Demystifying the Term Sheet: A Founder’s Guide to Smart Fundraising
Shilpa Gududur
Shilpa Kiran Gududur has over 23 years of experience. She is a Practicing Company Secretary, Registered Valuer – SFA, and Insolvency Professional. She serves as an Independent Director for a listed company. Her practice areas include Valuation, Corporate Law, FEMA Compliances, IBC and representation before NCLT. She has experience in various industries, including Banking, Construction, and Manufacturing. She was the Compliance Officer of Unnati, the first Section 8 Company to be listed on the NSE Social Stock Exchange.
Raising capital can be one of the most exciting and defining moments for a startup. But between pitches, investor meetings, and due diligence, there lies a slim document that holds immense power — the Term Sheet. Often just one or two pages long, a term sheet outlines the key terms and conditions of a proposed investment agreement between a startup and its potential investors.
What is a Term Sheet?
A Term Sheet is a preliminary document exchanged between a startup and an investor that outlines the broad terms and conditions under which the investment will proceed. It acts as a roadmap for drafting legally binding agreements such as the Shareholders’ Agreement (SHA) and Share Subscription Agreement (SSA). A poorly negotiated term sheet can trigger several long-term operational and strategic issues, restrict future fundraising and expansion plans, or even make exits painful.
Key Clauses Every Term Sheet Must Include:
- Valuation (Pre-money / Post-money)
- Investment Amount
- Type of Security Issued (Equity / CCPS / CCDs)
- Liquidation Preference
- Board Composition & Voting Rights
- Anti-Dilution Protection
- Founder Lock-in / Vesting Schedules
- Exit Rights (IPO, Buyback, Drag/Tag Along)
- Information Rights & Reserved Matters
- Exclusivity & Confidentiality
Common Pitfalls and Real-World Lessons from Indian Startups:
- Excessive Control Rights: Many first-time founders unknowingly agree to broad Investor Affirmative Rights—also called Reserve Matters—that extend beyond strategic decisions into day-to-day operations. These include investor approvals on hiring, vendor contracts, product changes, and even pricing strategies, which can cripple a startup’s agility. In several Indian startups, founders lost operational control due to board composition clauses that gave investors majority representation or casting votes. Fundraising was delayed or derailed in cases where investor veto rights blocked new rounds unless specific terms were met.
- Founder Vesting and Exit Risks: Founder vesting is a common term meant to ensure long-term commitment, but if not carefully negotiated, it can backfire. In scenarios where founders are forced to exit, whether due to investor pressure or internal disputes, unvested shares may be forfeited entirely. This has happened in a few Indian startup cases where founders had exited prematurely and walked away with little to no equity, despite having built significant early value. To mitigate this, founders must define fair vesting terms, include acceleration clauses for involuntary exits, and ensure clarity on the treatment of vested versus unvested shares.
- Misalignment of Exit Expectations: A common pitfall is the mismatch between a founder’s long-term vision and an investor’s exit timeline. Some term sheets allow investors to enforce exit rights after a defined period, often five to seven years. This has led to pressure on startups to seek acquisition or public listing prematurely. In a few Indian cases, founders were forced to explore suboptimal exits or debt-driven buybacks, putting financial strain on the company when investors demanded their capital back during downturns or cash crunches.
- Overly Aggressive Anti-Dilution Clauses: Startups facing down rounds often trigger anti-dilution protections granted to early investors. While intended to protect investor value, these clauses can drastically dilute founder equity—sometimes leaving founders with a marginal or even negligible stake. Several Indian startups have seen founding teams lose control and motivation as their ownership was eroded during subsequent down round fundings.
- Drag-Along rights: Drag-along provisions, while useful in aligning shareholder exits, can pose a risk if not properly negotiated. They allow majority investors to force all shareholders, including founders, to sell their stake during a company sale, even if the valuation is not favorable. In several Indian startup exits, founders had little say in the deal terms and were compelled to go along with investor-led exits that prioritized return over long-term growth, leading to disenchantment and reduced morale.
- Liquidation Preferences Favoring Investors: One of the most overlooked yet damaging clauses is the liquidation preference. In some startups, investors secured 2x–3x preferences, entitling them to receive two to three times their original investment before any distribution to common shareholders (including founders). In real-world cases, founders walked away with marginal payouts or nothing at all. Without proper caps or negotiation, such preferences can turn even a decent acquisition into a founder’s financial disappointment.
Even If Non-Binding, Term Sheets Can Become Binding!
While a term sheet is typically considered non-binding and subject to the execution of definitive agreements, Indian courts have recognized that such documents can become enforceable if parties act upon them in a way that shows a legitimate expectation of performance.
Case Study – OYO vs Zostel (2021):
In the high-profile OYO-Zostel dispute, Zostel claimed that OYO had entered into a binding agreement to acquire its business based on a signed term sheet in 2015. Although OYO maintained that the term sheet was non-binding and subject to execution of definitive documents, the arbitral tribunal ruled that a binding agreement had been concluded and that Zostel had performed its part. The tribunal directed OYO to execute the definitive agreement, reinforcing that parties cannot dispute the terms of an agreement after benefiting from it. This case is a cautionary tale that even “non-binding” term sheets can carry legal weight when relied upon by one party.
Conclusion: Walk in With Your Eyes Wide Open
The term sheet is not just a legal document — it’s the foundation of your investor relationship and a reflection of your long-term vision. Founders must negotiate it carefully, ideally with professional guidance. A few overlooked lines can turn into major governance roadblocks down the road.
In the dynamic Indian startup landscape, with increasing scrutiny and investor activism, a smartly structured term sheet is not a luxury — it’s a necessity.
If you’re a founder navigating fundraising, remember: clarity now prevents conflict later.
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