A term sheet is often the first formal document exchanged between a startup and an investor. It outlines the key terms and conditions of a proposed investment before detailed legal agreements are drafted. Think of it as a handshake in writing, it sets expectations before the real paperwork begins. The job offer letter is the employee document most similar to a startup term sheet: both outline the main proposed terms at the start of a relationship, are generally non-binding, and pave the way for a formal, binding agreement if both parties proceed.
What Is a Term Sheet?
A term sheet is a non-binding document that summarises the important points of agreement between a startup and its potential investors. It lays the groundwork for final agreements like the Shareholders’ Agreement (SHA) and Share Subscription Agreement (SSA).
It typically covers topics like the company’s valuation, investment amount, equity stake, investor rights, governance structure, and exit terms. While most parts of a term sheet are non-binding, key clauses like confidentiality, exclusivity, and costs are often legally binding.
Why Is a Term Sheet Important?
A well-structured term sheet is crucial because it:
- Sets Early Alignment: Clarifies expectations before time and money are spent on legal drafting.
- Protects Both Sides: Outlines rights and obligations to minimise future disputes.
- Speeds Up Fundraising: Helps identify deal breakers early without lengthy negotiations.
- Signals Commitment: Shows that both startup and investor are serious about moving forward.
Key Components of a Term Sheet
| Section | What It Covers |
|---|---|
| Valuation and Investment | Pre-money or post-money valuation and how much the investor will invest. |
| Type of Securities | Preferred stock, common stock, convertible notes, etc. |
| Liquidation Preference | Who gets paid first in the event of a sale or shutdown. |
| Board Composition | How board seats are distributed between founders and investors. |
| Voting Rights | Specific corporate actions requiring investor consent. |
| Anti-Dilution Protection | How investors are protected if future rounds are raised at lower valuations. |
| Founder Vesting/Clawback | Rules around founders’ equity vesting if they leave early. |
| Exit Rights | Tag-along rights, drag-along rights, right of first refusal, etc. |
Example: Early-Stage Startup Term Sheet Scenario
Imagine a healthtech startup raising ₹5 crore at a ₹20 crore pre-money valuation.
The term sheet might include:
- Investment: ₹5 crore for a 20% post-money stake.
- Board: 2 seats for founders, 1 seat for lead investor.
- Liquidation Preference: 1x non-participating.
- Founder Vesting: 3-year vesting with a 1-year cliff.
- Anti-Dilution: Broad-based weighted average protection.
This document sets the stage for drafting final binding agreements.
Is a Term Sheet Legally Binding?
Mostly, no — the main commercial terms are non-binding. However, some clauses are binding, ehich include:
- Confidentiality: Protects sensitive business information.
- Exclusivity (“No Shop” Clause): The startup agrees not to negotiate with other investors for a set period.
- Expenses: Specifies who bears the cost of drafting final agreements.
Thus, even a “non-binding” term sheet has serious legal implications.
Case Study: Zostel vs. OYO – When a “Non-Binding” Term Sheet Became Contentious
Background:
In 2015, OYO Rooms signed a “non-binding” term sheet to acquire Zo Rooms from Zostel Hospitality in an all-stock deal, offering Zostel’s founders a 7% stake.
The Dispute:
Zostel claimed it had fulfilled its obligations by transferring assets and staff. OYO later claimed no definitive agreement was signed, and thus the deal was invalid.
Arbitration and Legal Battle:
- In 2021, an arbitral tribunal ruled that Zostel was entitled to seek specific performance based on the parties’ actions.
- However, the Delhi High Court clarified that actual shareholding rights would only crystallize upon signing of definitive agreements, which had not occurred.
- The dispute remains ongoing, with Zostel seeking enforcement and OYO challenging it, impacting even OYO’s IPO plans.
Key Takeaway:
Actions matter as much as documents. Even a “non-binding” term sheet can create binding obligations if parties start behaving like a deal is done.
Final Thoughts
A term sheet is not just a document, it’s the foundation of a startup’s relationship with its investors. Even if “non-binding,” the signals it sends, and the actions taken afterward, can have lasting consequences.
Startups should treat every term sheet with the seriousness of a final contract because, in the world of venture funding, intent and action often speak louder than words.