Startups and financing go hand-in-hand, and all paperwork and legislation become significant. The "term sheet" may be utilised for various investments, and this article will tell you about the evolution of term sheets in India.
Overview
A term sheet indicates that the parties—founders and investors—have reached a preliminary degree of comfort following negotiations. This in-principle agreement covers various essential business elements, including the valuation. The concept and attributes of term sheets have witnessed quite some change in the past few years, and it requires a detailed study to comprehend the evolution of the term sheet in India,
The term sheet formalises the conversations and incorporates non-contractual agreements between the parties. Following the execution of the Term Sheet, the parties will conduct due diligence and then negotiate, agree upon, and execute the Definitive Agreements. A legally binding obligation to complete the deal is formally created upon enforcing these definitive agreements. Therefore, a term sheet does not impose any legal commitments on the investor to invest or the corporation to issue shares to that investor.
Why Is Everything so Challenging For Business Owners?
Because these entrepreneurs are working with knowledgeable investors, it is complicated. Although entrepreneurs may find all of this intimidating, they will discover that the term sheet protects the rights and innocence of the investors and their ownership. Entrepreneurs work with knowledgeable investors who make investments based on well-defined objectives and tenets. Investors must be extra cautious in allocating their funds because they are responsible for handling other people’s money. Investors, therefore, devise specific measures to protect themselves, and these concepts are finally reflected in a term sheet and the other contracts.
Evolution of Term Sheet In India
A pure one-time reserve requirement with all money at par is now rather prevalent, but a different typed of term sheet can be seen if we observe the evolution of term sheets in India. In the past, a waterfall was almost always dependent on the investor liquidation and funding preference series, with a minimum of 2X or even 3X. Double dipping was very frequent, especially in rounds for the development stage.
Even while large rounds are currently being funded at high valuations, many businesses may run afoul of the anti-dilution clause in later rounds as the valuation requirements adjust in reaction to changes in the external market. Founders and early investors would be wise to guarantee a wide-ranging weighted average of the anti-dilution clause because a full ratchet can irreparably harm a cap table.
Founders view super pro-rata rights as a fantastic endorsement of their business’s popularity. However, super pro-rata indicates that individuals who won’t lead or price the round have already received a significant percentage of the following round. This clause is nearly tough for incoming investors to deal with.
There hasn’t been any modification regarding the Employee Stock Ownership Plan (ESOP) pool. ESOPs are not included in pre-money calculations because the founders are solely responsible for them. Investors must determine the price and founder equity upfront in the ESOP pool using pre-money calculations as more and more businesses go public.
Voting and veto rights have also advanced, but they still need improvement because the founders wanted more control for themselves. Special voting rights for founders are more frequent and are also favoured in board composition. In the wake of the transfer of power from investors, the reach of veto rights has also been reduced. Investors may grant these in prosperous times if they agree to let go of them.
Purpose of a Term Sheet
Evolution of the term sheet in India serves several purposes, including:
Establishing the Foundation
Term Sheets provide a framework for negotiations. They set the groundwork for further discussions and deal-making processes.
Identifying Deal Structure
Term sheets help clarify the nature of the transaction. It also sheds light on investment type, valuation, rights and obligations, and timelines.
Streamlining Negotiations
By outlining key terms upfront, a term sheet helps streamline negotiations. It also reduces the likelihood of misunderstandings.
Facilitating Due Diligence
Term Sheets offer a starting point for assessing the viability and risks associated with a proposed transaction. It helps enable the due diligence processes.
Elements of a Term Sheet
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Parties and Transaction Details
The term sheet should clearly identify the parties involved, their legal names, addresses, and roles. It should provide an overview of the transaction, including its nature, purpose, and scope.
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Valuation and Investment Terms
This section outlines asset valuation and the terms and conditions of the investment. It also sheds light on investment amount, equity stake, and special rights granted to investors.
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Corporate Governance
Matters related to company management and control are covered here. This section discusses board composition, voting rights, decision-making processes, and investor consent requirements.
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Rights and Obligations
The term sheet highlights the rights and obligations of each party. Dividend payments, anti-dilution protections and exit mechanisms are discussed in detail.
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Conditions Precedent
This section outlines the conditions to be satisfied before the deal can go through. It includes aspects such as regulatory approvals, due diligence, documentation, or shareholder approvals.
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Confidentiality and Exclusivity
Here are provisions to protect confidential information and establish exclusivity during negotiations.
How to Make a Term Sheet Solid?
Both investors and founders should have excellent legal counsel. Why wouldn’t you use the same strategy when choosing your legal counsel for something significant to your life? You wouldn’t think twice about spending a lot of money to find the best doctors! Usually, founders believe they can create their term sheet because of internet “open source” type templates.
Using the template is more important than using the template. A founder needs good guidance as he structures a deal with the investor, and good counsel entails more than just creating effective documents.
The Legal Position of Term Sheets
Let’s examine the legal status of term papers by Indian legislation. The following is a summary of the several cases in which the Supreme Court of India reviewed various term sheet-related issues:
- The drafted term sheet should be read entirely, not in bits and pieces, to grasp the parties’ intentions
- The acquirer was authorised to terminate the term sheet if the sell side did not meet the conditions outlined in it and the behaviour of the sell side, in general, would not inspire trust. The parties do not yet have a binding legal connection, so the acquirer was within their rights to consider all the relevant factors before determining whether or not to engage in a contractual contract.
- Consensus ad idem, or a meeting of the minds, can be determined from the parties’ actions even though all parties have not yet signed a legally binding agreement.
Conclusion
An essential instrument in venture capital is the term sheet. The final terms of a transaction are negotiated using this document, which describes the investment parameters. As it can help set clear objectives and prevent misunderstandings later on, a term sheet can be helpful for both businesses and investors.
A term sheet is not a binding contract; instead, it is a strategy for the transaction. Terms sheets are generally consistent from Venture Capital Company to venture capital firm, and the goal is to make them simpler and more explicit. At Valiksearch, we provide our readers with valuable and trustworthy information. Visit the website to read educational and engaging blogs and receive expert advice.
Frequently Asked Questions (FAQs)
What does a term sheet mean in business?
A term sheet is an agreement that outlines the terms and conditions of a proposed deal. It serves as a roadmap for negotiations and further discussions.
What are the key terms of a term sheet?
Key terms may vary, but common elements include Valuation Investment amount Equity stake Corporate governance Rights and obligations Conditions precedent, and Confidentiality provisions
How do you negotiate a term sheet?
Negotiation involves carefully considering proposed terms, assessing implications, and engaging in open discussions. Clearly communicating expectations, addressing concerns, and seeking professional advice are important.
Is a term sheet enforceable?
Generally, a term sheet is not legally binding. However, certain provisions, such as confidentiality and exclusivity, may be enforceable. Legal experts can provide guidance on enforceability in specific jurisdictions.
What are the risks of a term sheet?
Risks include misunderstandings, failure to meet conditions, changes in market conditions, and delays. Seeking professional advice and conducting thorough due diligence can mitigate these risks. Vakilsearch's expertise in term sheets can assist Indian businesses in facilitating successful transactions. Get in touch with our experts to get yours today!
Term sheets—Are they contracts?
This term sheets is merely an expression of potential commercial transactions between the buyer and target and is not a contract or legally binding agreement.
What happens following a term sheet?
Deal finalisation is the next step after you've decided on the investors you would like to work with and have discussed and signed their term sheets.
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