Having a term sheet that investors deem acceptable is one of the prerequisites to entering into an agreement with any investors. A term sheet is the first document to be created before entering into negotiations with investors and it essentially contains the agreements that are reached at the preliminary stages of the negotiations. This article intends to tackle the intricacies of a term sheet, its components, and what is expected of an entrepreneur and an investor in its consideration.

What is a Term Sheet?

A term sheet functions in the same capacity as an engagement-it creates the terms within which a future marriage, in this case, an agreement, would be made pending the completion of formalities that includes, but is not limited to, signing of a contract. By virtue of the term sheet, the parties to an agreement seek to commit themselves to the negotiation process with nothing more than the hopes of a more advanced agreement. It coordinates the expectations of the parties and the elaborate mechanisms the parties might devise to take away of the substantive and procedural requirements dealing with a deal.

What Each Term Sheet Should Include

These are the most important aspects to focus on in every term sheet:

Participating Parties

Each term sheet should include participating parties to the transaction clearly. This means that the investor and the company he is investing in must be clearly identified. This allows the investor and entrepreneur to understand the details surrounding the investment.

Style of the Deal

Deals must be categorize into a specific structure. Generally, there are two main types of deals:

Loan: Cash is advanced as a debt which has to be paid back with interest.

Investment: Cash is provided in exchange for a share of the business.

Value of the Investment

The value that is being dealt, either in the form of a loan or investment, have to clearly defined. It can range in values from Rs. 10 crores to Rs. 1000 crores. Having an exact investment figure ensures that everything is above board.

Disbursing Funds

From the start, it is critical to establish how the funds would be disbursed, including the what, when, where, and how questions, such as what is the timeframe for payment, delivered, and sourced.

For instance, if a firm needs Rs. 10 crores, they might want Rs. 5 crores right away to begin product development, followed by Rs. 5 crores after the minimum viable product (MVP) is complete. The term sheet should define the stages of disbursal and the conditions for the release of funds.

Tenure

It is also important to note the length of time for which funding is being given since investors always expect a clear exit strategy within a given timeframe. Investments with a short-term horizon of 3-5 years is typical, as well as long-term investments such as the building of roads or airports which can take decades.

Interest Payment (Loans)

Loans which are included in the deal outline must have the rate of interest stated clearly. This could be a fixed rate, say 10 percent, 12 percent, or 14 percent, and there must be a clear statement as to how frequently the company pays out interest, monthly, quarterly, or annually.

Fees

When a deal occurs, there may be certain costs attached such as a due diligence fee, legal fees, and additional costs that arise for the transaction. The term sheet should specify these expenses, including which party- the entrepreneur or the investor- is responsible for these costs.

Exit Order

As part of an investment strategy, one of the most important strategies for an investor to know is how they will cash out their investment, this is known as the exit strategy. There must be a clear exit plan in order for investors to be motivated to close a deal. This could include leaving a company through:

Entrepreneur share buy back.

-Third party buyouts in case an entrepreneur does not have sufficient money to buy their shares.

-Initial Public Offering (IPO) where the shares are registered with a stock exchange and offered to the public with the intention of enabling a hitherto dormant investor liquidate his holding.

Setting the exit procedure beforehand will eliminate most anticipated issues.

Right of First Refusal (ROFR)

Investors who are already invested in a company and want to invest further in the same company will get the first chance to purchase more shares which is known as Right of First Refusal (ROFR). In essence, when an entrepreneur wants to sell shares or a new investor wants to buy a stake, the investor always has the chance to accept or decline the offer first.

Board Seats

The board seats are negotiations because they represent control in the company. An entrepreneur shouldn’t give out too much board seating to investors because they will control too many important decisions. Balance should be achieved in these situations, so the entrepreneur and his team can make important decisions.

Voting Power

Voting power is associated with the importance of being a shareholder during shareholder meetings. Entrepreneurs should keep control of the voting rights by creating different types of classes of shares, like Class A with voting rights attached, and Class B without voting rights. That way, the entrepreneur can be in control regardless of how much equity the investors have.

Decision-Making Power

The negotiation document defines decision making responsibility for which an investor will be assigned. Some decisions will definitely need to meet certain levels of investor consent, but other decisions may be left to the entrepreneur. What must be retired is the extent to which the investor can get involved in the business, such as making some strategic changes, mergers, and acquisitions.

Arbitration Clause

An arbitration clause is a provision of a legal contract that requires the parties to resolve their disputes with the help of an independent arbitrator. An Arbitrator is usually a person authorized by the law to settle disputes outside the courts. This type of agreement must also stated what type of arbitrations will be used as well as the venue of the arbitration should be included in the term sheet. It is cheaper and quicker to address things through arbitration than with lengthy legal procedures that could take months to settle.

Non-Disclosure & Exclusivity

The two are exceptional in preemptively solving possible disputes that may arise out of breaches of confidentiality of both parties during the negotiations. This would help prenuptial entrepreneurs avoid looking for negotiations to other investors while the term sheet serves this purpose. In so doing, the deal would avoid prenuptial entrepreneurs negotiating for more than they could truly deliver antagonistically without setting up possible integrity conflicts between a buyer and a seller. After this step, prenuptial investors can approach other offers knowing they do not jeopardize already sunk costs in ineffective negotiations.

Duration for Signing Final Agreement

In our case, the company’s term sheet should articulate how long, 30-90 days, will it take to finalize the deal. This depends on how complex the deal is. Having a set time frame would mean that a funder has taken precise steps towards closing an agreement after undergoing all the forwa step thereby having clarity as to what issued time payment would be given.

Conclusion: Why a Well-Drafted Term Sheet Matters

Investors and entrepreneurs can negotiate a term sheet successfully if it is drafted accurately. These 15 components, if incorporated, work towards making sure both parties understand each other well and do not walk away with different interpretations of the agreement. A term sheet is crucial in an investment deal because it acts as a guide to negotiations and agreements that may take place later on. It is essential in the creation of business relationships.

Deals are only done when the funds are in the account as per Mr. Sanjay Kathuria and a term sheet guarantees that both parties will make every effort to uphold their end of the arrangement.