Why is a Term Sheet Important For an Investment?

A Term Sheet is an introductory document presented before an investor in the fundraising procedure and is crucial to convince the investor. The term sheet to a huge extent is responsible to get a good investment.

What is a Term Sheet?

The Term Sheet is the agreement that mentions the terms and conditions of an investment. This agreement is non-binding in nature.

The Term Sheet is the template for the future contract to be signed by the parties. In other words, the term sheet is a trailer to the actual legally-binding contract of investment towards which the parties are proceeding.

A Term Sheet usually comes into the picture at the time of fundraising by a startup.

What are the essential elements of a Term Sheet?

To draft a Term Sheet, the following points are necessary:

1. A valuation

Valuation is the price per share of the company that is calculated to apprehend how investment-worthy a company is. The valuation is calculated on a fully diluted basis, which implies the equity value of the company that is to be divided by all the issued shares.

2. Securities being issued

The shares and securities which are to be invested in and the main terms and conditions relevant to the shares and securities are to be mentioned in the Term Sheet. For example, the dividends payable later, preferences upon a sale or dissolution of the company, rights of the shareholders to convert into common shares, rights to require a redemption, etc.

3. Board rights

The Term Sheet should contain the right of the investor concerning the appointment and election of the nominees to the board of directors of a company. Investors will usually only request a right to appoint a minority of the board. Investors may also insist upon approving independent directors who will hold the balance of power and/or bring one or more observers to all board meetings.

4. Investor protections

The investor protection terms are important to convince an investor for fundraising. The investor's protection clauses of a Term Sheet may include - incurring secured debt, declaring dividends on shares, corporate reorganizations and buyback of shares.

The protection clauses may also include the right over the decision regarding managements like making relevant changes for the growth of the business and hiring and firing senior officers.

5. Dealing with shares

The rights of a shareholder to acquire and sell their respective shares of the company is necessary to be mentioned in the Term Sheet.

6. Miscellaneous provisions

These include matters such as the right of the investor to conduct due diligence before closing, exclusivity provisions and payment of the investors' expenses.

Advantages of Term Sheet

The Term Sheet has the following advantages:

• The term sheets are generally non-binding, therefore, you can be flexible regarding the binding obligations and recommend the terms and clauses for the legally-binding contracts to be entered into later.

• Through a Term Sheet, you can easily point out the reasons for dispute or contention and actively negotiate on that point. The Term Sheets help to get a fair idea regarding the upcoming deal.

• Though the Term Sheet is not a legally binding document it enables the parties to feel more confident on the points to be discussed regarding future investment and transactions.

• The Term Sheet enables both parties to consider and understand in a similar way regarding the important matters relevant to the upcoming investment.

What are the disadvantages of a Term Sheet?

Nothing can be foolproof, therefore, the Term Sheet has certain disadvantages too. They are as follows:

• The drafting of the Term Sheet involves real effort and research keeping a balance of the company's motto and the investor's requirement, to convince. However, there is no guarantee that the investor shall be convinced even after that.

• The clauses mentioned in the Term Sheet and if it is agreed by the investor, then in the final legally-binding contract, you have to introduce all of those, which imposes a commitment. For any changes, you have to negotiate with the investor.

• Once a Term Sheet is signed, you do not get much leverage in the preparation of the final investment agreement.

A Term Sheet is an introductory document presented before an investor in the fundraising procedure and is crucial to convince the investor. The Term Sheet to a huge extent is responsible to get a good investment.