Term Sheet

CS Shirish Bhootra
Sep 27, 2022
3 min read

Written by CS, Shirish Bhootra

Introduction:

A term sheet is a document that discloses the terms of the deal between the parties. Its area of coverage is basically during negotiation between parties for the prospective deal.

Key Factors:

It is an agreement between parties during negotiation which discloses the terms of a prospective deal between parties.
Its contents include the key financial factors and other terms relevant to the proposed investment between parties (Founder and Finance Source).
It is also known as a Letter of Intent, Principal Agreement or, Memorandum of Understanding.
The first step in financing transactions where transaction terms are negotiated is the term sheet. Its area coverage includes but is not limited to venture capital and private equity. It is also applicable to traditional straight debt financing.

Some Facts about Term Sheet to Review:

Term Sheet: Legal Binding Force

A term sheet is not legally binding. It is subject to exceptions in case of legal liability for confidentiality, exclusivity, and costs. It focuses on defining the terms and evaluating if the deal has enough legs to close between the parties.

Valuation of Your Business?

Evaluate the company's worth by setting the companies operating in the same segment as a benchmark. A high valuation may demand high performance in securing funding.

Due Diligence:

The due diligence process must be performed with due care and attention. Among various major concerns raised by venture capital and private equity sources, one is the improper execution of the due diligence process by the founder regarding their long-term partner. There should be clarity in terms of how the investors would contribute to the company in ways other than funding.

Term Sheet Format: Important Clauses

Financial Instrument:

Stocks, which include preferred stocks and common stocks, are the most common types of equity. Convertible debt notes are also being considered now.

Participation Rights related to Partner :

They may be classified into three categories, ranging in their economic upside potential to investors.

Non-Participating
Capped Participation
Full Participation

Pro-rata Rights:

Pro-rata rights provide initial investors with an opportunity but not the obligation to invest in future rounds so as to maintain their ownership and avoid the dilution effect affecting the ownership.

Liquidation Preference:

It deals with the situations relating to the occurrence of a liquidation event, like the sale of a company, mergers, etc. The payout in such events is to be done as per liquidation preference.

Anti-dilution Provisions:

This right acts as a safeguard to an investor from equity dilution caused by future stock issues if the stock is sold for a value less than the value that the investor has originally paid at the time of acquisition.

Protective Provisions:

Protective Provisions provide investors veto rights that otherwise were not capable of being exercised at the board level of management.

Drag Along Rights:

This segment of the term sheet deals with the aspect that allows shareholders to compel other stock classes to agree to their voting demands on the occurrence of events such as a sale, merger, or dissolution.

Right of First Refusal:

In order to control the executions of transactions related to secretive stock transfers, all the investors should be informed regarding the purchase of stocks by other investors. Approval of the board is a prerequisite for the transfer of ownership related to directors.

Conclusion:

A term sheet is like the first step to constructing a building. It plays a crucial role in case of transactions that involve negotiation. It protects the interest of parties to the transaction with clarity.