How to Prepare your Investment Term Sheet | Lawyers Advice in Delhi NCR | Corporate Law Attorney in Delhi NCR | Corporate Lawyer in Delhi NCR |
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The term sheet is a initial document in any transaction which is a nonbinding agreement that serves as a template for basic terms and conditions and other relevant information. The terms sheet should mention that all the obligations discussed will be contingent upon the deal reaching its finalisation. It is an informal document which helps in having a broad understanding about the process and the expectations of the parties before entering into a formal deal. The term sheet is a standard agreement which is undertaken at a preliminary stage of the discussion between the investors and the founders during negotiation but it creates no formal contractual liability on such parties. It also serves as a guideline to check the feasibility of the deal and the proposed investment. It also helps in assessing if the returns on the investment is as good as the investment one puts in the deal. Once it reaches a fair conclusion a more formal detailed agreement can be drawn up to bind and conform the parties to the deal.
As the term sheet is an informal agreement between the parties, not all clauses have legal consequences except for clause like confidentiality as it implies that the parties are restricted to share or disclose any information to any third party. Once the parties decide to take the deal forward other processes like conducting due diligence takes place and after thorough negotiation and discussion are agreed upon, the parties sign on legally binding agreements to create a formal deal. Most of the details in a term sheet contain standard details like the parties identities, their names, the amount of investment, other rights, etc. whether the investors get to be on the Board of Directors, and other special rights like affirmative rights.
Though the term sheet is an informal document it should not exclude any significant elements of a deal because if the parties do not agree on such aspects due to any fundamental issues then it might prove to be difficult for the parties to finalise the deal eventually. The term sheet helps in mitigating the scope of a misunderstanding or legal dispute and solidifies the relationship between the parties which gets the momentum going for future discussions. It also helps in facilitating final agreement thereby saving effort and time. Since all deals are different with its unique issues, the terms and conditions affecting the deal should be discussed and focused upon early on, for example deals with respect to technology will have issued regarding intellectual property or manpower hence proper understanding to execute such matters have be agreed upon and same should reflect in the term sheet as well.
Sometimes, the investors may want the company they are dealing with to keep the discussion as exclusive which is sometimes referred as “no-shop” period. During this period, the investors will not be under any obligation to have any exclusive discussion only with the company but the company will be expected to not have negotiations with any other investors. Hence the company should be careful before agreeing to such “no-shop” period as they may lose out on other better opportunities with other investors. Therefore, depending on the financial situation and other relevant factors affecting the progress of the company such an option of “no-shop” period should be considered.
In P. Panneerselvan v. A. Baylis and Others (AIR 1986 Mad 284), the Madras High Court had held that in the absence of appropriate intention, uncertain and void material details, an agreement will be deemed to be unenforceable. Further, in Nanak Builders and Investors Pvt. Ltd. v Vinod Kumar Alag (AIR 1993 Delhi 315), the Delhi High Court held that where the parties involved have discussed the terms and conditions and have mentioned the same formally into writing in the agreement and have not discussed anything further to have another formal agreement for the same deal, the Court would consider such an agreement to be legally binding in nature. In yet another judgment, Barbudev v. Eurocom Cable Management Bulgaria EOOD and Others ( EWCA Civ 548, 27 April 2012), the Court had held that if the parties do not intent to create a legally binding document then even a side letter is not legally enforceable even though it is signed by the parties.
Most Important Clauses of an Investment Term Sheet are:
Stock Voting Rights: It is common for an investor to seek voting rights hence the nature and scope of the same should be clearly defined, discussed and mentioned in the term sheet. An investor will also possess a right to appoint one or more Board of Directors in a company. The Investor ordinarily holds the number of votes corresponding to the number of shares. The Term Sheet should also specify whether the investor has special powers to gain control of the company in the event of any default. The investor will also often have a right to appoint one or more members for the Board of Directors in a Company.
Investor Protective Provisions: Investors usually request special approval rights regarding specific subjects of importance to their investment ordinarily called as “protective provisions.” The nature and scope of the Investor’s protective provisions have to be mentioned in the term Sheet.
Non-Compete and Non-Solicitation Agreements: Often times investors will require the employees of the company to sign a non-compete and non-solicitation in order to safeguard their own investment in the respective company.
Anti-Dilution Protection: In the event that a company winds up and the company decides to issue equity shares to some third party at a lower price than it was originally issued for, the investors will be entitled to anti-dilution protection. When such a scenario arises the company and the promoters shall issue the investors additional equity shares.
Representations and Warranties: Though the term sheet may not mention all the representations and warranties it usually is recommended to mention some of the essential representations and warranties, especially those that are related to the particular transaction to define the scope of the deal. The term sheet should specify that such representations and warranties are not exhaustive and that the other details will be mentioned in the final agreement.
Closing Conditions: The terms and conditions should be specified in the term sheet like satisfactorily completing all the financial and legal due diligences for the closure of the investment. Also, it is important to mention whether there will be additional investors after the initial closing within a reasonable period. This helps the investors to contribute capital in the company.
Information Rights: Often companies will consent to make the financial details available to the investors and they might even inspect the corporate details and records. These rights serve the investors with essential details regarding their investment. It is also usually common for some companies to consent to divulge quarterly or annual details. There could be consequences of providing all the confidential information to the investors hence it is necessary to assess the level of information that it is ready to disclose and also it is essential to evaluate the relative value of such information and whether the company is capable of complying and adhering to such requirements.
Pre-Emptive Rights: If the Investor is granted pre-emptive rights they are provided with pro rata right to participate in any future issues of shares, and such right should be specified in the term sheet. Although such rights usually terminate upon an IPO by the Company it is important to state such a right in the agreement clearly as it includes costs and sometimes make the future financing complex.
Right of Refusal and Co-Sale Rights: If the company decides to have the right of refusal and co-sale rights mentioned in the term sheet then the investor will be eligible to have the right of first refusal i.e. when the founders or other shareholders decide to sell their shares, the investor will have the right to be first offered such shares. Further, in the right of co-sale, the investor will have the right to sell its shares along with the company and other shareholders. Hence such important clauses should definitely be mentioned in the term sheet to avoid any dispute at a later stage
Signatures: Even though the provisions mentioned in the term sheet are not binding on the parties as it is just an initial discussion and negotiation between the parties, it is always a good practice to get the term sheet signed by the parties involved in the deal as it serves as an evidence for future deals with the lenders or the suppliers and other parties. Further, when the term sheet is executed it will prove that the contents mentioned in it was all approved and consented by the parties.
Though term sheet is a document that does not legally bind the parties, in any case, the parties involved in the deal should be careful while negotiating and including all the terms in the agreement. The parties involved can make the term sheet binding if they mutually agree to it and mention the necessary provisions in the agreement that will help create the same as document of evidence for future reference. Also, in case the parties want the term sheet to be legally binding they can always execute it on stamp paper to formalise the same.
Authored By: Adv. Anant Sharma & Emilia Chettiar