An agreement that outlines the terms and conditions of the investment is known as a term sheet. Even though it isn’t legally binding, any investor will expect you to uphold it after you sign it. You must therefore be fully aware of the issues involved and be able to negotiate the best term sheet for both you and your company. In an ideal world, a term sheet would include fair clauses that would protect the interests of both you and your investors. However, the truth is that term sheets aren’t always impartial or just, and they can have long-lasting effects on your company. This is due to the fact that an equity investment will essentially become a partner in your company. Therefore, it’s imperative to make sure you bargain for the greatest conditions before making a contract.
Key features in Term Sheet:
- An assessment:
An estimation of company’s worth as an investment opportunity. The enterprise value less debt is subtracted from the company’s equity value, which is then divided by all of the issued shares, securities convertible into shares, and options that have already been granted or are still available under the company’s Employee Stock Option Plan. This is how valuations are typically expressed: as a price per share.
- The issuance of securities
The stock or other securities that the investor is buying, together with the key terms (e.g., preferences upon a sale or dissolution of the company, dividends payable, rights to convert into common shares, rights to require a redemption, etc.). Typically, venture capitalists ask for convertible debentures or preferred shares.
- Board privilege:
The power of an investor to choose board candidates through appointment or election. Typically, investors will only ask for the ability to choose a small portion of the board members, but they may insist on the appointment of independent directors who will hold the balance of power and/or invite one or more observers to every board meeting.
- Protection of Investor:
Important company decisions need investor approval. These often include the creation and issuance of shares that are more valuable than the shares held by investors, taking on secured debt, restructuring the business, repurchasing shares, and paying dividends on shares. Additionally, management-level decisions like selecting and removing top officers and altering the course of the company’s operations may be included.
Why it is important to have term sheet?
Nevertheless, the creation of a term sheet is not legally binding on any party. But before engaging into a business contract, all parties will benefit greatly from creating a term sheet.
- Helps in building parties’ relationship– It establishes an easy-going interaction between possible investors and start-ups.
- Time-Saving– Negotiating a term sheet for a commercial deal takes less time.
- Removal of Misperception– It greatly lowers the likelihood of superfluous details occurring and decreases the likelihood of a misunderstanding.
- Leave the contract– If the agreement is not carried out as promised, it gives both parties the freedom to end it without damaging their reputations.
What steps must be taken to convert the term sheet into a signed deal?
Once venture capitalists have expressed interest in investing in the company, a number of processes must be taken before the term sheet and agreement are signed. Accepting the particular terms and conditions of the contract is the next stage. The procedure is extremely technical, so a lawyer must be properly involved in structuring it.
Several steps must be taken before you can sign the final contract. Before concluding the agreement, there are several actions that must be taken:
- Discussing about the term sheet,
- Doing a thorough investigation and negotiating the specifics of the final contract
- Deal completion.
- The completion of the deal also includes:
- Launching due diligence
- Contract understanding
- The time it will take before the term sheet is signed.
It is always a worthy option to read the things before signing it. A the term sheet is the drafted to reduce the distance between investors and start-up founders it is important that it should be drafted in a well designed format that leaves no place for the misconception between both the parties i.e. the effective clauses must be added with clarity in language for easy understanding. Term sheets are proven more crucial for the start-up companies as compared to the well developed companies.
Associate at Aggarwals & Associates, S.A.S Nagar, Mohali