India has been known as the third largest ecosystem of the world, and no wonder, it is home to more than 39K active startups, according to Inc42’s The State of Indian Startup Ecosystem 2018 report. The startups have raised billions of dollars in funding and have been performing exceptionally well over the years, bringing a lot of foreign as well as domestic investor interest.
At present, the investors across domains have been examining the ample number of funding requests from several startups, however, from an entrepreneur’s point of view, there’s a lot of risk in opening its books/data or startup idea and its uniqueness to an investor while they seek funding support.
We have had cases like OYO vs ZO Rooms, which is a case up and running in the court while at the same time, Infibeam recently backed out of a deal to buy Snapdeal’s Unicommerce. In such situations, an entrepreneur’s survival kit is the term sheet.
A term sheet is a nonbinding agreement setting forth the basic terms and conditions under which an investment will be made. A term sheet serves as a template to develop more detailed legal documents.
However, as a budding or early stage entrepreneur sometimes makes a lapse of judgement or runs off the mill to secure a quick investment, they may skip up seeking support and understanding of the term sheet from a lawyer. Not everything and not always goes wrong, but even as you run around to ensure an increase in bank balance for your startup, we bring you some essentials to keep in mind for your term sheet.
In this week’s Startup 101 series, Sharda Balaji, founder of NovoJuris Legal explains the components of a term sheet. Balaji looks closely at the terms and conditions typically listed in a term sheet and what an entrepreneur needs to know while drafting one.
She explains that the components of a term sheet usually include valuation of an enterprise pre and post money, how much worth the investor invests in and therefore, the dilution or stake they will have in the company.
“The instrument of investment could be either equity, typically angels do that, or preferred stock, which is what institutional investors would do,” she explains.
Notably, some of the transfer restriction on the founders includes:
- Founders will have to be in the company till the time the investors have invested in
- If promoters were to sell, then the first right of first refusal to the investors
- The ability to buy founder’s stake in case of liquidity or liquidation events such as IPO, M&A, company buyback etc.
Some other important elements are the ability for an investor to tag along when a promoter is selling and if the investor has not had an exit over a period of time, say five to seven years, then an ability for the investors to drag the founders and sell it to another party, usually a third party.
The term sheet also comprises some of the control mechanisms, such as how do board meetings happen, how do shareholder meetings happen, some of the reserved matters or affirmative concerns a promoter will have to obtain from the investors.
Also, some basics of term sheet include clauses of confidentiality, non solicit, non compete etc.