Tag Archives: Termsheets


In the previous post ( read Part 4 here) , we discussed a few exit options. In this post we discuss about IPO, which is the preferred option in most investment deals. Many a time, even the early stage investment agreements capture quite a detail.

Negotiating Termsheets

As captured in the previous post, investors invest to exit with big returns and investment decisions are targeted towards startups which can create those great exits. Promoters on the other hand, may or may not have the same urge to ‘exit’ but the vision could be to create a long term successful organization. However, the investment agreements require the promoters to enable or provide exit to the investors, lest the investor may trigger its ‘default drag along right’.  It is very imperative to have clarity on the exit mechanism in the agreements including the timing of such exit or the decision tree (sequencing) of various exit options.

Tip: While one of the ways is detailing for all exit options to be provided in 5-7 years from investment date (IPO, trade sale, strategic third party sale, company buy-back), a smart way would be sequence the exit. Example IPO in 6 years, else provide for strategic third party sale after 6 years, beyond that time the investors can pressurize the promoters for a company buy-back at a pre-agreed IRR and only if nothing works, only then can the investors trigger their default drag along right. In one particular case, the company was not scaling up to the expectation and the investor after 2 years of investment, couched a drag along as a third party sale. The promoter did not make any money nor did he get a great salary during the investment (because it was a small series A round). 

Of the many exit options available, IPO (initial public offering/ listing of securities on stock exchange) is one of the most popular exit option, because when there are right market conditions, an IPO  option is likely to enable the investor to realize very high returns. However, as always, there is a flipside as well. The economic conditions for going public, is both the growth and scale of the company and very importantly external conditions which are not within the control of the promoters. There are very high costs involved in carrying out the IPO process, very high levels of information disclosures, strict regulatory requirements and restrictions. Another key point is that, the investors will exit when its shares are actually sold on the stock market, which might not happen concurrently with the IPO and accordingly the investor might be exposed to fluctuations and other market risks that are related after the IPO is carried out.

Tip: In order to protect a small IPO, which would enable investors to exit but may become burden-some for the promoters, it is a smart negotiation point to have a ‘qualified’ IPO, which provides for a total amount, which is sufficiently large to guarantee an IPO in major stock exchanges.

Given the importance of exits, even early stage investment deals capture IPO in detail. IPO can be either through issuance of new shares or offer of existing shares for public subscription. IPO can be either in India or outside of India. While there are many regulatory requirements that a company needs to ensure before getting into a scheme of an IPO, some of the eligibility criteria for a company to fulfill are, Net worth of Rs.1crore in each of the preceding 3 years. Net tangible assets of at least Rs. 3 Crores for each of the preceding 3 years along with track record for distributable profits for 3 out of immediately 5 preceding years. There are requirements of lock-in of promoter shares.  Hence, the clauses in the SHA, wherein the investors shall not be treated as promoters and not subject to lock-in requirements as per the listing guidelines.

While IPO on main stock exchanges is great, there are other platforms like SME Exchange. There are two basic criteria for determining the status of SME are capital and profits. Capital requirement is for a company to have minimum paid up capital of Rs. 1 crore and a maximum of Rs. 25 crore. Profit criterion is for a company to have distributable profits in two out of last three financial years. The amount that can be raised from the public is upto Rs. 25 crores. To facilitate the listing there are two platforms available in India BSE-SME Exchange and EMERGE –NSE.

A quick look at the other eligibility requirements for SME IPO:

Maximum Post Issue capital of Rs. 25 crores

  • Minimum number of members for a public issue is 50
  • Market making is mandatory for 3 years
  • Underwriting is required for 100% of the issue size (Merchant Bankers to underwrite 15% in its own account)
  • Issue lot size is dependent on the number of shares based on IPO price band
  • Trading lot size is multiples of Rs.1 lakh.
  • After listing the requirement of minimum number of members is not required to be continued.
  • Companies listed on SME Exchange can anytime migrate to the main Bombay Stock Exchange, provided shareholders’ approve.

While there certainly are benefits in SME listing, it might be a tad unappealing to investors who want bigger exits with greater liquidity on the markets.

Listing without IPO for SMEs:  SEBI’s new ‘Listing Of Specified Securities On Institutional Trading Platform) Regulations, 2013’ preamble states to provide easier exit options for informed investors like  Angel Investors, VCFs and PE  etc to provide better visibility, wider investor base and greater fund raising capabilities to such companies. These initiatives to help in greater exit opportunities and create liquidity for these investors. Further, SEBI has proposed to relax few norms for the ITP listing, where minimum amount for trading or investment on the ITP will be Rs 10 lakh and such companies would also be exempted from offering up to 25% of its shareholding to public through an offer document in order to get listed. There are further eligibility criteria that are listed by SEBI for availing the listing on ITP.

Further provisions are proposed where companies listed on the ITP will not have access to public money, can continue to have private placement rounds. Therefore, listing can be done without an IPO and the expenses associated with it. The biggest advantage is that it is economical and less procedural as compared to the IPO process.

Traditionally, the investment agreements have envisaged listing outside of India as well. Specially so, if the investment fund is not based in India.  So, clauses related to IPO in the USA with demand rights, piggy back rights etc. are captured. Piggyback rights entitle investors to register their shares when a company goes public. Whereas, demand rights requires the company to conduct a public offering and is a superior right compared to the piggyback rights.

Tip: Savvy promoters should negotiate for piggyback rights alone. We also understand that promoters can ask for the same right.

More often than not, during the early stage investment the promoters are keen on getting the investment and scaling businesses. Many a time, exits specially IPO looks like a distant dream and the focus on these clauses is usually less of a priority during negotiation.  We would love to see workshops/ seminars on ‘exit options’ and we could share our knowledge.

Our second customer at NovoJuris, Pennywise Solutions got acquired by Ogilvy and it is very satisfying to see these success stories. Even more satisfying is the squeaky clean due-diligence report of the company that Ogilvy was thrilled with. We’ll share this experience (‘sell-side experience’ as they call) pretty soon. Read article here.

Tip:  While there are termsheet level discussions for acquisitions that come by, many a time we have seen the deal fall through for non-compliances. We urge the promoters to take compliance seriously. It is boring but very important.

We would really love to hear your experiences and thoughts.

DisclaimerThis is not a legal opinion and should not be construed as one.  Please speak with your attorney for any advice.


The most critical aspect in any investment deal for the investors is the exit clause, which is when they get to see the return on investment. In a typical early stage investment deal, the options are initial public offering (IPO), strategic sale to a third party, company buy-back and in a few deals (rare), we see promoter / promoter led-buyback. In this post, we touch upon some of these exit avenues.

The termsheet would refer to the exit options and also refers to the definition of Liquidation Event.

Liquidation Event covers

  1. Winding up. i.e. things don’t go well and the company needs to be shut down.
  2. Consolidation, merger, reorganization where the current majority of shareholders do not continue holding a majority after such corporate actions or change in control of more than 50% shareholding. Sale of more than 50% shareholding to another party.
  3. Transfer of substantial assets.

Given that the investor will have to repay his investor (limited partners or LP as we call them), the time-horizon is driven by the LP’s terms in the fund. We generally see 5 years to 7 years for investors seeking exit.

In early stage investment, (example, incubators, accelerators, mentors, friends and family round, individual angels), we have seen that they would like to retain flexibility of exiting (either full or in part) at the next round of investment. This is a point that the entrepreneur has to be conscious about, because this has an impact on the deal closure timelines.

Tip: Angels may not be angels. (Please don’t get us wrong. Angels provide huge strategic value and the money required in the formative stages of the startup). In one particular case, we saw that the an angel network actually negotiate the investment terms to an extent that it was becoming a Series A investment deal breaker, because (i) they were not consulted by the founder prior to signing the Series A termsheet and (ii) wanting rights like the Series A investor without participating in the investment round. We finally figured that the underpinning thought of the angel network was to get an exit and at a price higher than the Series A round. This is where experience of handling investment deals becomes critical and probably founders’ soft-skills.

In earlier posts we have discussed that the investors are keen on big exits and multiply their investment amount and not so keen on the dividend amount.

Tip: Typically in a friends and family round we have seen high dividend rates or a request for return of investment money when the business becomes ‘life-style business’. In these cases, a founder can think of structuring the deal as optionally convertible debentures (if investor is in India).

You would now realize that there is an interplay of instrument, dividend rate, exit option and liquidation preference.

The clause on Exit talks about the process of exit while the clause on liquidation preference details the distribution of the money received on exit.

Let’s look at strategic third party sale (also called as trade sale). The exit can either be for only the investors or all shareholders. M&A (Mergers & Acquisitions), of privately held company is the most popular type of exit strategy. Merger is typically through a court process wherein two or more entities combine and shares of the acquiring entity is exchanged. Acquisition, could be either asset sale or entity sale. Asset sale is where the acquirer cherry picks the assets and many a time leave the liabilities behind. Entity sale is typically done as a share purchase agreement. Now, each of these are big topics to write about, since there are many nuances including taxes, if it is a majority stake-sale and the like. In all of these scenarios, the purchase price is determined by the acquirer. If the investors like the deal they should exit?

Tip:  Remember we said the investor wants to see the investment amount multiply? During exit, the investor evaluates the growth potential of the company, IRR (internal rate of return) on the investment amount and many other external factors. It is recommended that some base / floor price of exit (formula / fair market value /IRR) is determined, because if there is no exit provided within the 5-7 year horizon, then it gets linked to default-drag along right. (Default Drag Along Right is the ability of the investor to drag the shareholders and sell it to a party at the price /terms that the investor determines with such third party, only if the promoters have not been able to provide an exit)

Super Tip: Super important for the founder to not provide for a plain Drag Along Right, where the investor can drag at any point in time and have only Default Drag Along Right.

In a buy-back of shares by the company, there are laws, rules and regulations governing such buy back. Up until recently, buy-back was also used to overcome the dividend distribution tax  and the recent Finance Act, 2013 which imposes a 20% tax on the company undertaking the buyback, very much like dividend distribution tax.

Another recent development is the cooling off period between buy-back in the new Companies Act 2013 as compared to the Companies Act 1956. Earlier, we had a board approval process for 10% of equity shares and shareholder approval process for 25% for shares.  While a cooling off period of one year had been prescribed between two successive buy-backs authorized by the board of directors, however enabling provision was captured where a buy-back of up to 10% of the paid up equity capital and free reserves of the company by way of a board resolution, immediately followed by another buy-back of up to 25% of the total paid up equity capital and free reserves by way of shareholders’ resolution

The new Companies Act 2013 prescribes a cooling off period of one year between two buy-backs which means multiple buyback in a year is not possible. This could have an impact of reducing the ability to give a timely exit to private equity investors even in cases where the company may be sitting on surplus cash.

Tip: We recommend that the promoters think about having a floor price (IRR may be a good one), so that an exit discussion gets enabled.

While providing for a Promoter or Promoter led buy-back seem to be a great option, generally, we do not see that listed as an option in early stage investment. Strange, isn’t it? Do you think it is a notion that the early stage promoter would not have the money to buy-out or is it because the price and terms would not be favorable to investors?

Though the term used is ‘buyback’ the transaction is a secondary sale of shares between two shareholders.

Tip: Given the changes in taxation, promoters need to understand the concept of withholding of taxes. In one particular case, the Singaporean investor was not willing of the promoter to withhold taxes (completion of this transaction was a dependency on a Series B deal) and finally the promoter under took a sub-optimal route of having a stronger indemnity clause.

We would really love to hear your experiences and thoughts.

In the next post, we will discuss other exit options. 

Disclaimer: This is not a legal opinion and should not be construed as one.  Please speak with your attorney for any advice.


We covered interesting tips on negotiating the ‘commercials’ of a termsheeet – http://novojuris.wordpress.com/2013/08/27/term-sheets-negotiation-and-tips-part-1/ and http://novojuris.wordpress.com/2013/09/03/term-sheets-negotiation-and-tips-part-2/.

Negotiating commercial aspects of the termsheet is kind of expected unlike ‘controls’ (please see Part I of this series). Most investors would give a standard response of ‘style of investment’ and ‘these are minimum controls to retain our investment in the company’ and shy away from negotiating. They do have a point here.

If you take a loan from a bank, there is a requirement of an asset guarantee, corporate guarantee and/or many a times, a personal guarantee. Banks also have monthly information and reporting requirements.  There is an interest that is paid, on the loan which is the ROI the bank works on. If the loan is a large one, there will be certain matters which require the bank’s prior approval. Compared to the bank loan, an early stage investment does not require such guarantees.  What they do believe in is the founding team and the scalable idea, with no guarantee of getting back their investment amount. With this perspective, you could negotiate the ‘control’ aspects. No, we aren’t trying to be philosophical, but suggesting that you prioritize your list of things to negotiate.

Board Composition:

Here’s how the mechanics work: In a company, the decisions are made at two forums, meeting of board of directors and shareholders’ meeting. The powers that vests with the board, is then delegated to the CEO and others in the company.

In a board, one director has one vote. While in a shareholder meeting, one share gets one vote. (This is where a majority (51%- ordinary resolution) and (75% – special resolution) voting requirements matter). When an investor takes a 26% stake, she gets a veto voting right on important matters, without which, special resolution matters cannot be decided by the company.

Also, in a limited liability company, the investor gets a control by having a representation in the board and having veto rights on a list of really important matters called ‘Reserved Matters’. This means that without the investor’s consent, the agenda items listed in Reserved Matters cannot be decided upon by the rest of the board, though the rest of the board form a majority.

Before you think it is very prestigious to be a Director of the Board, let me quickly add that it does come loaded with liabilities, duties, responsibilities under various statutes (labor laws, tax laws, economic laws, securities related laws and Companies Act.) When there are non-compliances, it is the directors who are held responsible. So, you also have a few institutional investors who do not take a director’s position but opt for a ‘board observer’s position’ which is not a legal position and does not carry voting rights.

Board Composition or the size of the board, determines the ratio of the founder-to-investor representation on the board. The number of board seats for the investor should be relative to the size of the investment.

In India, we typically see that more 15 – 26% shareholding calls for one board seat, in early stage investments (the range covers angels, angel networks, micro VC’s, seed stage, series A). We also see that the investor gives away the right should their shareholding fall below 5%. This is limited only to board seat and others, such as right to receive information or veto on shareholder related Reserved Matters continue.

Some tips: (most of it is common-sense do you say?)

  • The lead investor gets a board seat – This payments company with a really soft spoken founder: We witnessed a not-so-fun round of negotiation, when 3 institutional investors, totaling to about Rs.1.5 crores of investment, each asking for a board seat and each investor having a really long list of Reserved Matters.  It was quite a task to trim it to one board seat and one common Reserved Matters list.
  • If in a large network of individual investors, get the decision making done through one person, so that the investor group dynamics are minimized and the founder can focus on business – This feedback company founder thanks us quite a bit for this tip.
  • If co-investment, the decision making can be as a group. But, it does come with its challenges during ‘exit’ scenarios.
  • It is suggested to have an odd number (as opposed to an even number) of individuals on the board, so that there is no ‘tie’ in the decision making.
  • It is ‘nice’ if the founding team has a majority of directors, the dynamics of the number should work in their favor.  But, if the Reserved Matters (typically a list of about 25 to 30 items, which covers nearly all important aspects of business decisions) require an investor’s affirmative consent, then, do you think it helps?
  • Ensure that the Independent Director is indeed independently appointed and takes independent decisions in the interest of the company. – The investor in this deals company said, ‘Oh, we’ll get you an independent director who adds tremendous value to your business.’

We enjoy many discussions with entrepreneurs. But this one comes to my mind when I write. It was a majority stake sale (51%) that we recently completed and the BITSian founder, true to his engineering (as in, logical thinking) background comes up with an entire working of 49%:51% stake and is adequately represented with a 25 member board seat. You get the point 🙂 .

Keep the board size small + meaningful.

Disclaimer:  This is not a legal opinion and should not be construed as one.  Please speak with your attorney for any advice.

Term Sheets – Negotiation and Tips – Part 1

So, you have found someone (a VC) who wants to back you with the money you so desperately need. Just sign above the dotted line. Well, not so fast…

A term sheet is a non-binding document that lays out the important terms under which the VC or angel investor will make an investment in a company. A term sheet is used as a framework for discussion, negotiations and clarifications, before the final share holder agreement is drafted. (A share holder agreement or SHA is a binding document which legally formalizes the transaction.)

Since the term-sheet is the basis of the final SHA, it covers critical aspects like valuation of the company, control over decision making, exit options and how the investor’s capital would be protected against downside. Since a term sheet is usually drawn by an investor, it is usually loaded in favor of the investor and usually designed to protect the capital that the investor invests in the company, and to protect the investor from any action that may be detrimental to the investor’s financial interest in the company. It is therefore important that entrepreneurs understand the terms of a term sheet, do their homework well, decide on what terms they are comfortable with and what they are not comfortable with, and then, discuss the same with the investor. It is advisable to consult a lawyer who understands term sheets, and can advice you about what terms to be flexible on and what terms to accept. And most importantly, help you understand the consequences in case there are terms that are not in the best interest of the venture or the entrepreneur.

A term sheet, at a high level, can be broadly divided into two buckets – the commercial and the legal component.

www.investopedia.com is a good place for you to begin with for understanding the concepts and definitions.

Commercial Legal
Valuation Board Composition, Protective Provisions (Veto Rights)
Liquidation Preference – 1X, 1X+ participatory Investor Rights- ROFR, ROFO, Tag, Pre emptive Rights
ESOP Founder Vesting
Dividend Exit mechanism
Founder Vesting Information & Registration rights
Anti Dilution- full ratchet, broad based

The reason why we present it this way is that, while “commercials” can be negotiated quite a bit, the “legal” part of it cannot be negotiated to the same extent.  Founders need to pick their battle J

This post briefly touches upon valuation and liquidation preference.


Valuation can be broken down into pre-money and post-money valuation. The pre-money valuation is what the investor values your entity as of current date. The post money valuation is the sum of the pre-money valuation and the investment amount. To give you an example, if your company is valued at INR 3,00,00,000 and the investor is putting in INR 1,50,00,000, then the post money valuation is INR 4,50,00,000. The valuation helps the investor determine the stake he would like to take in your entity.

TIP: In early stage investment, valuation is more of an art, unlike later stage companies which would have revenues and a prior history to base valuation on.

While valuation is the most important aspect, the entrepreneur should evaluate the other benefits too – marquee investor, network, opening doors with large enterprises, recommending a smart employee, probably their ability to obtain brilliant exits. Take a look at their portfolio and probably speak with the company founders to get a better perspective of the “value add”.

The scale that the business can achieve and the founders ability to exhibit that in the plan, truly helps. Also, the founder should not forget in exhibiting their commitment to the scale.

Being educated of valuation numbers in other startups similar to yours or what the market is generally garnering helps.

Like in any other negotiation strategy, having more than one offer increases the negotiation strength, but in depressed markets having one offer itself is difficult. Watch, if you are being extremely desperate and also showing it.

The best strength, ofcourse, remains in building a rock-star product / startup.

Some of our experiences, if that is going to help you:

Buzz in cloud – 

Context: A data center with a very large tract of land allotted by the government, with prior experience of having built a data center, very senior management team, at a time when “cloud” is a buzz word.

Outcome: This should get great negotiation strength, right? Not necessarily, the desperation was so high to have money in the bank, that literally nothing was negotiated.

Media Moghul – 

Context: Senior management professional with immense execution capabilities in India’s richest company, was never an entrepreneur, about 48 years old, no team, just a ppt of the idea, no proof of concept yet. There’s nothing to negotiate? Not quite, the idea is so immensely scalable anywhere in the world, had the ability to stretch into multiple different business segments, founder charms enterprises to give him extremely expensive equipment with a growth-story.

Outcome: We close the deal with investment terms that one can dream of.

India education story – 

Context: Two founders who studied finance in NY, think of a product in technology (have no knowledge of tech), outsource the entire product build to a vendor with no contract or IP ownership terms discussed (well, there was an email broadly describing royalty payments and equity sharing etc.), extremely ambitious, projections of revenue and early traction very promising, very aggressive valuation expected by the founders.

Outcome: The term sheet was signed-up with the aggressive valuation with a clause that, if the numbers portrayed were not reached, then the valuation would be adjusted. The deal fell through during due-diligence, due to incorrect portrayal of number of earlier users, early revenues were not true, no IP owned, the tech vendor disappeared without giving out the source code.


Dividend in simple words refers to a percentage which provides a share in the profits of the company. If the investment uses ‘preference shares’ as the instrument, then from legal perspective the instrument has to mention the rate of dividend. A typical dividend clause reads as cumulative or a non-cumulative clause.

 TIP: Investors look for big exits and not the small money in the form of dividends. From a founder perspective, keep the dividend rate low, can be as low as 0.001% and non-cumulative. (i.e. dividend is only paid for the year it is declared in, as opposed to an accumulation till the year it is declared).

Liquidation Preference

Liquidation preference in simple terms determines how the pie is shared in case of a liquidity event.(the money sharing clause when there is an exit). The clause also determines the sequence of pay-out.

 Liquidation event typically includes IPO, company buy-back, promoter or promoter led buy-back, trade sale, merger, acquisition, strategic sale (which may lead to change of more than 51% control), dissolution or winding up and the like.

The term sheet will specify the ‘preference’ the investor will get over other shareholders (founders/other early investors). The term sheet carries the multiples of returns the investor shall get, in the case of liquidation.

The clause also would also detail whether the investor just participates (i.e. to the extent of his shareholding percentage) or wants a 1x + participatory, also known as double-dip (i.e. the investor gets to take his investment amount first and then participate in the remaining proceeds).

Though majority of the deals in India are 1x + participatory, we have seen few deals with 1.5x + participatory.  It was in one deal we saw 2x+ participatory and interestingly it was from a social impact fund.

E.g. if the investor invests Rs.1 cr for 25% stake in your startup, and the term sheet stipulates a 2x return for the investor. Lets examine a Rs. 10 cr exit.

  • If just participatory right, the investor gets 25% of Rs. 10 cr = Rs. 2.5 cr.
  • If 1x+ participatory, the investor gets Rs.1 cr + Rs.2.25cr = Rs. 3.25 cr.

So, you negotiated hard for a 25% dilution during the valuation clause?

What’s the money that the founder makes if there is a small exit, say Rs. 5 cr.?

TIP: From a founder’s perspective, you may think of negotiating just participatory right.

If individual angel investor, he may evaluate but from institutional investor perspective, his math doesn’t add up for providing a return to their limited partners (the investor in the fund).

You may want to think of limiting the extent of participation in the remaining proceeds after the initial 1x. Uphill task, but we try.

If you have had some great experience, please share.


Disclaimer:  This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

Ramya Sridhar is an attorney specializing in private equity and commercial contracts.