First Refusal (ROFR) apply to these requirements.The investor shall have Pre-emption Rights to maintain their shareholding in the company. The No Shop term lays down an exclusive period agreed between the investor and the company which restricts the company from initiating or participating in any negotiations with a third party. The Non-Compete clause further restricts the company from engaging in with a competitor of the investor.
The Liquidation and Exit Rights of the investor are the most essential part of the agreement. In case the company decides to stop its functioning, in that case the investor shall be paid his investment amount with dividend/interest. The liquidation clause may also include any other particulars the investor wants to be followed. The investors must lay down the options in which the promoters can facilitate the exit of the investor from the business. It can be done either by Third party sale/funding, by an IPO, buy back, or by selling the other investors and shareholders shares to recover money in case of failure of the promoters to return the investment back.
Lastly, The term sheet contains confidentiality and expiry restrictions, which restrict the distribution of the information contained within to the parties concerned and set a deadline for signing the term sheet in order to proceed.
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