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Term Sheet 101 and How they are Fundamental to Future Negotiations (Silicon Valley × LexStart)


Silicon Valley: S02E01 (Part 1) - Having won the TechCrunch Startup Battlefield, Richard and the Pied Piper team await a “term sheet” from Peter Gregory, while fielding offers from other investors. Not a bad fix to be in, for an entrepreneur!

An integral stage in any investment transaction is the negotiation of a term sheet. A ‘term sheet’ is a document outlining the terms of investment, and precedes the definitive transaction documents. Simply put, a term sheet is an “agreement to agree” to the broad contours of a deal.

A term sheet is a Non-Binding Agreement entered into by the parties to a transaction, and serves as the foundation for, both future negotiations, and the drafting of definitive and legally-binding transaction documents.

It is the first step in the process, leading to definitive agreements. Having hashed out the business side of things, the negotiation and execution of a term sheet typically initiates the legal processes in any investment transaction. In light of the stipulations laid down in the term sheet, both the parties carry out due diligence, accompanied by transaction documents that are drawn up in accordance with the findings in the due diligence report.

The term sheet should set forth the stipulations critical to the transaction, without delving into the technicalities enunciated in a binding contract.

14 Key items that must be included on Term Sheet are:

1. Securities to be issued.

2. The investment amount.

3. Valuation.

4. Percentage stakes.

5. Payment terms.

6. Liquidation preference.

7. Dividends payable, how and when.

8. Conversion of securities (if applicable).

9. Voting rights.

10. Anti-dilution provisions.

11. Exit rights.

12. Terms of due diligence.

13. Confidentiality.

14. Governing law.

While the term sheet is a non-binding agreement, parties are free to provide for certain clauses which may be legally binding. An “exclusivity” or “no shop” clause, which restricts the company from soliciting other investors for a short duration of time post the execution of the term sheet, is typically one such clause which finds prevalence in term sheets.

The term sheet is a key document which must be carefully drafted, since it helps reduce the time and effort required to finalize:

  1. The Shareholders’ Agreement,

  2. The Share Purchase Agreement or

  3. The Share Subscription Agreement,

  4. Other Transactional documents.

The term sheet ensures that the parties agree to the key aspects of the deal before rushing into the expensive and time consuming processes required to close a transaction.

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