A term sheet is a document that summarizes the principal terms and conditions for the proposed investment in a company by investors and is executed by and between the promoters, the company, and the investors.
A term sheet is legally non-binding. This document captures the key points of the agreement entered into by both parties, before actually starting with a time-consuming due diligence process and executing the final legal agreements.
The following are important points/clauses to be included in the term sheet:
As we all are aware, we use the words “term sheet” in connection with fundraising from investors. As the investment is the main limelight in any fundraising activity, we need to incorporate this clause in the term sheet. This clause mentions the total amount of investment, investment amount per investor, and type of instrument issued namely equity shares, preference shares, concrete number of shares and price etc.
Before an investor decides to invest in a company, they will assess the value of the company. Valuation has two major aspects namely pre-money and post-money valuation. Hence while drafting this clause we need to ensure it states the details of the pre-money and post-money valuation of the company. Pre-money valuation refers to the valuation of a company or asset before an investment or financing. Post-money valuation is the value of a company after an investment has been made.
- Instalment/ Tranche
From an investor’s point of view, it is always safe to invest the money in a business in instalments rather than as a one-time investment. These instalments are usually connected to some milestones to be achieved by the company within a given time frame. Hence we need to incorporate all such details of pre-negotiated payments as the company achieves financial and/or operational milestones (such as no. of downloads, no. of users, turnover targets, etc) as agreed with the investor. The timeline or the due date of payments, with details of the number of tranches, due dates of tranches, and total investment should also be mentioned in this clause.
- Shareholding pattern
The investor will need to know the status of the company’s shareholding pattern before and after the investment. Hence, this clause is required which details the list of shareholders and percentage of their shareholding before and after the investment.
- Use of Proceeds
This is a very important clause in the term sheet. While pitching your business to the investor in the initial stages of fundraising, the company should have plans for how it will be utilizing the investment money in the long run as well as in the short run. However, before executing the final legal agreement, it is required to document the same and should be agreed upon by both parties in the term sheet. Hence this clause details the purpose for which this investment is raised and the ways/methods of utilizing the same.
- Board participation
The Board of directors is a group of individuals chosen to represent the interests of the shareholders in the company. Its mandate is to establish policies for corporate management and oversight and to make decisions based on this. This clause mentions the composition of the board after the investment deal. Investors might want to make adjustments to take a bit more control over the board. This might not be acceptable to those founders/directors etc. who feel they will need freedom in operations and decision making. However, not all investors are interested to take control over day-to-day business aspects. Some investors choose an observer role alone.
- Pre-emptive rights
This clause gives investors the right to maintain their level of ownership throughout subsequent financing rounds. The pre-emptive right is the right to purchase shares newly added into the company before it can be offered to any other person or entity.
- Promoter lock-in
This is a mechanism to minimize the risk of losing the founder. The promoter lock-in period restricts the promoter from transferring his shares within the specified time frame to ensure his presence and commitment to the company. The company shall have executed employment agreements with the promoters and senior management team. These employment agreements will include standard clauses like non-compete, non-solicitation, non-disclosure and confidentiality. It will also have a clause to safeguard the company’s intellectual property (IP) rights.
This clause states the pre-conditions to be obliged before proceeding further. It can be as follows:
- A due diligence process has to be completed
- All regulatory permissions will have to be obtained
- Amendment to the company’s Memorandum of Association (MoA) & Article of Association (AoA) as required etc.
This clause is mandatorily required in any term sheet as in the process of fundraising the investor will be exposed to a lot of confidential information and ideas with respect to the business. There is a risk of this being leaked out to the general public and competitors and hence this binding provision regarding maintaining the confidentiality of the information supplied by the company and maintaining the confidentiality of the negotiation of the transaction is incorporated.