Understanding Term Sheet

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Understanding Term Sheets

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What is a Term Sheet?

1) A term sheet is a non-binding shareholders agreement setting forth the basic terms and conditions under which an investment will be made 2) It serves as a template to develop more detailed legally binding documents 3) Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is then drawn up

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What is included in a Term Sheet?

1. Valuation of the company – Pre and Post Money 2. Amount of investment 3. The percentage stake sought 4. Voting rights 5. Liquidation preference 6. Anti-dilution provisions 7. Investor commitment 8. Exit Rights of the investors 9. Option pool

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What is included in a Term Sheet?

1. Information and Inspection rights 2. Arbitration 3. Other essential terms

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Why do we need a Term Sheet?

1) Preclude the possibility of a misunderstanding and lessening the likelihood of unnecessary disputes 2) Ensure that expensive legal charges involved in drawing up a binding agreement or contract are not incurred prematurely.

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Key Clause – Drag Along 1) Typically secures benefits of the majority share holder 2) Drag along means if I sell, you need to sell along 3) This clause enables a majority stakeholder to force a minority stakeholder into sale of the company/shares

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Key Clause – Tag Along Rights 1) This clause is an opposite of drag along 2) Tag along means if you sell, I have right to come along 3) This clause provides right to a shareholder to sell along, if other shareholder is selling their stake

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Key Clause – Anti-dilution Protection 1) Prevents interest of existing share holders if the company further issues equity at lower valuation as compared to previous round 2) This is designed to protecting investors from loosing ownership of the company 3) Exercise of such clause will result in issuing additional bonus shares being issued to those with anti-dilution rights

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Key Clause – Liquidation Preference 1) Liquidation preference sets out who gets paid first, and how much in event of sale, liquidation, or bankruptcy 2) It is often found investors keeping this clause in their favour to protect their risk in investment

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Key Clause – Option Pool 1) An option pool is a way a startup company can acquire talented employees by offering them stock if the company does well enough to go public. Employees receive percentages of the option pool when they're hired, with the amount changing based on how early the employee joins the company and what their position within the company is.

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Key Clause – Affirmative Rights This clause lists down the events for which affirmative consent shall be taken from the investors. Some examples are: 1) Amending company’s organizational documents; 2) Changing company’s share capital including issuing new shares, creating new classes/series of shares, issuing ESOPs, etc. ; 3) Paying dividends; 4) Any fresh issue of shares or other instuments 5) Approving any merger, asset sale, acquisition, change of control transaction, etc. ; 6) Approving company’s liquidation or dissolution; 7) Any other significant events;

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Key Clause – Exit Rights Details relating to investor’s safe exit from the company is described. Some common inclusions are: 1) Preferred exit 2) IPO, Next Funding Round 3) Drag Along 4) Tag Along

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