A term sheet is a non-binding agreement which shows the terms of an investment which have been decided by the investor and the company. But what is it in investment deals? Let’s find out below.
A term sheet, which outlines the fundamental terms of an investment, is a non-binding agreement between parties. The term sheet serves as the model and foundation for intricate, legally significant papers. A binding agreement or contract to the terms of the term sheet is drawn out if the parties concerned reach an understanding of the details.A term sheet should, in essence, summaries the key points of an agreement without getting into the nitty-gritty details and contingencies covered by a legally enforceable contract. It also ensures no unnecessary, high-cost legal fees are associated with drafting a legally enforceable agreement or contract.
Aspects of term sheets:-
There are some aspects which you need to remember about the term sheets. These are mentioned below:
- The term sheets are not legally binding. They are just notable agreements based on the key issues
- If you own a successful business, there might be scope for negotiation. However, if you are just starting your own business, you would have to follow the terms mentioned in the term sheet
- The term sheet needs to be clearly worded.
Contents of a Term Sheet:-
It is less risky to invest in a business which is more successful and established. In these circumstances, a founder may have the considerable negotiating power to secure advantageous terms. On the other hand, because early-stage enterprises with no trading history are riskier, investors can anticipate tougher terms, such as a bigger equity stake.
The common contents of term sheets are as follows –
- The names of both the parties which are involved
- Investor’s legal identity
- The kind of investment that is being provided
- The procedure and date of the company’s valuation
- Total funding amount
- The basis on which the per-share price shall be calculated
- Various exit provisions like IPO, liquidation or sale
- Voting rights, veto or board seats
- Anti-dilation provisions
- Conversion rights
- Pre-emption rights.
Common terms one could find in a term sheet
Various industries may utilise distinct Term Sheet templates. But there are a few common words and phrases that the agreement always mentions. They are mentioned below:
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Plans for employee share options:
There are various plans that a company comes up with for its employees, which involve the usage of shares in it. These incentive schemes are set up to reward the staff with shares of the company.
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Dilution
During dilution, the existing shares by the shareholders go down, or they get diluted as a result of the new shares’ introduction. In this process, the company issues a new set of shares, and that leads to the dilution of the existing shares with the shareholders.
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Pre-money value
The pre-money value refers to the overall valuation of the business before any Fresh Capital Share is introduced into the company by notable investors.
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Preference shares
The preference shares are commonly referred to as the “class of shares”. They are issued to significant investors and have been preferred over other shares in the company during different scenarios. This can be when there is an issuance of dividends or when the company moves into the liquidation phase.
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Voting rights
Voting rights are vital rights which are provided to those holding the shares. In this right, the holders of the shares can vote during the tenure of the company meetings. However, it has to be noted that this is not the same as the directors’ meetings during which the business decisions are undertaken.
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Reserved matters
There are some decisions in which there might be a need to increase the right of voting for the shareholders. It is because the final decision might have negatively affected them in some way or the other.
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Pre-emption rights
In the pre-emption rights, the shareholders get the liberty to bid for the shares just in case the company comes up with a new set of shares.
Advantages of Term Sheet
Let’s examine a few benefits of a term sheet:
- It serves as a summary of all the important information that needs to be shared with both parties. The term sheet is transparent and equitable to the parties when all of the terms of investment are contained in one document
- A term sheet contains binding clauses like secrecy and exclusivity clauses even though it has no clear-cut legal obligations
- Confidentiality provisions go without saying. They impose a duty of confidentiality on the parties in the term sheet
- In the closing stages of negotiations between a company and the investor, a term sheet is a handy reference.
Common shortcomings to keep in view while reviewing a term sheet
If you have a small business and you’re looking out for some investment, you should keep a check on some red flags. These are the red flags which you should avoid while you are reviewing the term sheet. Check them out below:
- Just in case the investment turns out to be in the form of a loan, you should keep a watch on the interest rate. The interest rate should be constant. Otherwise, it could land you in financial problems
- Your company’s valuation needs to be realistic
- You should not provide too much equity to your investors. Investors interested in taking over a large share of your business might gain more control over your business. If you want to set a limit, you can keep it at 20% per funding
- You must not allow many investors on board. Also, giving them many voting rights doesn’t seem necessary either
- Always look out for investors who are genuinely interested in making your business a huge success.
Conclusion
You should always seek financial and medical advice just in case you are negotiating a notable term sheet. There is a dire need for you to work with a firm that hails a lot of experience in offering legal help for startups. One such firm is Vakilseacrh.
It has the required knowledge that could assist you in protecting your business on financial terms. Getting the right legal advice is also very important since calculations associated with the company value and share price are too difficult. It’s better to get in touch with Vakilsearch and get it sorted all at once without any issues.
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