How to Start a Term Sheet

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What is Term Sheet?

The term sheet is that document that summarizes the terms by which an investor can build a monetary or financial investment in the company.

A term sheet is basically a legally non-binding document that a business presents to the investor. Term sheets are documents that lay down the important terms of any risk or venture capital investment. It is very important to recollect that a term sheet has no law enforcement, and is just a document through which the preliminary discussions between a business and its investor take place. There may be many types of a term sheet exchanged between the two parties before an investment is actually made.

Drafting a Term Sheet

A term sheet contains the broad parameters upon which an investment is finalized. Broadly, it contains the summary of what is to be present in the transaction agreements. These agreements are later negotiated on the basis of the initial terms finalized in a term sheet. A term sheet contains information on which an investor makes his investment.

Benefits of Term Sheet

A term sheet may not even result in an investment, as negotiations may fall is vital to have a document that represents the terms and conditions of the future transaction. a term sheet is a document essential to both the company as well as the investor for the following reasons.

  • It acts as an overview of all the critical terms that need to be conveyed to both the parties. Having a clear view of the terms of an investment in one document makes the term sheet transparent and fair to the parties.
  • While a term sheet has no definite legal obligation, it does have binding clauses such as confidentiality and exclusivity clauses:
  • Confidentiality clauses are self-explanatory. They bind the parties to the term sheet into confidence.
  • Exclusivity clauses are also known as “no shop clauses”. They prevent the company from looking for other investors for a certain period, while the term sheet is being negotiated.
  • A term sheet acts as a ready reference in latter stages of negotiation between a company and the investor.

Is a Term Sheet legally Binding?

The document called a "Term Sheet is not binding, but the parties agree to enter into a definitive agreement after negotiating the terms.

A Term Sheet usually outlines the following:

  • The valuation of the company.
  • The amount and timing of the investment.
  • The form of investment by the investors.
  • Non-solicitation.
  • Protective Provisions.
  • The number of directors the investors can elect. 
  • Vesting of the founders' stock.
  • Price-based anti-dilution protection in connection with future sales of the company's stock.
  • Pre-emptive rights of the investors to purchase any future stock issuances on a priority basis.

What are the Basic Elements of a Term Sheet?

Basically, few of the elements of a Term Sheet are as follows:

  • Investment Structure to mentioned in term sheet
  • One of the important element Corporate Governance
  • Dilution and Exit Rights
  • Other Covenants etc.

What are the clauses to be kept in mind while signing the term sheet?

  • Business Valuation was done.
  • Liquidation of Existing Equity Shareholdings of shareholder.
  • Liquidation Preference Structure in case of dissolution of company.
  • There are Restrictive Provisions with respect to Approvals Required from Investors.
  • Drag Along Rights.
  • Tag Along Rights.
  • Ratchet Rights.
  • Escrowing Founder’s Shares- Founder ‘s Vesting.
  • Exclusivity

Frequently Asked Questions

Term Sheet is a non-binding document that indicates all the terms and conditions shared with the investors.

No, a Term Sheet is not a Legally Binding Document.

The Elements of a Term Sheet are Investment Structure, Corporate Governance, Dilution, Exit Rights, and Other Covenants, etc.

The Clauses of a Term Sheet are Business Valuation, Liquidation of Existing Equity, Restrictive Provisions, Drag Alone Rights, Tag Alone Rights, Ratchet Rights, Escrowing Founders Shares, and Exclusivity.

The term “Investment Term Sheet” is basically a Statement of Intent and not to be understood as a certified understanding besides the Confidentiality inside it.

The key factors of a Term Sheet are Valuation of the Company, Amount and Timing of the Investment, Form of Investment by the Investors, Non-solicitation, Protective Provisions, Appointment of Directors, Vesting of the Founders' Stock, Price-based Anti-Dilution Protection, and Pre-emptive rights of the Investors to Purchase.

The other name for Exclusivity Clause is No shop clauses.

A Term Sheet plays a significant role for both Investor and Company.

Normally, a period of 3 to 4 days are required to Draft a Term Sheet.

The Binding Clauses of a Term Sheet are Exclusivity and Confidentiality Clause.

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