The Termsheet Anatomy and Sample Series A Termsheet

Ask entrepreneurs who have received investments from institutional VCs and they will testify that VCs were most sticky on these rights and most negotiations happened around these terms.

The previous post Termsheet – The Prenup Agreement briefly illustrated the stages of the fundraising process – from initial interaction and due diligence to issuing termsheet, signing definitive agreements and fund transfer.  Also discussed were components of the termsheet to give a flavour of the rights and terms an Investor typically proposes.

In this second part, I will try to put to rest some of the concerns which many entrepreneurs have when they read the termsheet. Some of the common questions that always pop-up in the head are:

1. “WTF, how can they put such a term in the termsheet?”

2. “Hey, how can you do that? We are the founders and this is our company?”

4. “Is it us or does it just appear in every damn f***ing termsheet!”

5. “Hey if you want all this, what do I get at the end?”

Typically there are almost 40-42 terms in a typical Series A termsheet. I have classified these terms under three separate categories based on the amount of importance it holds from a VC’s perspective and hence also for the entrepreneur. The three categories are illustrated in the following infographic

The Gold Cup

The terms included in this category are very critical. Seldom, will a VC miss out on any of these terms. Hence while negotiating there are very few chances (read as negligible) you will be able to convince them to forgo any of these rights.  Ask entrepreneurs who have received investments from institutional VCs and they will testify that VCs were most sticky on these rights and most negotiations happened around these terms.

The rights act as a control mechanism for  VCs to safeguard their investment, ensure there is no mis-utilization of funds, control the exit transaction, be involved and have a say in all strategic issues of the company.

As an entrepreneur these terms might get you agitated or all worked up. However, these terms will only be enforced when things get really bad and the situation is irreparable. If the company is doing well, why would a VC force an exit on you or discourage you from taking strategic decisions which will benefit the company in the long run? Having said that, you should negotiate these terms well because VCs should not forget that they are providing risk capital. If they want those big fat returns they should also be prepared for some failures and if so they should not be unreasonable in those circumstances either.

The following classification will help understand the function of the terms included in this category:

  1. Exit Transaction – Exit Clause (QIPO), Drag – along, Buy Back of Investor Shares
  2. Capitalization Clarity – Post Closing Shareholding pattern, Pre-money valuation
  3. Distribution of Proceeds –Liquidation Preference (Participatory / Non Participatory)
  4. Key Decisions – Reserved Matters, Right of First Refusal (mainly for sale of shares by ), Voting rights, Board Representation / Composition
  5. Control over conflicting activities by promoter – Vesting of Founder Shares, Lock-in period for Founder Shares, Tag along
  6. Setting milestones to achieve a tranche based investment [Many times the Investors even keep aside a portion of their shares to reward the founders for achieving the milestones]

The Silver Cup

These rights are critical and very frequently used to negotiate (give on these and stick to those) the Gold Cup rights. The Silver Cup rights help the VC to achieve the following objectives

  1. Indemnify from liabilities arising from past and future operations of the company – Indemnity, covenants and representations and warranties, Keyman, E&O and D&O Insurance
  2. Secure interests in future round of funding – Anti-dilution, Pre-emptive rights
  3. Ensure the founders’ don’t  participate in any conflicting activities – Use of Proceeds, Non- Compete, Non – Solicitation and Non – Disclosure, Transfer
  4. Access to critical information of the company’s performance –Information Rights
  5. Ensure exclusivity and confidentiality of the proposed transaction to avoid term-sheet ‘shopping’ –
  6. Providing guidelines for closure of the current transaction – Investment Amount, Closing Conditions, Expenses related to the transaction, Nature of Document

The Bronze Cup

The ones included here are certain standard rights and definitions. These are the least argued upon in any discussion. VC and founders always accommodate requests from the other side.

  1. Rights – Conversion, Dispute Resolution, Dividend, Due Diligence, Governing Law and Jurisdiction, Registration and Piggyback Rights
  2. Definitions –  Investors, Promoters, Promoter Shares, Type of security, Closing

As promised earlier, attached is a Sample Series A Termsheet. In the next two subsequent posts I will help dissect the key terms of the termsheet [mainly the ones in the Gold & Silver Cup].

– Download from here

[Kulin Shah worked with Reliance Venture Capital for 3.5 years before starting his entrepreneurship journey. The article has been reproduced from Kulin’s blog.]

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