Ideas|Products|Startups|VCs

Many promoters and budding entrepreneurs have some notions about termsheet, some treat it as the scariest piece in the investment process and for some getting a termsheet is a milestone.

In simple words, termsheet is a guideline document for entrepreneur issued by the investor. If you are playing a game no fun without playing with rules and regulations. So treat this investment process as game of scaling the venture. I have come across term sheets ranging from $200k-$20M, good news is most of the clauses are common irrespective of size of investments.

Lets look at the most common clauses in a tech investment termsheet i have come across:

Vesting of Founder’s shares :

The shares held by Founding team will be locked for 3 years; subsequently they will unlock in equal annual installments over a period of 3 years. If any of the founding team decides to leave the company at a time before such period , the locked share would have to be sold at par to the existing shareholders of Company and Investor will be given the first option to purchase the said shares. Should Investors decline to purchase the shares, such shares will be sold to other shareholders in proportion to their shareholding. Such shares at the investor discretion can be placed in ESOP Pool.

ESOP Shares:

The company will create an ESOP pool of 6% prior to investment.

Tag Along Rights:

Subject to the lock-in provisions herein contained, in the event the Founders sell their shares to a 3rd party investors would have a right to sell its shares on the same terms to the same party. The tag-along shall be a pro-rata right so long as the total number of shares transferred by the founders is less than 50% of their share holding in the company. If any shares in addition to the above are proposed to be transferred, the investor shall have the first option to sell their shares to proposed purchaser.

Right of first Refusal:

Off late i have come across couple of instances where VCs have not invested after signing the term sheets and really put startup and entrepreneur in back foot by their ‘No Shop‘ clause in the term sheet. Signing a term sheet with a no shop agreement is likely to send you back a month or more if the VC doesn’t end up funding the company.  I can see the insistence of no shop language in larger M&A deals but see no place for them in early stage rounds.

So what is a No Shop Clause?

In simple words ‘No shop’ clause, prohibits the entrepreneur from speaking to other investors while the VC completes his due diligence.

No Shop/Confidentiality provision is one of the two provisions in the term sheet that is usually “binding” on the company and the investors – meaning it is enforceable even if the rest of the contemplated financing is never completed.

The implications of the No Shop provision are very straightforward. The “No Shop” portion requires the company to refrain from actively pursuing any other investment or any sale of the company for a set period of time after the term sheet is signed. Most of the time the only point of negotiation is the length of the No Shop period. This ranges from 30 to 90 days, but is typically 45 or 60 days.  Once the term sheet is signed, both sides are usually anxious to get the transaction closed as quickly as possible.

This is an important issue because if your VC walks away after you sign the term sheet (which happens from time to time), your company may be considered damaged goods and it will be difficult for you to find another investor.  Accordingly, if you get any indication that your VC is getting cold feet, you want to be able to move quickly to re-kindle discussions with other investors, if possible.

If you believe in your startup and aiming at large market and have a lot of leverage (such as many VCs interested in your company), you may be able to knock this provision out entirely.  Remember: every clause in a termsheet is negotiable.

-Hitesh, vcBytes.com