What is a Term Sheet?
A term sheet is a non-binding document that outlines the fundamental terms and conditions of an investment deal between a startup and investors. It serves as a blueprint for the definitive legal agreements (Share Purchase Agreement, Shareholders Agreement, etc.) that will be drafted later. While most provisions in a term sheet are non-binding, certain clauses like exclusivity, confidentiality, and no-shop provisions are legally binding.
In the Indian startup ecosystem, term sheets are standard for seed rounds, Series A, and subsequent funding rounds. They cover critical aspects including company valuation, investment amount, investor rights, governance structure, and exit mechanisms. Understanding term sheet nuances is essential for founders to negotiate favorable terms while securing necessary capital.
Purpose of a Term Sheet
- • Establishes framework for investment negotiations
- • Identifies major deal points before expensive legal drafting
- • Aligns expectations between founders and investors
- • Demonstrates investor commitment to the deal
- • Provides roadmap for due diligence and closing
- • Enables comparison between multiple investment offers
Binding vs Non-Binding Provisions
Typically Binding
- • Exclusivity/No-shop period
- • Confidentiality obligations
- • Due diligence access rights
- • Expenses and cost allocation
- • Governing law and jurisdiction
Typically Non-Binding
- • Valuation and investment amount
- • Liquidation preference terms
- • Board composition
- • Anti-dilution provisions
- • Founder vesting schedules
Anatomy of a Term Sheet
A well-structured term sheet typically contains several key sections that address different aspects of the investment. Understanding each section helps founders navigate negotiations effectively.
1. Offering Terms
Investment amount, pre-money valuation, post-money valuation, security type (equity/CCPS), and percentage ownership.
2. Corporate Governance
Board composition, board meeting requirements, observer rights, and information rights.
3. Protective Provisions
Investor veto rights over major decisions like M&A, additional funding, asset sales, and charter amendments.
4. Economic Rights
Liquidation preference, anti-dilution protection, dividend rights, and redemption rights.
5. Transfer and Exit Rights
Drag-along, tag-along, right of first refusal, co-sale rights, and pre-emptive rights.
6. Founder Restrictions
Vesting schedules, non-compete agreements, IP assignment, and full-time employment requirements.
Valuation and Investment Amount
Valuation is often the most negotiated aspect of a term sheet. It determines how much ownership investors receive for their capital investment. Understanding pre-money and post-money valuation is crucial for founders.
Pre-Money vs Post-Money Valuation
| Metric | Definition | Example |
|---|---|---|
| Pre-Money Valuation | Company value before investment | ₹8 Crore |
| Investment Amount | New capital being invested | ₹2 Crore |
| Post-Money Valuation | Pre-money + Investment | ₹10 Crore |
| Investor Ownership | Investment ÷ Post-Money | 20% |
Founder Tip: Always Clarify Which Valuation
When discussing valuation with investors, always clarify whether you're talking about pre-money or post-money valuation. A "₹10 Crore valuation" could mean ₹10 Cr pre-money (resulting in different ownership) versus ₹10 Cr post-money. Use explicit language to avoid misunderstandings.
Fully Diluted Basis
Ownership calculations are typically on a "fully diluted basis," meaning all outstanding securities are considered, including:
- • Issued and outstanding shares
- • Reserved shares under ESOP pool
- • Convertible securities (convertible notes, CCPS)
- • Warrants and options
Type of Security
Investors in Indian startups typically invest through Compulsorily Convertible Preference Shares (CCPS) or Compulsorily Convertible Debentures (CCD). Understanding these instruments is essential for founders.
Compulsorily Convertible Preference Shares (CCPS)
CCPS are the most common investment instrument for startup funding in India. They combine debt-like protections with equity upside.
- Liquidation Preference: CCPS holders get paid before equity shareholders
- Conversion Rights: Convert to equity shares at predetermined ratio
- Dividend Rights: May have preferential dividend rights
- Voting Rights: Typically vote only on matters affecting their class
- Must convert within 10 years (FEMA compliance)
Compulsorily Convertible Debentures (CCD)
CCDs are debt instruments that automatically convert to equity. They're sometimes used for bridge rounds or specific regulatory situations.
- • Treated as debt until conversion, then as equity
- • May carry interest until conversion
- • Conversion terms specified in the instrument
- • Must convert within 10 years per FEMA
Convertible Notes (for early stage)
Convertible notes are short-term debt that converts to equity in the next funding round. They're popular for seed/angel rounds but have regulatory considerations in India.
Liquidation Preference
Liquidation preference determines the order and amount investors receive when the company exits (sale, merger, or liquidation). It's one of the most important economic terms in a term sheet.
Types of Liquidation Preference
Non-Participating (Founder-Friendly)
Investor chooses between: (1) receiving their liquidation preference amount, OR (2) converting to common shares and sharing pro-rata. Most common in India.
Participating (Investor-Friendly)
Investor gets their liquidation preference AND participates pro-rata with common shareholders. Results in higher investor returns.
Liquidation Preference Multiples
The multiple determines how much investors get before others receive anything:
- 1x (Standard): Investor gets their investment amount back first
- 1.5x - 2x (Aggressive): Investor gets 1.5x or 2x their investment
- 3x+ (Very Aggressive): Rare except in distressed situations
Example: 1x Non-Participating
Investor invests ₹2 Cr at ₹8 Cr pre (20% ownership). Company sells for ₹10 Cr.
- • Investor can take ₹2 Cr (their investment back)
- • OR convert and get 20% of ₹10 Cr = ₹2 Cr
- • In this case, both options are equal
If company sells for ₹50 Cr: Investor converts to get 20% of ₹50 Cr = ₹10 Cr (better than ₹2 Cr preference)
Anti-Dilution Protection
Anti-dilution provisions protect investors if the company raises a future round at a lower valuation (down round). There are two main types with significantly different impacts on founders.
Types of Anti-Dilution
Weighted Average (More Common)
Considers both the lower price and the amount of new shares issued. Results in moderate adjustment to conversion price. Founder-friendly approach used by most reputable investors.
Full Ratchet (Aggressive)
Conversion price is fully reduced to the new, lower price regardless of how many shares are issued. Can result in massive dilution for founders. Should be avoided if possible.
Broad-Based vs Narrow-Based Weighted Average
- Broad-Based (More Common): Includes all outstanding shares, options, warrants, and convertible securities in the calculation. More founder-friendly.
- Narrow-Based: Includes only currently outstanding shares. Results in higher adjustment. Less common in India.
Founder Warning: Full Ratchet Impact
If you raise ₹10 Cr at ₹40 Cr pre (20% dilution), then a down round at ₹20 Cr pre with full ratchet: The first investor's conversion price drops from ₹40 Cr to ₹20 Cr effective valuation, doubling their ownership percentage. This can wipe out founders.
Board Rights and Governance
Board composition determines who controls company decision-making. This is a critical governance aspect that founders should carefully negotiate.
Typical Board Structures
| Stage | Common Structure | Example |
|---|---|---|
| Seed/Angel | 2-3 members | 2 Founders + 1 Investor/Independent |
| Series A | 3-5 members | 2 Founders + 2 Investors + 1 Independent |
| Series B+ | 5-7 members | 2 Founders + 3 Investors + 2 Independents |
Board Observer Rights
Investors often request board observer rights - the right to attend board meetings without voting power. This is generally acceptable but should be limited to:
- • No more than 1-2 observers
- • Right to exclude observers from sensitive discussions (compensation, litigation)
- • No voting rights even in observer capacity
Information Rights
Investors typically require regular financial and operational information:
- • Monthly financial statements (within 30 days)
- • Quarterly board meetings
- • Annual audited financials
- • Annual budget approval
- • Notice of material events
Protective Provisions (Veto Rights)
Protective provisions give investors veto rights over specific major decisions. While investors need protection against misuse of their capital, excessive veto rights can paralyze company operations.
Standard Protective Provisions
These are generally accepted veto rights for investors:
- • Sale or liquidation of the company
- • Amendment of investor rights
- • Creation of new share classes with superior rights
- • Change in authorized share capital affecting investor rights
- • Declaration of dividends
Potentially Problematic Provisions
Founders should push back on these or require supermajority thresholds:
- • Approval of annual budget (can cause operational paralysis)
- • Hiring/firing executives above certain level
- • Entering new lines of business
- • Individual expenditure approvals
- • Changes to business plan
Voting Thresholds
Veto rights can be structured by:
- Majority of the class: Most common - majority of preferred shareholders must approve
- Supermajority: Higher threshold (e.g., 66% or 75%) - more founder-friendly
- Individual investor: Each investor has individual veto - most restrictive
Drag-Along and Tag-Along Rights
These provisions govern how shares can be sold and ensure alignment during exit scenarios.
Drag-Along Rights
Drag-along rights allow majority shareholders to force minority shareholders to join in a sale of the company. This is important because buyers typically want 100% ownership.
Key Drag-Along Terms
- • Trigger threshold: What percentage constitutes "majority" (usually 50-75%)
- • Same terms: Minority must receive same price and terms as majority
- • Representations: Limitations on representations minority must give
- • Timing: Notice period and closing mechanics
Tag-Along Rights
Tag-along rights protect minority shareholders when majority sells. If majority sells to a third party, minority shareholders have the right to join the sale on the same terms.
Tag-Along Protection
- • Right to sell pro-rata portion in any permitted transfer
- • Same price and terms as selling shareholder
- • Notice period to exercise tag-along
- • Mechanism if buyer doesn't want minority shares
Right of First Refusal (ROFR)
ROFR gives existing shareholders the right to purchase shares being sold by another shareholder before they can be sold to an outside party. This maintains control within the existing shareholder group.
ROFR Mechanics
Step 1: Sale Notice
Selling shareholder provides notice with terms of proposed sale to third party.
Step 2: ROFR Period
Company and/or investors have 15-30 days to decide whether to purchase shares at the same terms.
Step 3: Exercise or Waiver
If ROFR exercised, shares sold to existing shareholders. If waived, seller has limited time to complete third-party sale on same terms.
Right of First Offer (ROFO)
ROFO is similar but requires seller to offer to company/investors first before seeking outside buyers. If they decline, seller can seek outside offers but often must come back if the outside offer is lower.
Founder Vesting
Founder vesting ensures founders remain committed to the company over time. Unvested shares are subject to repurchase by the company if a founder leaves.
Standard Vesting Terms
| Parameter | Standard | Notes |
|---|---|---|
| Vesting Period | 4 years | Sometimes 3-5 years |
| Cliff Period | 1 year | No vesting before cliff |
| Vesting Frequency | Monthly or Quarterly | After cliff period |
| Acceleration | Single/Double Trigger | On acquisition/termination |
Acceleration Events
Single Trigger
Accelerated vesting upon acquisition of the company. Fully vests all unvested shares on change of control.
Double Trigger
Requires both acquisition AND termination without cause (or resignation for good reason) within 12 months of acquisition.
Founder Tip: Pre-Issue Vesting
If you've been working on the company for 6+ months before investment, negotiate for some "pre-vested" shares representing your work to date. It's reasonable to argue that 6-12 months of work should count toward vesting.
Exclusivity and No-Shop Clauses
These binding provisions prevent founders from shopping the deal to other investors while the current investor completes due diligence and documentation.
No-Shop / Exclusivity Period
- • Typical Duration: 30-60 days from term sheet signing
- • Scope: Cannot solicit, encourage, or discuss alternative financing
- • Exceptions: Often excludes unsolicited approaches
- • Fiduciary Out: May negotiate superior offers that emerge unsolicited
Confidentiality
Term sheet terms and existence of discussions must remain confidential. This protects both parties if the deal doesn't close.
Founder Strategy
Keep exclusivity periods reasonable (30-45 days max). Ensure there's a "fiduciary out" if a clearly superior unsolicited offer emerges. This protects your duty to shareholders while respecting the investor's process.
Term Sheet Negotiation Strategies
Negotiating a term sheet requires balancing getting the best terms with maintaining a positive investor relationship. Here are strategies for effective negotiation.
Priority Ranking for Founders
Must Protect (Non-Negotiable)
- • Avoid full ratchet anti-dilution
- • Maintain board control or at least deadlock
- • Reasonable vesting (not excessive)
- • No excessive liquidation preference multiples (>1x)
Important to Negotiate
- • Participating vs non-participating preference
- • Scope of protective provisions
- • Board composition
- • Vesting acceleration triggers
Can Give On
- • Information rights frequency
- • Board observer rights
- • Registration rights
- • Minority covenants
Creating Competition
The best way to get favorable terms is to have multiple interested investors:
- • Run a structured fundraising process with multiple meetings
- • Create urgency with clear timelines
- • Be transparent (but not too detailed) about other interest
- • Get multiple term sheets if possible
- • Use one term sheet to improve another
When to Get Legal Help
Engage a startup-experienced lawyer before signing the term sheet. While term sheets are mostly non-binding, they establish the negotiation framework. It's harder to change terms after signing the term sheet, even if non-binding.
Legal Costs and Fees
Understanding the costs involved helps founders budget appropriately and negotiate cost-sharing arrangements.
| Cost Item | Typical Range | Notes |
|---|---|---|
| Founder Legal Fees | ₹75,000 - ₹3,00,000 | Depends on complexity and negotiation |
| Investor Legal Fees | ₹1,00,000 - ₹5,00,000 | Often paid by company (capped) |
| Due Diligence Costs | ₹50,000 - ₹2,00,000 | Financial/tax DD if required |
| Stamp Duty & Filing | ₹10,000 - ₹50,000 | Share issuance, SH-7 filings |
Cost-Sharing Norms
- Investor Legal Fees: Usually company pays investor counsel fees (with a cap of ₹1-2 lakhs typical for seed/Series A)
- Founder Legal Fees: Company typically pays for founder counsel as well
- Capped Amounts: Always negotiate a cap on legal fees company will pay
- Abort Costs: Negotiate who pays if deal doesn't close
Budget Planning
For a typical seed/Series A round in India, budget ₹2-5 lakhs for total legal costs. This includes both sides' legal fees, due diligence, and filing costs. Include this in your fundraising ask so you're not using operational funds for legal expenses.