The term sheet is the most consequential document in a venture capital transaction. While it is technically non-binding (except for exclusivity and confidentiality clauses), the terms agreed upon set the framework for the definitive agreements. For Indian founders, who may be negotiating with experienced institutional investors for the first time, understanding these key clauses is essential.
1. Liquidation Preference
Liquidation preference determines who gets paid first and how much, in any liquidity event including sale, merger, or winding up. A 1x non-participating preference is market standard and fair. Participating preferences with multiples can significantly dilute founder returns in moderate exit scenarios. Founders should understand the waterfall analysis under different exit scenarios.
2. Anti-Dilution Protection
Anti-dilution clauses protect investors if the company raises capital at a lower valuation in the future (a "down round"). Broad-based weighted average anti-dilution is the standard in Indian VC transactions. Full ratchet anti-dilution is aggressive and significantly penalizes founders in down-round scenarios.
3. Board Composition and Voting Rights
Board seats and voting rights determine governance control. Founders should retain board control in early rounds. Key protective provisions (reserved matters) that require investor consent typically include new share issuance, related party transactions, and changes to the articles of association.
4. Drag-Along and Tag-Along Rights
- Drag-Along: Allows majority shareholders to force minority shareholders to participate in a sale. This protects investors by ensuring they can facilitate an exit even if some shareholders disagree.
- Tag-Along: Protects minority shareholders by allowing them to participate in any sale by majority shareholders on the same terms. Founders should ensure mutual tag-along rights.
5. ESOP Pool
Investors typically require a pre-money ESOP pool of 10-15% to be created or topped up. This dilutes existing shareholders (including founders) before the investment. Founders should negotiate the ESOP pool size carefully and ensure it aligns with actual hiring plans rather than inflated investor demands.
Liquidation preference and anti-dilution clauses are the two provisions that most significantly impact founder economics at exit. A 2x participating liquidation preference can reduce founder returns by 40-60% in moderate exit scenarios. Always negotiate these before signing.
6. Exit Provisions
Exit provisions, including IPO timelines, put options, and strategic sale rights, define how and when investors can exit their investment. Indian VC transactions typically include a 5-7 year exit timeline with provisions for extension. Understanding these provisions helps founders align long-term company strategy with investor expectations.
Term Sheet Negotiation Priorities
- Liquidation preferences: Push for 1x non-participating over participating structures
- Anti-dilution: Broad-based weighted average is founder-friendly vs. full ratchet
- Board composition: Maintain founder control with balanced board representation
- Vesting schedules: Standard 4-year with 1-year cliff; negotiate acceleration triggers
- Protective provisions: Limit investor veto rights to truly material decisions