Termsheet: From the point of view of startup
A term sheet is a “non-binding agreement” laying out the
essential terms and conditions under which investments are going to be made.
Term sheets are most associated document related to startups rather than other
mature companies. As per general practice, a term sheet is prepared by the
investors in an early funding round and by the company in later funding rounds.
(A non binding contract is an agreement where the parties are not legitimately committed to complete its terms. Their motive is to express the parties' intention as part of the negotiation process)
Term sheet widely covers 3 areas:
2. Corporate Governance
Every part is equally important for the startup while
dealing with the investor.
Valuation of the company, Funding amount, and bifurcation of stake, preference of liquidation, anti-dilutive provisions and commitment of investor are some points that should be concluded in the term sheet.
Finalizing term sheet includes preparing the agreement, performing due-diligence by the investor or third party, consultation with a legal professional for drafting the agreement.
Valuation: The initial step in any negotiation with investors is agreeing upon the valuation of the startup. Valuation is the net worth of the startup as on the date of valuation. Valuation has implications on the level of control employ with founders in the startup, the involvement of investors in settlements (in case of dilution) as well as the ability to raise funds in the future.
Liquidation preference: Liquidation preference is the kind of repayment that investors will get in case the startup shuts down and the assets are being liquidated for settlement. In spite of the fact it is advisable for startups to agree for 1X liquidation preference so that investors will get minimum of what they have invested, however, it is possible for investors to demand multiple preference as well.
Kind of shares offered: There are various classes of shares that can be offered to investors in exchange for their investment. The nature of shares offered has implications on the level of power and control they will use in the startup and their rights in general, and in case of liquidation, the investors always pick for preferred shares since it offers them rights that are not available to the common shareholders.
Option Pools: The set of stocks reserved for current and future manpower to retain them is an option pool. A significant thought here is whether option pools are included in pre- or post-money valuations. If included in pre-money valuation, the whole burden will have to borne by the founders in case of dilution.
Dividend rights: Generally, Dividends are some portion of profits that are distributed among equity shareholders. However, in case of startups, during the initial period they tend to plough back all the profits into the business.
Information Right: An Information right drives a company to provide investors with financial statements and other company data. Major information rights include the opportunity to visit the company’s facilities, inspect the company’s books and records and discuss matters with company officers. Information rights provisions additionally comprise provisions that make sure that investors keep the facts confidential.
Drag Alone: This could be a right that permits a majority shareholder to drive a minority shareholder to participate in the sale of a company. The dominant holder doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller. Though this clause was meant to be employed in good faith, however, check should be conducted and all such clauses should be modified to safeguard the interest of the stakeholders.
Board Composition influences the level of founders control and investors that will employ in the startup. Therefore, it is important to consider the size and composition of the board. Giving exclusive right to single investor for various positions should be avoided.
Investor Rights: Several clauses and rights are included in this broad head and startups must consult with their lawyer regarding this.
Participation Rights: Through participation rights, investors get better returns upon liquidation and often they are try insist to including it in term sheet. Yet, it is not standard practice to include it and the founders must ensure it is not included. In case the investors are too insistent, then a cap should be considered to secure the interest of the founders.
Voting Rights: Despite being preferred shareholders, investors get voting rights like common stakeholders. Under the situation and areas involving decision-making, they get voting rights detailed in the term sheet.
Rights: Major decisions that influence the startup in a big way will require
the consent of the investors and these decisions structures the consent rights
in the term sheet.
Founder Provisions: Founders and the management of the startup are basically its representatives and having them onboard for a longer period gives investors a feeling of trust and confidence in the startup. Term sheets will include founder vesting schedules to guarantee they do not leave in the short-term.
The founders of the startup should be well-prepared before negotiating the term sheet with the investor. The terms and conditions have an implication on overall return, control and ownership of the startup, not just in the present but in the future too. Management should take decisions keeping in mind the best interests of the startup.
Other cautious points that startups should consider while dealing with the investor:
that focus a lot on the exit
of reasonable timelines and pressure on the revenue numbers only, ignoring the
business development required time for a products or services.
debt financing (obligation) and convertible note terms. This may make startup
out of the market, and it could lead to bankrupt.
looking for and demanding a large dominant stake
Any provision included in agreements may not make sense
today, but one of them may be triggered in the long run and could put founder,
co-founders, employees and co-investors in a bad situation, or better yet,
shield any startup from abuse and unjustified moral harassment.
How Virtue Ventures helps you in preparation of term sheet?Virtue Ventures provides you easy access to an experienced
lawyer who will render a professional expertise at reasonable cost.
How To Get The Term Sheet Prepared?Preparing a Term Sheet is must as it specifies what the
company is gaining and what the investor is expected to receive in return.
Virtue ventures will guide you the 3 steps by which startup get term sheet.