A term sheet is crucial for investment. You should know what are the pros and cons of standard term sheets before signing one. This article covers all the pros and cons of standard term sheets and the important details that a term sheet should contain
Overview:
Whenever a business deal is finalised, a term sheet is signed by both the investor and the founder of the company. The term sheet acts as an agreement between these two parties. All the terms and conditions of the business are drafted in the term sheets. This article is about Pros and Cons of Term Sheets.
What Is Term Sheets in Venture Capital?
A standard term sheet is a non-binding agreement with a record of all the terms and conditions. It also acts as a legal document that lays out the important rules and regulations for investment. In most cases, new start-ups will utilise term sheet to invite investors, and venture capitalists. However, the term sheet comes with its own set of pros and cons.
Pros of Standard Terms Sheets
If this is the first time you’re starting a business or you are unaware of how to approach for funding, then term sheets act as an added advantage.
- The term sheets provide an opportunity for an individual to discuss all the funding details in greater depth with the investor
- Term sheets play a crucial role when it comes to avoiding biassed contracts
- By having a good term sheet you can exercise your rights under multiple scenarios
- The term sheet helps you to easily walk away from a deal if unable to reach an agreement
- A term sheet provides leverage to an individual to clearly express his point of view and allow the parties to accept them
- The best part of a term sheet is it increases commitment among both the sides in attaining a common objective.
Cons of Standard Terms Sheets
If you are focusing on raising capital from several investors, then using a term sheet will not help.
- Writing up a term sheet is usually costly, the cost of the term sheet will vary based on the clauses present in it
- Enclosing a term sheet in your contract can cause many limitations
- Occasionally in a company negotiation, the facts left without discussing provides you with the most power
- Utilising a term sheet can affect one or both sides in challenging circumstances
- Another major disadvantage is that one cannot discuss the details of the term sheet outside the legal council
- It is crucial to reduce the proposed terms and conditions in the term sheet
- Without a lawyer’s review, if the terms are signed it may result in a regretful situation.
What Does a Good Term Sheet Contain?
As per our experts at Vakilsearch, a standard term sheet should contain all the following aspects.
Board of Directors
- When organising a board of directors meeting, it’s important to comprise it on the term sheet
- The term sheet guarantees that the firm is administered properly
- The board members can make committee votes in the council
- Appointing board members also enables the firm to develop and proceed to circulate the generated funds to all other members.
Company Information
The Term sheet always contains details of the company’s name, its valuation, and the investors involved. It encompasses all the details of the company in a potential agreement.
Complete Investment Overview
A term sheet should contain all the details of an investment.
- The primary investment involved
- The total amount of stake expected to be earned in the future
- Terms of investor’s commitment to the business
- The time period the investors plan to be vested in the company.
Information About Voting Rights
Some corporations choose to include all the information regarding voting rights and explain it in detail in the term sheet. It shows that the company’s future plan is overseen by the investor.
What Are the Pros and Cons of Term Sheets? :Liquidation Preferences
Firms may also involve the liquidation preference in the term sheet. It clearly shows how the company will proceed after liquidation and the total amount that is shared among the investors.
Participation Rights and Pro-rata Rights
- Participation rights will be maintained only by investors
- They can agree to take back their investment by getting a return on investment before other investors
- They can continue to participate in the funding process without the fear of losing money in the future
- Pro-rata rights are reserved for investors who are willing to participate in future financing to maintain their ownership stake.
Purchase Price
If the business focuses on using a term sheet in case of a merger it should contain all the information regarding primary purchases, price assets, collaterals, and payment methods. Any company assets that are not part of the deal will not be mentioned in the term sheet.
How Vakilsearch Can Help in Drafting the Term Sheet
The experts at Vakilsearch can provide great insight when it comes to drafting the pros and cons of term sheets. All you have to do is contact us through vakilsearch.com. Our expert team will get in touch, collect all the required information, and draft the term sheet within 2 to 4 business days and send it for your approval.
Remember, legal is now easy at Vakilsearch!
FAQs
What should be included in a Term Sheet?
✸ Amount of Investment
✸ Valuation of the Company
✸ Type of Securities being issued
✸ Investors' Rights
✸ Founders' Rights
✸ Liquidation Preferences
✸ Exit Terms
What is the difference between a term sheet and a MoU?
MoU is a non-binding agreement, while a term sheet is a more detailed document that outlines the specific terms of a deal.
What is the difference between a term sheet and an LOI?
LOI is a non-binding document that expresses one party's intent to enter into a deal with another party. A term sheet is more detailed than LOI and includes the specific terms of the deal.
What are Term Sheets for Startups?
Term sheets are used by startups to raise capital from investors. They outline the specific terms of the investment, such as the amount of investment, the valuation of the company, and the investors' rights.
Who prepares the Term Sheet?
The investor’s or the startup's lawyer prepares the term sheet.
What is the use of term sheet?
Term sheet serves as a blueprint for the formal legal paperwork that will be drafted later. It outlines the key terms of the investment, such as the amount of investment, the valuation of the company, and the investors' rights.
Is a term sheet legally binding?
A term sheet is not legally binding, but it is a strong indication of the parties' intent to enter into a deal.
Is term sheet a binding document?
A term sheet is not a binding document, but it is a good starting point for negotiations.
Is a term sheet legal?
A term sheet is legal, but it is not a legal document. It is a non-binding agreement that outlines the basic terms of a potential deal.
Is term sheet legally binding in India?
A term sheet is not legally binding in India, but it is a good starting point for negotiations.
What is term sheet also known as?
A term sheet is also known as head of agreement, letter of intent, or memo of understanding.
