Termsheets

A Termsheet is a “preliminary” and a “non-binding” document which is signed between the startup and the investor. It outlines the key financial and other terms of a proposed investment.

It is preliminary because investors use a Termsheet to achieve a conditional agreement on key terms (such as valuation and shareholder rights) before the due diligence is carried out. Once the due-diligence is over, the termsheet forms the basis for drafting the two final investment documents – (1) subscription agreement and (2) shareholders agreement. Many times these two final documents can also be clubbed into one.

With the exception of certain clauses (commonly those dealing with confidentiality, exclusivity and sometimes some fees in the event of investment not proceeding ahead) provisions of a termsheet are not usually intended to be legally binding. A termsheet also usually contains certain conditions which need to be met before the investment is completed and these are known as “conditions precedent”.

So what is the structure of the termsheet?

A terms sheet can be considered to be made up of 3 layers.

(1)   In simple terms, the core layer of a term sheet includes number related terms. It shall mention the pre and post money valuation of the company. It will cover the number of shares to be allotted to the incoming investor. If the instrument is a convertible note, then it will cover the coupon rate payable, if any.  As ESOP dilutes the shareholding of the investors, this part of the termsheet also covers the agreement on the ESOP pool. For example, the termsheet may state that before the conclusion of the final agreements, the startup will create the ESOP pool and it shall not affect the shareholding of the incoming investor.

(2)   The second part of the termsheet is a group of clauses that protect the investment directly. These are the set of clauses which protect the investments in a very numerical way.  Most of these clauses are related to the scenario what happens if the business doesn’t do well.

o   If the business raises further rounds of capital at a lower valuation then this part of the termsheet defines what happens to this set of investors. These are called anti-dilution clauses.

o   The second set of important clauses that are covered here are the “exit” related rights.

o   The third very important right that is covered here is liquidation preference. The liquidation preference defines which investors get paid first when a company is liquidated (typically distress sale but profitable also). Generally preferred shareholders are usually paid back first

(3)   The third set of clauses in a termsheet are the ones which protect the investors’ interest indirectly. In an early stage investment, the investor is banking only on the entrepreneur really. The clauses in this group ensure that the investor has some say in the strategy of the company and the founders take care of the interest of the investors. Some of the clauses are:

o   Voting rights & Board seats

o   Information rights.

o   Veto rights

o   Restrictive clauses on promoters - for example ensuring that they don’t have a conflicting business or they don’t take higher than a specified salary or the vesting schedule of founder shares.

Once a Term Sheet is issued, next steps include: 

1. Legal teams get involved to thrash out the details

2. Investors assess financial reports and audits through an accounting firm

3. Deal proceeds if data checks out; otherwise the terms are renegotiated or the deal is dropped

4. Detailed rights discussion leading to finalization of Share Holders Agreement and subscription agreement.

 5. Document signing

6. Transfer of funds

7. Regulatory filings