INTRICACIES OF A TERM SHEET- The Bargain of Investors
Author: Anmol Mathur
Designation: Student, Queen Mary University Of London
Funding of a business idea is that magic moment every entrepreneur seeks. While pop culture and media outlets shrink financing of a business to a mere investor nod, the actual transaction is much more complex and detailed. When a deal is agreed upon, a term sheet is drafted which contains the basic terms and conditions under which an investment can be made. The term sheet lays down a blueprint as to how the funding will entail. When investors buy or fund a business, they are seeking certain preferences in their favor.
Term sheet in totality is the first negotiating ground where businesses seek funding in lieu of investors seeking control and liquidity preferences. A standard term sheet contains valuation, investment made, liquidation preference, board of directors, voting rights, redemption rights, dividends, exclusivity and the right to first refusal.
A term sheet categorically mentions the investment, the terms of the investment and the conditions precedent for the investment to take place. The term sheet also briefly entails as to the purpose of the investment. The purpose of the investment can be R&D, hiring, business expansion etc. Certain clauses like Minimum Shareholding and Board can be instrumental in bringing investor control in a deal. An investor can propose selection of directors on their approval and can request information rights with reference to the board of director’s shareholder meetings. In businesses, investment can be made in multiple rounds. Hence new investors can demand for Superior Rights that makes sure that the company and the promoters provide equal rights to the old and new investors.
Certain transfer restrictions can be put to avoid confusion and multiplicity of transactions. These transfer restrictions include a Tag Along option that gives the right to an investor to tag along with a promoter, when they are planning to sell their shares to a third party. Similarly, a Promoter Lock-in clause can ensure that promoters can not sell their shares in the presence of investors, without their approval. Additionally, a Right of first refusal gives the right to the investor to purchase shares or part of shares before any third party has the access to do the same.
To maintain their proportional hold on a company, Investors can include Pre-emptive rights clause. Pre-emptive rights give the investor equal terms and conditions to participate in future rounds of fundraising as that of new investors. While Pre-emptive rights makes the investors buy more shares to maintain their shareholding, under Anti-dilution rights, in later rounds of funding if a company issues any equity related securities at terms that are more favourable than those received by the investors in that case the investors will receive additional value/equity from the company.
Liquidation is an important point of negotiation in a term sheet. In an event of liquidation, an investor can ask for a guaranteed payment valued once, twice or even thrice (shares purchased)and can ask to be paid much before any other shareholders.
The term sheet also includes an Exit clause which lists the circumstances in which an investor chooses to exit from a company. Any material breach by the promoters can also trigger events of default where the investors may not choose to be part of the company. With respect to the time, money and effort that goes in negotiating a term sheet, an Exclusivity clause is added which mandates the company and it’s promoters not to entertain or seek any other offers for a set period of time.
In conclusion it can be said that a detailed and well thought out term sheet can be crucial in finalising a deal with much needed clarity. Even though the term sheet is a non-binding agreement, it becomes the stepping stone for more legally binding documents that will be negotiated at later stages. The process of Due Diligence can be kickstarted once an affirmation is made on the terms of Term Sheet.