Term sheet terms explained in plain English (India)

Term sheet terms decide far more than your valuation. Liquidation preference sets who gets paid first in a sale, anti-dilution protects investors if a later round is priced lower, pro-rata lets them keep their stake, and the option pool and board terms decide how much you own and control. Here they are in plain English, with Indian examples.

Who this is for: Indian founders reading their first term sheet, usually for a seed or Series A round, who want to know what each clause means before the lawyers start talking.

First, what a term sheet is and isn't

A term sheet is a short document, often two to six pages, that sets out the main terms of an investment. In India it's usually followed by two long agreements: the share subscription agreement (how much money, for what shares) and the shareholders' agreement (everyone's rights afterwards).

Most of a term sheet isn't legally binding. A few clauses usually are: confidentiality, exclusivity (often called "no-shop") and governing law. Exclusivity is the one to watch. It stops you speaking to other investors for a period, commonly 30 to 60 days. Agree to it only when you're ready to commit to this investor.

Indian rounds are usually done with compulsorily convertible preference shares (CCPS). Most of the investor protections below are written into those shares and into the shareholders' agreement. If you're raising on CCPS, CCDs or an iSAFE, our post on how Indian startups raise early money explains the instruments.

Valuation and the option pool

Pre-money and post-money

Pre-money is what the company is worth before the new money. Post-money is pre-money plus the new money.

Example: an investor puts in ₹8 crore at a ₹32 crore pre-money valuation. Post-money is ₹40 crore. The investor owns ₹8 crore divided by ₹40 crore, which is 20%.

The option pool shuffle

Investors often ask for an ESOP pool, say 10% of the company after the round, to hire future employees. The question is whose shares pay for it.

If the term sheet says the pool is "included in the pre-money", the pool is created before the investor comes in, so only existing shareholders are diluted by it. Your real pre-money valuation is lower than the headline.

What to negotiate: size the pool to an actual hiring plan for the next 18 to 24 months, not a round number. If you need 6%, don't agree to 12%. Our post on ESOPs in India explains how pools and grants work.

Liquidation preference

This decides who gets paid first, and how much, if the company is sold or wound up.

1x non-participating (the common, fair version)

The investor gets back the greater of (a) their money, or (b) their percentage of the sale price. Not both.

Participating preference (the expensive version)

The investor first takes their money back, then also takes their percentage of whatever is left. People call this "double dipping".

Worked example

Same round as before: ₹8 crore in for 20%. The company is sold for ₹30 crore.

At a big exit the difference shrinks. At a modest exit, which is the most common kind, participating preference takes a lot from founders and employees. Push for 1x non-participating. Be very wary of multiples above 1x.

Anti-dilution

Anti-dilution protects investors if you later raise money at a lower price per share (a "down round"). It adjusts their conversion price so they get more shares.

• Broad-based weighted average: the adjustment depends on how much lower the new price is and how much new money comes in, measured across all shares. This is the market standard and reasonably fair.
• Narrow-based weighted average: the same idea, but counted over fewer shares, so the investor gets a bigger adjustment.
• Full ratchet: the investor's price drops all the way to the new, lower price, however little money is raised at it. This can be brutal for founders. Avoid it.

What to negotiate: broad-based weighted average, with exceptions for ESOP grants and other agreed issues so routine share issues don't trigger it.

Pro-rata and pre-emptive rights

Pro-rata, often called a pre-emptive right in Indian agreements, lets an investor invest in future rounds so their percentage stays the same. It's standard and usually fine.

Watch for:

• Super pro-rata: the right to buy more than their share in later rounds. It can crowd out a new lead you might want.
• Pro-rata for very small investors: if a dozen angels each have it, managing a later round becomes slow. Many term sheets give pro-rata only above a minimum holding.

Board seats, information rights and investor vetoes

Board composition

A typical seed board is two founders and one investor director, or founders plus one investor and later one independent. Keep founder control of the board as long as you reasonably can. Agree in writing how the board changes at the next round.

Information rights

Investors usually ask for monthly or quarterly financials, an annual budget and audited accounts. That's reasonable. Make sure the timelines are realistic for your team, for example monthly accounts within 30 days. Our monthly investor update template makes this easier.

Reserved matters (investor vetoes)

Indian shareholders' agreements usually list "reserved matters" or "affirmative vote matters" that need the investor's consent. Some are fair: changing the share capital, selling the company, changing the business entirely. Others can slow you down: approving the annual budget, hiring above a salary level, every contract above a small amount.

What to negotiate: keep the list to big, rare decisions. Day-to-day running of the company should stay with you.

Other terms you'll see

Founder vesting and leaver clauses

Many term sheets ask founders to put some or all of their shares on a vesting schedule, even though they already own them. The idea is fair: if a founder leaves in month six, the company shouldn't carry a large, idle shareholder.

The details are what matter:

• Credit for time served. If you've been building for two years, ask for that time to count. A common outcome is a portion vested at signing, with the rest vesting monthly over the next two to four years.
• Good leaver and bad leaver. A good leaver (illness, being let go without cause) usually keeps vested shares. A bad leaver (fraud, serious breach) may have to sell them back at a low price. Make sure "bad leaver" is narrowly defined, not "anyone who resigns".
• Acceleration. If the company is sold and you lose your role, some or all unvested shares can vest at once. Ask for it, especially for a sale where the buyer doesn't keep you.

How to read a term sheet in one sitting

Before the call with your lawyer, go through the term sheet once with a pen and these five questions:

1. What do I own after the round, including the option pool, in a simple before and after table?
2. What does each side get in a modest sale, say at the post-money valuation or below it?
3. What can't I do without the investor's permission? List every reserved matter.
4. What happens if the next round is priced lower? Find the anti-dilution clause.
5. What binds me today? Usually confidentiality, exclusivity and governing law.

If you can answer all five in plain words, you're ready to negotiate. If you can't, ask the investor to explain. Good investors are happy to.

Paperwork after you sign

Once the round closes and shares are allotted, there's compliance to do. If any investor is foreign, the company must report the allotment to the RBI on Form FC-GPR within 30 days, with a valuation certificate from a CA or SEBI-registered merchant banker. There are also filings with the Registrar of Companies. Your CS or CA will run these, but put the dates in your calendar.

What's actually negotiable at seed

Valuation gets most of the attention. These matter just as much:

1. Option pool size, and whether it's in the pre-money.
2. Non-participating versus participating preference.
3. The anti-dilution formula.
4. Board composition, now and at the next round.
5. The length of the reserved matters list.
6. The length of exclusivity.

Common mistakes

• Negotiating only valuation. A higher price with a big pre-money pool and participating preference can leave you worse off.
• Signing a long no-shop too early. You lose your other options.
• Accepting full ratchet anti-dilution because "we'll never have a down round".
• Agreeing to vetoes over the budget and hiring. Every decision then waits on a call.
• Not modelling the exit. Run the numbers at a modest sale, not only a dream one.

Questions people ask

What is a liquidation preference in simple terms?

It decides who gets paid first, and how much, if the company is sold or wound up. A 1x non-participating preference means the investor gets back either their money or their share of the sale price, whichever is higher. It's the most common and most founder-friendly version at seed and Series A.

What does pro-rata mean in a term sheet?

Pro-rata, or a pre-emptive right, lets an investor put in more money in future rounds so their percentage doesn't shrink. It's standard and usually fine. Watch for super pro-rata, which lets them buy more than their share, because it can squeeze out new investors you might want later.

Is a term sheet legally binding in India?

Mostly not. The commercial terms are usually non-binding, and the final shareholders' agreement and share subscription agreement are what bind. A few clauses are typically binding, such as confidentiality, exclusivity and governing law. Read those carefully, because exclusivity stops you talking to other investors for a set period.

Which term sheet terms are negotiable at seed?

More than founders think. The size of the option pool and whether it sits in the pre-money valuation, participating versus non-participating preference, the anti-dilution formula, board composition and the list of investor veto rights are all commonly negotiated. Valuation gets the attention, but these terms often matter more.

Sources

• Carta: Term sheet terms to watch out for (opens in a new tab)
• Wilson Sonsini: VC financing fundamentals (2024) (opens in a new tab)
• Treelife: FC-GPR filing after foreign investment (opens in a new tab)

This is general information, not legal or tax advice. Check with your CA or lawyer for your company's situation.