Why you need to know how term sheets are negotiated
Although a term sheet is just an informal early stage non-binding agreement between an investor and start-ups, it is critical to understand the importance of it is by far the magnetic compass that sets the tone for later documents.
The terms of laid down as mere bullet points in a term sheet forms the fulcrum on which rest of the paperwork is designed and negotiated, from funding, corporate governance to exit terms. It is, therefore, a blueprint of future legal relationship between investors and the entrepreneurs.
Term sheets have a jargon of their own which might overwhelm the entrepreneurs and amateur lawyers alike and special attention must be paid to it. This is a repeated exercise and part of angel or VC/PE funded business ecosystem. Any failure to not learn these ropes adequately can lead to potentially damaging impact on the future of any business, its employees, founders and co-founders. The recent showdown between Shopclues co-founders is a case-in-point.
Points to remember for a lawyer and entrepreneur vis-a-vis termsheet?
There is no clear set of rules and steps to be followed while negotiating a term sheet. Each term sheet and business is unique and requires specialized study to formulate adequate premises to seek bargain on one’s own terms.
As a lawyer, you are acting in best interests of your client (the investor or the entrepreneur) and need to be their wing-person. It is critical that you pay attention to the valuation method that would add maximum value to the business where neither party feels cheated. Minor changes or variations in the valuation method employed can lead to staggering differences in the value of stakes in a company and its potential for growth. A successful negotiation requires both parties to feel win-some in the end. A poorly employed valuation methodology can break a business in no time.
As an entrepreneur, you must focus on raising as much capital as possible without giving away too much of ownership with clear idea on what your exit plans look like. Most of times, founders and investors have wildly different interpretations of what exit would resemble like!
As a lawyer, you need to work closely with your entrepreneur or investor to gain a clear picture of the outlook on the returns expected from the business and consequences of missing business milestones. Most of the times, investor prefer to keep liquidation preference intact in order to protect their funds in case a company were to go into liquidation.
Board representation and veto powers can have significant impact on corporate actions in a company. It may appear immaterial during the good times but can cause immense confusion during stressful times. There is overt attention paid to non-compete clauses in an agreement but little focus is given to intellectual property assignment clauses which ultimately help a company differentiate and create value.
Negotiating Termsheet = Managing Risk Efficiently
- Learn how anti-dilution clauses are critical to your business and consult your lawyer thoroughly to understand the intricacies that govern it
- Thoroughly understand the implications of “drag-along” provisions in your business. It can lead to unmanageable complications arising at the time of selling the company
- The capital structure of your business emerging out of this deal can strongly influence your future ability or inability to raise capital in any business
- “Right of first refusal” can prove to be an albatross around the neck if and when you raise further capital or choose to liquidate your losses
Learn how to align your business interests with that of your investor in the bullet points of the term sheet and create a future proof partnership to realize your business objectives by enrolling in this online course.
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