Understanding Term Sheets – a Note for First-Time Indian Founders

This article was written by Vishal Kanchi, Associate, and Karthik Jayakumar, Partner.

The following article focuses on breaking down term sheets for first-time Indian founders. It addresses foundational questions such as, ‘what is a term sheet’ and ‘is a term sheet a  binding document?’, and other information that first time founders would need to know when undertaking a round of investment.

Introduction:

What is a term sheet?

A term sheet is essentially a preliminary document, which elaborates on the proposed terms and conditions, as mutually agreed between parties, that would form a base for the proposed transaction and the more full-blown agreements.

It is commonly used as a document to act as a precursor to most transactions including scenarios entailing acquisitions, funding or investment in companies through venture capital funds, angels or other entities, as well as other form of investments.

It is generally looked at as a preliminary milestone in an investment process, where the rights as well as responsibilities of both the investors and investee are put together in a brief format pursuant to the preliminary negotiations, post which, due-diligence and building of definitive documents is undertaken, subject to anything that may get unearthed through the due-diligence process.

Contents of a Term Sheet:

What are the key points covered in a term sheet?

From an Indian commercial perspective, a term-sheet generally has the following particulars:

1.       Details and particulars of the parties and the company:

The term-sheet delves into the basic particulars and details such as the name and details of the company being invested in, the name and details of the promoters as well as the investors and a basic summary of the business the company is engaged in. It also captures the shareholding capital structure of the company pre and post-completion of the transaction.

2.       The terms of the instrument (type of security being issued to the investor): 

A term-sheet generally elaborates on the nature of security or instrument that is being issued to the investor or that is being made the part of the proposed transaction, be it debt or equity or of any other form, along with its specific details such as its conversion in case of convertible securities or instruments.

3.       The terms of the transaction:

The financial particulars of the proposed transaction, as agreed between the parties with respect to the investment amount, number of securities issued in return, the tranches in which the investment takes places, as well as the manner in which the investment amount is utilized are captured.

4.       The rights of the investors:

The term sheet also briefly enumerates the rights that shall be guaranteed to the investor, pursuant to his subscription to the securities, including but not limited to provision of pre-emptive rights, voting, exit, drag-along or tag-along rights, anti-dilution, the order of liquidation preference, transfer rights, governance rights such as option to appoint a director or board observer and information rights. We will break down the typical rights in our subsequent notes on specific concepts.

5.       The obligations of the company/promoters:

The obligations set out pursuant to the proposed transaction such as condition precedents, valuation, promoter vesting, lock-in, protective covenants such as non-compete and non-solicit, representations and warranties and indemnification and other obligations or restrictions are also typically outlined in the term sheet.

6.       Miscellaneous:

The term-sheet also elaborates on other important aspects that would form a part of the definitive documents and imposes certain obligation and restrictions on both parties such as confidentiality, exclusivity-meaning not approaching any third party with regards to a similar transaction for a particular period (generally 90 days), expenses of the proposed transaction, dispute resolution and governing law in relation to the proposed transaction as well as the term-sheet, and others.

Distinction from definitive documents:

Essentially, a term sheet is signed prior to the proposed transaction and other due-diligence process, based on a preliminary discussion between the parties, where the core aspects of the proposed transaction, as elaborated above, are outlined.

These particulars are more exhaustively set out in the definitive documents, and the same shall unambiguously govern the rights and obligations of the proposed transaction.

A term sheet, in a simpler manner, forms the base of such definitive documents, and outlines the particulars of the transaction, signalling the interest of the parties to undertake such a transaction.  

Is a term sheet a binding document?

A term sheet can be either of binding or non-binding nature. It is necessary to specifically and explicitly state and identify whether the particular term-sheet is intended to be a binding or a non-binding one.

The judicial precedents have had a mixed opinion on the subject.

In an instance, where even though it was explicitly stated that the term-sheet was non-binding, when a party had carried out all the obligations stipulated in the term-sheet, the tribunal held that it was binding, as the intention of the parties and the actions taken in pursuance of the same, had rendered it as binding.

However, this decision by the tribunal was set aside by the Delhi High Court, which reaffirmed that intentions of the parties should not affect and negate the clear terms written in the term-sheet.[1]

Thus, it is vital that the term-sheet explicitly and clearly indicate its binding nature. Further, some of the clauses such as confidentiality, exclusivity and arbitration may be construed as binding, even if the overall term-sheet has been declared as non-binding.

Conclusion:

In summary, a term sheet serves as a preliminary document outlining the fundamental terms and intents of the parties in a proposed transaction, forming the groundwork for definitive agreements. It is essential, when undertaking the formation of a term-sheet, to clearly outline the envisioned language and intentions, to ensure unambiguity and avoid legal complications.

[1] Oravel Stays Private Limited v. Zostel Hospitality Private Limited, O.M.P. (COMM) 151/2021