One Document that Startups need for getting Funding

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When investors seek to fund a startup, there arises a need to sign a “Term Sheet”. This document is the cornerstone that will determine its future relationship with the Business Angel or Venture Capital firm. These are basically the terms on which the investor shall make the financial statement in that Startup/Company.

A term sheet creates no contractual obligations on the investor to invest and on the company to issue shares to the investor and acts as a mere “Letter of Intent”

A Term Sheet in most scenarios contains the following:

• Amount of the investment
• Type of security being purchased
• The pre- and post-financing values of the investee company including the capitalization table
• Rights, preferences, privileges, restrictions and obligations
• Representations and warranties

What Founders need to be aware of while getting a term sheet built?

1. Always use legal counsel — Though there needs to be a sound understanding of a term sheet by the founder, but a need for using a legal counsel always exist. There are a lot of legal terms and clauses which will throw the founder offguard due to lack of expertise.
2. Understand the Fair Terms and be reasonable — It is, of course, important to guard yourself against signing up to unfair terms. Equally, try to understand what the standard market practice for such deals is, so that you don’t end up balking at every other term in the term sheet that (wrongly) seems so unreasonable to you at first glance. Founders should understand that while some clauses may, prima facie, appear unfair, they are “standard market practice” for a good reason. Founders must make efforts to understand the intent behind each of these clauses, and seek advice from their legal counsel as to whether specific proposals in the term sheet offered by an investor are standard market practice or not.
3. Focus on Optimal Dilution — Sometimes, founders often get too obsessed about their notions of control and ownership of their startup, and this obsession impedes their ability to think optimally when they are raising funds. The point is they have to make a wise choice between excess dilution and under-dilution; they have to make optimal dilution.
4. Pay special attention to the liquidation preference clause — There are lots of investors who are absolutely fair with entrepreneurs, but there are some who ask for highly unfair liquidation preference clauses. An onerous liquidation preference clause can pretty much wipe out all value for the founders in certain circumstances.
5. Keep a pragmatic approach on funding — Focus should be on closing the deal fast and posturing and negotiations should be avoided. A dogmatic approach is therefore ridiculed.
6. Negotiate a little on protection but not a lot — While it is fair to provide the investors with multiple layers of protection to address fair risks, it is not fair at all for investors to seek unreasonable or unfair levels of economic and other rights in the garb of “downside protection”. Always prepare for the worst but hope for the best.

About the Author

This article has been authored by Rahul Parashar, Co-Founder & Chief Legal Advisor at LegalNow & Ayushi Sharma, Founding Intern at LegalNow.