1. Introduction
When founders consider how to write a term sheet, they usually see it as a formal step prior to the signing of definitive agreements. In reality, it is more than a preliminary document as it provides the legal form of commercial negotiations and solidifies the expectations at the initial phase.
At its core, a term sheet captures the principal terms that an investor offers to invest. While it is commonly described as non-binding, the label is misleading. The legal form of a term sheet is normally hybrid, and there are provisions that are meant to be binding at the onset while others are intended only as a roadmap for final agreements.
In practice, a term sheet performs three main purposes:
- it reflects the commercial understanding of valuation, investment amount, and securities,
- it describes the system of governance, including board composition, investor rights, and control mechanisms,
- it serves as the groundwork for detailed transaction documents that ensue.
This becomes particularly important in a startup transaction where investors are involved because founders often focus on valuation but not on the long-term consequences of control rights and exit mechanisms. Once these principles are captured in a term sheet, it becomes difficult to materially dilute them in the definitive agreements.
How to Create a Term Sheet to Investors is therefore not a matter of filling in a standard template. It requires careful judgment about what must be settled early, what can remain flexible, and how risks should be allocated at a stage when legal costs and negotiations have not yet escalated.
2. Legal structure of a term sheet
The interpretation of the legal structure of a term sheet is essential to drafting it properly. Many disputes arise not from the substance of the document, but from incorrect assumptions about its legal effect. Founders believe that since a term sheet is said to be non-binding, it does not have any legal effects. That is an oversimplification.
In substance, a term sheet operates as a document that contains provisions that are layered and some that are supposed to be a guide for the parties toward final documentation and are subject to further negotiations. Others are designed to be considered as binding with immediate effect and may be legally enforceable.
2.1 The non-binding and binding provisions
A term sheet is typically signed at a point once the parties have aligned on commercial basics but before detailed due diligence or full-form agreements are prepared. For this reason, most of the term sheets expressly state that they are not binding, except for certain identified clauses. General reflection of non-binding provisions is:
- the proposed valuation of the company,
- the size and structure of the investment,
- the type of securities to be issued, and
- the broad commercial or investor being contemplated.
These points are meant to record the current understanding between the parties. They serve as a working framework rather than a final commitment, and remain subject to further negotiation, satisfactory diligence, approval of regulations, and signing of definitive documents.
That said, simply labelling a document as “non-binding” language is not sufficient and does not conclusively determine its legal effect. Tribunals and courts look beyond labels; they examine the wording used and the conduct of parties to assess whether any obligations were intended to be enforceable.
2.2 Typical binding provisions in term sheets
Even where the commercial terms are said to be non-binding, investors often insist that certain provisions take effect immediately. These clauses are typically carved out in a straightforward and explicit manner and applied as a binding obligation. Examples of common binding provisions are:
- Confidentiality – restricting the disclosure of information that is divulged about the deal terms and information that is exchanged in the negotiation.
- Exclusivity or no-shop restriction – preventing the company from soliciting or negotiating with rival investors for a specific period.
- Costs and expenses- allocating responsibility for legal fees, diligence expenses and transaction-related costs.
- Governing law and dispute resolution – in the event of any dispute during the term sheet stage, specifying the applicable law and forum.
These provisions require careful drafting. Ambiguity in clauses that are intended to bind can create exposure for founders well before definitive agreements are executed.
3. Investor term sheet drafting in India
Drafting an investor term sheet in India cannot be approached purely from a commercial angle. Although the term sheets are sometimes termed as initial papers, the structure is shaped in large measure by the Indian corporate laws, foreign exchange laws, and common market practice. Founders who understand this legal backdrop are in a better position to negotiate terms that can be worked, enforced and are in line with the documentations that follow.
3.1 Regulatory environment that affects Indian term sheets
A term sheet is not a statutory filing. However, the information contained within is strongly conditioned by the regulatory regime constituent of the investments in Indian companies.
At a broad level, the laws are typically related to the negotiation and drafting of terms as follows:
- The Companies Act, 2013, which governs the issuance of shares, the composition of the board, the elective rights of the shareholders, and the approvals of the company.
- Foreign Exchange Management Act (FEMA) and other regulations governing the same, which is applicable in the event where foreign investment is involved, in relation to valuation, pricing and exit mechanisms.
- Sector-specific regulations that can either place limitations, approvals, or other conditions depending on the nature of business.
Because of these regulations, even at an early stage, investor term sheets in India are likely to show regulatory limitations. Indicatively, the valuation methodology, exit rights, or option structures are usually formulated in a manner that presupposes subsequent adherence to FEMA or the company law.
3.2 Common investment models in the Indian term sheets
Market practice in India indicates that there is a preference for investment instruments, particularly in venture capital and private equity transactions.
Typical Indian term sheet structures are:
- Equity shares often used in early-stage or simpler investment rounds.
- Compulsorily Convertible Preference Shares (CCPS) widely adopted because they allow investors to secure economic preference while remaining compliant with Indian regulatory norms.
- Compulsorily Convertible Debentures (CCDs) or any other convertible instruments, frequently used in structured transactions or investment linked to milestones.
In most cases, the terms sheet identifies the chosen instrument at a broad level, while detailed rights and mechanics of the choice are dealt with in definitive agreements. A clear understanding of these instruments is essential in drafting a term sheet that would be both commercially acceptable and legally sustainable in India.
3.3 Marketplace practice in negotiations
Unlike definitive agreements, term sheets are immensely marketed by legal principles. In competitive fundraises, investors normally rely on market standard terms to justify their negotiating positions.
The practice in the market is not uniform. It varies based on:
- stage of the investment (stage 1 seed, Series A, growth),
- profile of the investor (angel, VC, PE fund), and
- relative bargaining strength of the company.
4. When are term sheets used, and who uses them?
The knowledge of when a term sheet is being signed and who is relying on it will have a direct bearing on how to prepare a term sheet. A term sheet is not simply executed in isolation. It is signed at a certain stage in the deal cycle, typically once board commercial discussions have progressed, but before due diligence and long-form documentation begin.
This is also the reason why a term sheet cannot be treated as a summary by the founders. In many transactions, it becomes the anchor document for everything that follows. If there’s confusion about the legal structure of a term sheet at this stage, particularly around provisions that are binding and what is not, misalignment shows up later in the form of negotiations or disagreements over documentation.
4.1 Term sheets in startup fundraising
The term sheet is most likely to be applied after the investor’s internal decision to proceed and the founder’s readiness to explore valuation and rights. At this point:
- an investor desires comfort before committing time and money to diligence, and
- the company desires transparency and clarity before granting exclusivity or investing further resources in the transaction.
4.2 Series A, and growth-stage (seed): timing of detail
The drafting approach depends on the stage of funding.
- Seed stage: term sheets tend to be shorter, yet they set a commercial baseline. Founders should be careful and not look past governance and future dilution triggers at this early stage.
- Series A and Series B: term sheets are more structured with clearer articulation of valuation mechanics, control, and exit mechanisms.
- Growth-stage rounds: term sheets may become more structures incorporating tranche-based investments, performance-linked conditions, downside protection, and negotiated exit arrangements.
4.4 Who uses term sheets and why their incentives vary
Multiple stakeholders approach a term sheet with distinct priorities:
- Founders/promoters focus on dilution, control, and whether the overall trade-off justifies.
- It is employed by VC funds and angel investors to secure their commercial position early and allocate risk.
- It is used by private equity investors to gain a tighter articulation of economics, governance rights, and a defined exit pathway.
- It is used by strategic investors/acquirers to rely on it to outline the deal structure while safeguarding deal confidentiality and exclusivity.
4.5 India-specific angle: when and who have changed
In India, the timing and identity of the investor carry added significance, particularly where regulatory and structural limitations apply, for instance, when there is a foreign investor. As a result, investor term sheet drafting in India often addresses certain structural issues at an early stage:
- the proposed investment vehicle (commonly CCPS/CCD structures),
- reserved matters and government rights, and
- exit expectations framed in a way that they will be conducted in a compliant manner in the future.
5. Key components of a term sheet
To understand how to write a term sheet, it is necessary to start with an awareness of the core components of the term sheet. While the contents may vary based on the structure of the transaction and the negotiating strengths of the parties, the majority of investor term sheets follow a fairly standardized economic, governance, and protective provisions.
On a high level, the following components may be categorized into three:
- Terms of economics, which determine valuation and financial results.
- terms of control and governance, which regulate decision-making and control, and
- other risk-critical clauses, that address continuity, exit, and downside safeguards.
5.1 Economic terms
The economic provisions set out the financial bargain between the investor and the company. These provisions often receive the greatest attention during negotiations, particularly in a startup term sheet with investors, yet they are also the area where misunderstandings commonly arise.
5.2 Valuation and amount of investment
The term sheet typically specifies the valuation at which the investment is proposed, alongside the amount to be invested. This is usually expressed in terms of a pre and post-money valuation, and the distinction between the two is significant. From a drafting perspective, it is important to have clarity on issues related to valuation since it affects:
- the percentage of equity to be issued to the investor, and
- the extent of dilution faced by the founders and the existing shareholders.
Any ambiguity at this point is likely to cause disagreements when the capitalisation table is finalised during documentation.
5.3 Securities or type of investment instrument
Investor term sheets usually identify the instrument in which the investment will be made. The common instruments are equity shares, preference shares, or convertible instruments like CCPS or CCDs.
This option is not incidental in the Investor term sheet drafting in India. It often reflects regulatory factors, tax structuring, and the investor’s preference to seek economic security. While the term sheet identifies the instrument in great detail, the detailed rights are generally addressed in definitive agreements.
Dividends:
Dividend provisions deal with the entitlement of the investors to receive the dividends or not, and if so whether they are cumulative or non-cumulative. Although dividends may not carry immediate commercial significance in early-stage companies, they can influence long-term economics and cannot be overlooked.
Conversion rights:
Where preference shares or convertible instruments are used, conversion mechanics are typically outlined in the term sheet. This includes the power of the investor to convert the preferred securities to equity either manually or automatically, and the events that may trigger it such as IPO.
These provisions cannot affect both control and exit outcomes and should be aligned with the overall deal structure.
Anti-dilution provisions:
Anti-dilution clauses protect the investors if future shares are issued at a lower value. Term sheets tend to be general on the type of protection offered such as full ratchet or weighted average, without setting out detailed formulae.
Even high-level references to anti-dilution in a term sheet can significantly impact flexibility in subsequent fundraising.
Pro-rata rights:
Pro-rata rights allow investors to participate in subsequent funding rounds to maintain their percentage holding. These rights are common on venture capital transactions and are often treated as standard.
However, their scope and duration should be considered carefully, specially in cases where multiple future rounds of funding is expected.
6. Startup term sheet with investors
A term sheet with investors that are a startup is hardly ever a funding document. It is a report that indicates how risk, control and upside will be apportioned between the founders and the investors throughout life of the company. Founders that think solely through the lens of valuation easily miss out on the terms that get a much bigger effect on long-term control and economic performance.
To comprehend the process of writing a term sheet in the startup context, then, it is necessary to change the emphasis on headline numbers to balance of structure.
6.1 Reasons why valuation is not a complete measure
Valuation is often the most visible and emotionally charged element of a term sheet. It is natural for founders to focus on securing the highest possible valuation to minimise dilution. However, valuation by itself does not determine who ultimately controls the company or how exit proceeds are divided. Two term sheets offering the same valuation can produce vastly different results based on:
- liquidation preference terms,
- anti-dilution protections,
- board and voting rights, and
- mechanisms governing exit control.
6.2 Control rights: voting, board seats and reserved matters
Control provisions are among the most sensitive aspects of negotiation in a startup term sheet. Investors typically seek safeguards that allow them to oversee and protect the investment, whereas founders aim to preserve operational flexibility. Common negotiation points relating to control are:
- Board composition – number of directors, investor representation and appointment of independent director.
- Voting rights – whether specific decisions require investor consent.
- Reserved matters – a list of actions that cannot be undertaken without the prior approval of the investors.
6.3 Options pools, future financing, and dilution
The immediate funding round is not the only time of dilution. Founders must consider how agreed terms will affect subsequent rounds of funding. Key considerations that are likely to be observed in negotiation are:
- The teams of stock options (ESOPs) – does the option pool pre- or post-money.
- Pro-rata rights – the investor’s entitlement to maintain their ownership percentage in new rounds.
- Anti-dilution protection – safeguards in the event of down-round.
6.4 Preference and exit economics of liquids
Liquidation preference is one of the most misunderstood clauses in a startup term sheet. Although it may appear technical, it plays a decisive role in determining the exit proceeds between investors and founders. Negotiation normally centers on:
- whether the preference is single or a multiple, and.
- whether it is structures as participative or non-participative.
7. How to create a term sheet for investors
To build a successful approach to How to Create a Term Sheet for Investors it is not enough to be aware of the standard clauses that may be found in a term sheet. The document needs to be drafted in a structured manner, one that is both clear from a commercial standpoint and legally sound and flexible. A term sheet is not exhaustive; it is rather purposive. Every section signals what will later be expanded upon in the definitive agreements.
This is the stage where theory meets practice in the case of founders and promoters. The following process is the way experienced practitioners generally follow a disciplined process while drafting a term sheet.
7.1 Pre-draft preparation: harmonizing commercial fundamentals
Before drafting begins, internal alignment is vital. The difficulty in documentation is not due to poor language but from unresolved commercial positions. At this point, founders should have a firm view about:
- how much capital is being raised and for what purpose,
- the range of valuation that is commercially viable,
- the intended deployment of funds, and
- short-term and medium-term goals of the company, including future funding rounds.
This groundwork is particularly relevant in a startup term sheet with investors since early decisions tend to have lasting consequences. A term sheet should not only reflect the current round, but also the company’s expected growth trajectory.
7.2 Outlining economic terms
Once the commercial fundamentals are aligned, the next step is the process of outlining the economic bargain. This usually includes:
- the proposed valuation (pre-money or post-money),
- the size of investment, and
- the type of securities or instrument to be issued.
When preparing an investor term sheet in India, it is equally important to take into consideration that the structure proposed must have the ability to be executed in accordance with the applicable regulatory framework.
7.3 Defining other key clauses
Beyond economics and control, term sheets often address other provisions that manage risk and process management. These often include:
- liquidation preference, expounded on a high level,
- anti-dilution protection, often identified by the type and not the detailed formulas,
- confidentiality obligations,
- exclusivity or no-shop clauses, and
- allocation of legal and transaction expenses.
Most of these clauses are typically intended to be binding. There is a specific focus on their drafting, even at the term sheet stage.
7.4 Standard sequence of clauses in a market-standard term sheet
Although the formats vary, most standard market-level term sheets follow a broadly similar format, making them easier to review and negotiate. A standard format consists of:
- an overview of the transaction and terms of investment.
- Valuation and capital structure.
- Economic rights and details of the securities.
- Governance and control rights.
- Investor protections
- Founder requirements and obligations.
- Exit and transfer provisions.
- Exclusivity, confidentiality and cost-related clauses.
- Regulating law and miscellaneous provisions.
When a familiar structure is used, it lowers friction and ensures that the negotiations are more substantive, not formal.
9. Conclusion
A term sheet is usually the first formal document executed in an investment transaction, and its implications are far-reaching. In many cases, the smoothness of a fundraising process and the sustainability of the long-term relationship between the company and the investor can usually be linked to how carefully the term sheet was prepared.
The knowledge of how to write a term sheet is not merely a procedural exercise. It is a matter of strategy.
FAQ
1. What is a term sheet?
A term sheet is a preliminary, non-binding document that outlines the major terms and conditions of an investment between a startup and investors.
2. Is a term sheet a legal binding document?
Most of the commercial provisions are not binding. However, clauses relating to confidentiality, exclusivity, and governing law may be binding.
3. What are the main parts that a term sheet ought to include?
It typically covers valuation, investment amount, equity, liquidation preference, voting, board composition, and exit provisions.
4. What should we do with valuation?
Both pre-money and post-money valuations should be clearly specified to eliminate confusion on ownership percentages.
5. What are liquidation preferences?
It sets out the order in which investors are repaid before founders or other shareholders in the event of a sale or liquidation.
6. Are investor rights desirable?
Yes, additional voting rights and information rights, and protective provisions are usually incorporated to explain investors’ influence and oversight.
7. To what extent should the term sheet be detailed?
It must be concise and focused on key points brought to the fore, with detailed commitments to be provided in the conclusive agreements.
8. Who drafts the term sheet?
It is typically drafted by the lead investor, though startups should seek legal advice before signing.
9. Can terms be negotiated?
Yes, valuation, board representations, and investor rights are all things that founders and investors can negotiate.
10. What follows the signing of a term sheet?
It forms the basis for preparing the final transaction documents, such as the Shareholders’ Agreement, and indicates the goodwill of the parties to proceed with the investment.
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