When a startup raises funding from angel investors, venture capital funds, or strategic investors, one of the first documents discussed is the Term Sheet.
A term sheet is a preliminary investment document that outlines the key commercial, legal, and governance terms between the investor and the startup before final investment agreements are executed.
For founders, understanding the term sheet is extremely important because several clauses can directly impact:
- Founder control
- Shareholding dilution
- Future fundraising
- Investor rights
- Exit opportunities
- Corporate governance obligations
At the startup investment stage, a well-drafted term sheet helps avoid future disputes and creates clarity between investors and founders.
Key Points Founders Should Understand in a Term Sheet
1. Investment Structure & Valuation
The term sheet specifies:
- Amount being invested
- Valuation of the company
- Type of securities being issued such as:
- Equity Shares
- Compulsorily Convertible Preference Shares (CCPS)
- Debentures or Convertible Instruments
This determines how much ownership the investor will receive.
2. Rights Attached to Shares
Different securities may carry different rights.
The term sheet may clarify:
- Voting rights
- Dividend rights
- Liquidation preference
- Priority during exit or winding up
Founders should carefully review whether investors are receiving any special rights compared to ordinary shareholders.
3. Conditions Before Investment (Conditions Precedent)
Investors may require certain actions to be completed before releasing funds, such as:
- Creation of an ESOP pool
- Resolution of pending legal or compliance issues
- Founder share restructuring
- Renewal or renegotiation of important business contracts
These are called “Conditions Precedent” or CPs.
4. Exclusivity Clause
Once the term sheet is signed, the company may be restricted from negotiating with other investors for a specified period.
This ensures that both parties negotiate seriously and in good faith.
5. Standstill / Restricted Actions
Between signing the term sheet and completing the investment, the company may not be allowed to:
- Change shareholding structure
- Appoint senior management
- Raise additional funding
- Enter into major contracts
- Take significant business decisions without investor consent
This helps investors ensure that the business remains stable during the transaction process.
6. Compliance & Governance
The term sheet may require the company to maintain proper corporate governance practices such as:
- Conducting Board Meetings
- Holding Shareholder Meetings
- Maintaining statutory compliances and records
This is especially important as startups scale and prepare for institutional investment.
7. Founder Lock-in & Share Transfer Rights
Investors usually expect founders to stay committed to the business for the long term.
Common clauses include:
- Founder shares being locked-in for a certain period
- Right of First Refusal (ROFR)
- Tag Along Rights
For example, if founders sell their shares, investors may get:
- First right to purchase those shares, or
- Right to sell their shares alongside the founders
8. Investor Exit Rights
Investors generally expect clarity on how they may eventually exit the company.
Possible exit routes include:
- IPO
- Acquisition / Merger
- Secondary sale of shares
9. Legal Costs
The term sheet may specify which party will bear:
- Legal fees
- Due diligence expenses
- Documentation costs
Often, startups are required to bear part or all of the investor's legal expenses.
10. Confidentiality
Both parties are generally required to keep:
- Business information
- Financial details
- Investment discussions
strictly confidential.
11. Governing Law & Jurisdiction
The term sheet specifies:
- Which law will govern the transaction
- Which courts or arbitration mechanism will handle disputes
12. Validity / Tenure of the Term Sheet
The document may remain valid only for a specific period, after which:
- The deal may lapse, or
- Terms may need to be renegotiated
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