7. Term Sheet Analysis - The Most Important Document You'll Sign¶

7.1 Executive Summary¶

• Term sheets are binding on key economics: While labeled "non-binding," valuation, liquidation preferences, and board structure typically become enforceable once signed, limiting negotiation leverage in SHA phase.
• Liquidation preference structure determines exit outcomes: 1x non-participating is standard and fair; participating preferred (especially uncapped) can leave founders with nothing even in $50M exits.
• Anti-dilution protection varies wildly: Broad-based weighted average is market standard and founder-friendly; full ratchet is predatory and can destroy founder ownership in down rounds.
• Board composition dictates control: Balanced boards (founder seats = investor seats + independent) preserve operational flexibility; investor-majority boards from seed stage signal trouble.
• Hidden provisions matter most: Protective provisions, drag-along rights, and no-shop periods often receive less attention than valuation but dramatically impact founder autonomy and exit optionality.
• Indian regulatory overlay adds complexity: CCPS structure, RBI pricing guidelines, and FEMA compliance requirements make Indian term sheets more complex than US equivalents.

This chapter provides clause-by-clause analysis of standard term sheets with worked examples showing financial impact. Master this content before negotiating your first institutional funding round—the economics determined here shape your startup's entire lifecycle.

7.2 Understanding the Term Sheet: Purpose and Binding Nature¶

What is a Term Sheet?¶

A term sheet is a 5-15 page document outlining the key economic and control terms of an investment. It's the first formal expression of investor intent and serves as the blueprint for definitive legal agreements: the Shareholders' Agreement (SHA), Stock Purchase Agreement (SPA), and Voting Agreement.

Purpose:

1. Establish investment economics (valuation, liquidation preference, anti-dilution)
2. Define governance structure (board composition, protective provisions)
3. Set transaction mechanics (closing conditions, exclusivity period)
4. Create framework for legal documentation

Typical Timeline:

• Pitch meetings → 4-8 weeks
• Due diligence (preliminary) → 2-4 weeks
• Term sheet negotiation → 1-2 weeks
• Legal documentation (SHA/SPA) → 3-6 weeks
• Closing and fund transfer → 1-2 weeks

Total: 11-21 weeks from first meeting to closed deal in India (shorter in US: 8-16 weeks).

The "Non-Binding" Myth¶

Most term sheets begin with language like: "Except for [specified provisions], this term sheet is non-binding and does not create enforceable obligations."

What's Actually Binding:

• Exclusivity (No-Shop): Founder cannot solicit or negotiate with other investors for 30-90 days
• Confidentiality: Investment discussions and terms remain confidential
• Governing Law and Dispute Resolution: Arbitration jurisdiction and process
• Expenses: Often investor legal expenses paid by company (negotiate this)

What's "Non-Binding" But Practically Binding:

• Valuation: Changing valuation post-term sheet damages reputation and kills deal
• Liquidation Preference: Investors won't accept material changes in SHA
• Board Structure: Locked in at term sheet stage
• Anti-Dilution: Standard provision; difficult to renegotiate

Key Principle: Treat term sheet as binding. The only acceptable changes during SHA negotiation are clarifications and standardization of boilerplate provisions, not material economic revisions.

Pre-Money vs Post-Money Valuation (Critical Distinction)¶

The most important number in any term sheet is the valuation, but "pre-money" vs "post-money" creates confusion:

Pre-Money Valuation: Company value BEFORE the new investment.

Post-Money Valuation: Company value AFTER the new investment.

Formula:

Post-Money Valuation = Pre-Money Valuation + Investment Amount

Investor Ownership % = Investment Amount / Post-Money Valuation

Or alternatively:
Investor Ownership % = Investment Amount / (Pre-Money Valuation + Investment Amount)

Example:

• Investment: $5M
• Pre-Money Valuation: $20M
• Post-Money Valuation: $20M + $5M = $25M
• Investor Ownership: $5M / $25M = 20%

Critical Detail: Option Pool Treatment

The option pool (ESOP) can be included in pre-money or post-money valuation, dramatically impacting founder dilution:

Pre-Money Option Pool (Standard in India/US):

• 15% ESOP pool created BEFORE investment
• Pool shares dilute founders, not investors
• Effective pre-money valuation for founders is reduced

Example:

Founders own: 10M shares (100%)
Create 15% ESOP pool: 1.76M shares (expanding total to 11.76M)
Founders now own: 10M / 11.76M = 85%
Investment: $5M for 20% post-money
New shares issued to investor: 2.94M
Post-money total: 14.7M shares
Founder ownership: 10M / 14.7M = 68%

Post-Money Option Pool (Increasingly Common, Founder-Friendly):

• 15% ESOP pool created AFTER investment
• Pool dilutes everyone proportionally (investors + founders)

Same example with post-money pool:

Investment: $5M for 20% (based on 10M shares initially)
New shares issued: 2.5M
Post-money subtotal: 12.5M shares
Create 15% ESOP pool: 2.21M shares
Final total: 14.71M shares
Founder ownership: 10M / 14.71M = 68%
Investor ownership: 2.5M / 14.71M = 17% (not 20%)

Wait—investor only gets 17% instead of 20%? This is why post-money ESOP pools are negotiated differently: the investment amount increases or the pool percentage adjusts to ensure investor still receives target ownership.

Reference the financial models research from Batch 1 for detailed option pool dilution calculations and Excel implementations.

7.3 Clause-by-Clause Breakdown: Economics¶

Valuation and Investment Amount¶

Standard Language:

"The Series A Preferred Stock will be sold at a purchase price of $[X] per share (the "Original Purchase Price"), based on a pre-money valuation of $[Y] million (fully diluted and including an option pool equal to [Z]% of the post-financing capitalization)."

What to Look For:

✅ GOOD:

• Clear pre-money vs post-money designation
• Explicit option pool treatment ("pre-money including pool" or "post-money")
• Fully diluted share count specified
• Price per share calculable and matches valuation / shares

Worked Example:

Company: FinTech Innovations Pvt Ltd
Investment: $8M Series A
Pre-Money Valuation: $32M (pre-money, pre-option pool)
Option Pool: 15% post-money
Shares Outstanding: 10M (all common stock held by founders)

Step 1: Create option pool
Target pool: 15% post-money
Investor target: 20% post-money
Founders after everything: 65% post-money

Working backwards:
Founders must equal 65% after pool and investment
Pool must equal 15%
Investor must equal 20%

If founders have 10M shares and end with 65%:
Total shares = 10M / 0.65 = 15.38M shares
Investor shares = 15.38M × 0.20 = 3.08M shares
Pool shares = 15.38M × 0.15 = 2.31M shares

Verification:
Founders: 10M / 15.38M = 65% ✓
Investor: 3.08M / 15.38M = 20% ✓
Pool: 2.31M / 15.38M = 15% ✓

Price per share = $8M / 3.08M = $2.60 per share
Pre-money valuation = $2.60 × (10M + 2.31M) = $32.0M ✓

Liquidation Preference¶

This is the most critical economic term after valuation. Liquidation preference determines who gets paid what in an exit scenario (acquisition, merger, or liquidation).

Liquidation Preference: Comparing Options¶

Standard 1x Non-Participating (Founder-Friendly):

"In the event of any liquidation, dissolution, or winding up of the Company, the holders of Series A Preferred Stock shall be entitled to receive, prior to and in preference to any distribution to holders of Common Stock, an amount equal to one times (1x) the Original Purchase Price per share, plus any declared but unpaid dividends (the "Liquidation Preference"). After payment of the Liquidation Preference, the remaining proceeds shall be distributed pro rata among holders of Common Stock."

What This Means: Investor receives the GREATER of:

1. Their investment back (1x), OR
2. Their pro-rata share as if converted to common stock

Worked Example: $50M Exit

Series A Investor:
- Invested: $8M
- Ownership: 20% (as-converted basis)

Scenario 1: Take 1x preference
Payout = $8M

Scenario 2: Convert to common and take pro-rata
Payout = $50M × 20% = $10M

Decision: Convert to common (receives $10M)

Founders (65% ownership):
Payout = $50M × 65% = $32.5M

In a $50M exit, everyone converts to common and participates pro-rata. Liquidation preference doesn't matter.

Worked Example: $15M Exit (Down Exit)

Scenario 1: Take 1x preference
Investor payout = $8M
Remaining for common = $15M - $8M = $7M
Founders (65% of pre-money shares, but diluted overall):
Founders get $7M

Scenario 2: Convert to common
Investor payout = $15M × 20% = $3M

Decision: Take preference (receives $8M)

Final distribution:
Series A: $8M (53% of exit proceeds despite 20% ownership)
Founders + ESOP: $7M (47% of exit proceeds despite 80% ownership)

Liquidation preference protects investors in modest exits but creates "liquidation overhang" where founders receive disproportionately less than ownership would suggest.

Participating Preferred (Investor-Favorable, Common in Competitive Deals):

"In the event of any liquidation event, holders of Series A Preferred Stock shall be entitled to receive, prior to and in preference to any distribution to holders of Common Stock, an amount equal to one times (1x) the Original Purchase Price per share, plus any declared but unpaid dividends. Thereafter, the holders of Series A Preferred shall participate with the holders of Common Stock on an as-converted basis in the distribution of all remaining proceeds."

What This Means (Double-Dipping): Investor receives:

1. Their investment back (1x preference), PLUS
2. Their pro-rata share of remaining proceeds

Worked Example: $50M Exit with Participating Preferred

Step 1: Investor takes preference
Series A preference = $8M
Remaining = $50M - $8M = $42M

Step 2: Investor participates pro-rata in remaining
Series A owns 20% of company
Series A participation = $42M × (20% / 80%) = $10.5M
(Note: 80% is Series A + Common + ESOP excluding Series A preference)

Actually, let's recalculate properly:
All shareholders participate in $42M on pro-rata basis including Series A
Series A share = $42M × 20% = $8.4M

Total Series A payout = $8M (preference) + $8.4M (participation) = $16.4M

Founders (65% ownership):
Payout = $42M × 65% = $27.3M

Series A gets 32.8% of exit value despite 20% ownership!

Participating Preferred with Cap (Compromise):

"...the participation of Series A Preferred Stock shall be capped such that the aggregate distribution to Series A holders shall not exceed three times (3x) the Original Purchase Price per share."

With 3x cap, Series A can receive maximum of $24M ($8M × 3). In the $50M exit:

• Uncapped participating: $16.4M
• 3x capped: Max $24M (cap doesn't bind yet)
• At higher exits, investor converts to common when pro-rata exceeds cap

Multiple Liquidation Preference (Predatory, Rare):

"In the event of any liquidation event, holders of Series A Preferred Stock shall be entitled to receive, prior to and in preference to any distribution to holders of Common Stock, an amount equal to two times (2x) the Original Purchase Price per share..."

2x or 3x liquidation preferences typically appear only in distressed financings, bridge rounds, or when company has limited leverage. This is a major red flag.

Example: $30M exit with 2x preference

Series A 2x preference = $8M × 2 = $16M
Remaining for common = $30M - $16M = $14M
Founders receive: $14M despite 65% ownership

Recommendation: Accept only 1x liquidation preference. If forced to accept participating preferred, negotiate hard for:

1. 2x-3x cap on participation
2. Automatic conversion to non-participating in next qualified financing
3. Sunset provision (converts to non-participating after 5 years)

Anti-Dilution Protection¶

Anti-dilution provisions protect investors if the company raises a future round at a lower price per share than they paid (a "down round"). The conversion price of their preferred shares adjusts downward, giving them more shares for the same investment.

No Anti-Dilution (Rare, Founder-Favorable):

Investor receives no protection; down rounds dilute them equally with other shareholders.

Broad-Based Weighted Average (Standard, Balanced):

"If the Company issues Additional Shares of Common Stock at a price per share less than the Series A Conversion Price, the Series A Conversion Price shall be adjusted according to the following formula:

NCP = OCP × [(A + B) / (A + C)]

Where:

• NCP = New Conversion Price
• OCP = Old Conversion Price
• A = Fully diluted shares outstanding immediately prior to new issuance
• B = Aggregate consideration for new issuance ÷ OCP
• C = Number of new shares issued"

What "Broad-Based" Means: "A" includes ALL shares: common stock, preferred stock (as-converted), outstanding options, warrants, AND unallocated option pool shares reserved for future issuance. This maximizes the denominator, minimizing the adjustment (founder-friendly).

Worked Example: Down Round with Broad-Based Anti-Dilution

Company: FinTech Innovations (from previous example)
Current cap table:
- Founders: 10M shares common
- Series A: 3.08M preferred shares at $2.60/share ($8M invested)
- Option pool: 2.31M shares unallocated
- Total fully diluted: 15.38M shares

Down round scenario:
- Series B raises $5M at $1.50/share (42% down from Series A $2.60)
- New shares issued: $5M / $1.50 = 3.33M shares

Broad-based anti-dilution calculation:
OCP = $2.60 (original Series A price)
A = 15.38M (fully diluted including unallocated pool)
B = $5M / $2.60 = 1.92M
C = 3.33M

NCP = $2.60 × [(15.38M + 1.92M) / (15.38M + 3.33M)]
NCP = $2.60 × [17.30M / 18.71M]
NCP = $2.60 × 0.9247
NCP = $2.40 per share

New conversion ratio:
Series A now converts at $2.40 instead of $2.60
Series A now receives: $8M / $2.40 = 3.33M shares (was 3.08M)
Additional shares from anti-dilution: 250K shares

Impact on ownership:
Total shares post-down round: 15.38M + 3.33M + 0.25M = 18.96M
Series A ownership: 3.33M / 18.96M = 17.6% (was 20% without anti-dilution)
Founders ownership: 10M / 18.96M = 52.7% (vs 53.4% if no anti-dilution)

Series A protected from full dilution but not fully compensated.
Founders diluted additional 0.7 percentage points due to anti-dilution adjustment.

Narrow-Based Weighted Average (More Investor-Favorable):

Same formula, but "A" includes ONLY common and preferred stock outstanding, EXCLUDING unallocated option pool, warrants, and unissued securities.

Using same example with narrow-based:

A = 13.08M (only common 10M + Series A 3.08M, excluding 2.31M unallocated pool)
B = 1.92M (same)
C = 3.33M (same)

NCP = $2.60 × [(13.08M + 1.92M) / (13.08M + 3.33M)]
NCP = $2.60 × [15.00M / 16.41M]
NCP = $2.60 × 0.9141
NCP = $2.38 per share

Series A now receives: $8M / $2.38 = 3.36M shares
Additional shares: 3.36M - 3.08M = 280K shares (vs 250K with broad-based)

The smaller denominator in narrow-based creates more anti-dilution protection for investors, correspondingly more dilution for founders.

Full Ratchet (Predatory, Should Be Rejected):

"If the Company issues Additional Shares at a price per share less than the Series A Conversion Price, the Series A Conversion Price shall be automatically reduced to equal the lowest price per share at which such Additional Shares are issued."

No weighted average—complete reset to down round price.

Using same example:

Down round price: $1.50/share
Series A conversion price resets to: $1.50/share (from $2.60)

Series A now receives: $8M / $1.50 = 5.33M shares (was 3.08M)
Additional shares from full ratchet: 2.25M shares

Total shares: 15.38M + 3.33M + 2.25M = 20.96M
Series A ownership: 5.33M / 20.96M = 25.4% (vs 20% originally)
Founders ownership: 10M / 20.96M = 47.7% (vs 65% originally)

Founders lost 17.3 percentage points due to full ratchet!

Reference the anti-dilution calculations in the financial models research for complete Excel formulas and sensitivity analysis.

Dividends¶

Standard (Non-Cumulative, Common):

"The holders of Series A Preferred Stock shall be entitled to receive, when and if declared by the Board of Directors, dividends at the rate of [6-8]% per annum of the Original Purchase Price, payable in preference to any dividend on Common Stock."

Most startup term sheets include non-cumulative dividends, meaning if the board doesn't declare them, they don't accrue. In practice, startup boards almost never declare dividends—all cash is reinvested in growth.

What to Watch:

Example:

Series A: $8M at 8% cumulative, compounding
Year 1 accrued dividend: $8M × 8% = $640K
Year 2: ($8M + $640K) × 8% = $691K (total accrued: $1.33M)
Year 3: ($8.69M) × 8% = $695K (total accrued: $2.03M)
Year 5 total accrued: $3.77M

At exit, investor receives:
$8M investment + $3.77M accrued dividends = $11.77M
THEN participates in remaining proceeds if participating preferred

Redemption Rights¶

Standard (Rare in Early-Stage, More Common in Growth Rounds):

"At the election of holders of at least [50-66]% of the Series A Preferred Stock, the Company shall redeem the outstanding Series A Preferred Stock in three annual installments beginning on the [5^th / 7^th] anniversary of the Closing, at a price equal to the Original Purchase Price plus all accrued but unpaid dividends."

What This Means: Investors can force the company to buy back their shares at original price plus dividends after a specified period (typically 5-7 years). This is effectively a "get out" clause if the company hasn't exited or gone public.

Why It's Problematic:

1. Startups don't generate cash for buybacks; redemption forces fire sale or asset liquidation
2. Creates pressure to exit prematurely rather than building long-term value
3. Triggers if company is successful but chooses to remain private

Best outcome: No redemption rights at early stages.

7.4 Clause-by-Clause Breakdown: Control and Governance¶

Board Composition¶

Board composition determines day-to-day control and strategic direction. This is often more important than economic terms—a hostile board can fire founders, block exits, or force unfavorable pivots.

Standard Balanced Board (Seed/Series A):

"The Company's Board of Directors shall consist of [five (5)] members, as follows:

• [Two (2)] members designated by holders of Common Stock (the "Common Directors"), one of whom shall be the CEO
• [Two (2)] members designated by holders of Series A Preferred Stock (the "Series A Directors")
• [One (1)] member mutually agreed upon by Common Directors and Series A Directors (the "Independent Director")"

What This Means:

• Founders control 2 seats
• Investors control 2 seats
• Independent director acts as tiebreaker (must be mutually agreed)
• No single party has unilateral control
• Major decisions require cooperation

✅ GOOD for seed/Series A. Balanced structure preserves operational flexibility while giving investors oversight.

Founder-Friendly Variant:

• [Three (3)] Common Directors
• [Two (2)] Series A Directors
• [One (1)] Independent Director

Founders maintain 3-2 advantage, but rare unless founder has exceptional leverage.

Investor-Favorable Variant:

• [One (1)] Common Director (CEO only)
• [Three (3)] Series A Directors
• [One (1)] Independent Director selected by Series A

Multi-Round Board Scaling:

As company raises Series B, C, etc., board typically scales:

• Post-Series A: 5 directors (2 founder, 2 Series A, 1 independent)
• Post-Series B: 7 directors (2 founder, 2 Series A, 2 Series B, 1 independent)
• Post-Series C: 7-9 directors (2 founder, 2 Series A, 1 Series B, 1 Series C, 2 independent)

Key Principles:

1. Founders should maintain at least equal seats to investors through Series B
2. Independent directors increasingly important as board scales
3. CEO should always have board seat; other founders may rotate off
4. Board observers (non-voting) can be offered to investors not receiving seats

Protective Provisions (Veto Rights)¶

Protective provisions grant investors veto power over specific major decisions. Standard provisions are reasonable; overreaching provisions paralyze operations.

Standard Protective Provisions (Acceptable):

"So long as at least [50%] of the Series A Preferred Stock remains outstanding, the Company shall not, without the affirmative vote of holders of at least [50-66]% of the Series A Preferred Stock:

(a) Amend the Certificate of Incorporation or Bylaws in a manner adverse to Series A Preferred Stock (b) Authorize or issue any equity securities senior to or pari passu with Series A Preferred Stock.
© Redeem or repurchase any shares of Common or Preferred Stock (except pursuant to employee agreements).
(d) Declare or pay any dividend on Common Stock.
(e) Effect any merger, consolidation, sale of substantially all assets, or other liquidation event.
(f) Increase or decrease the authorized size of the Board of Directors.
(g) Incur indebtedness in excess of $[250K-500K] (other than equipment leasing or bank lines)".

✅ ACCEPTABLE. These provisions protect investors from:

• Equity structure changes that harm their position
• Insider transactions depleting company value
• Exits without investor approval
• Major financial commitments without oversight

Overreaching Protective Provisions (Push Back Hard):

(h) Hire or terminate any executive officer.
(i) Enter into any contract or commitment exceeding $[low threshold like $50K].
(j) Make any acquisition or investment of any kind.
(k) Change the principal business of the Company.
(l) Set annual budgets and make any material changes thereto.
(m) Open or close any facility or location.
(n) Enter into any lease for real property.

Negotiation Strategy:

• Accept standard protective provisions (items a-g above)
• Push back hard on operational controls (items h-n)
• If forced to accept operational vetos, negotiate high dollar thresholds:
• Contracts: Require approval only >$500K (not $50K)
• Hiring: Only C-suite hires requiring approval (not all managers)
• Budgets: Approval for material departures from board-approved budget (>20% variance), not every adjustment

Drag-Along Rights¶

Standard Drag-Along (Acceptable):

"If holders of at least [60-66]% of the outstanding capital stock (on an as-converted basis), including holders of at least [majority] of the Preferred Stock, approve a Qualified Sale, then all stockholders shall vote in favor of such sale and take all actions necessary to effect such sale.

'Qualified Sale' means: (i) a sale of all or substantially all of the Company's assets, or (ii) a merger or consolidation where Company stockholders own less than 50% of the surviving entity, where aggregate proceeds to stockholders are at least [2x] the aggregate Liquidation Preference of all outstanding Preferred Stock."

What This Means: If supermajority of shareholders (including investors) approve a sale meeting minimum value threshold, all shareholders—including dissenting founders and minority holders—must vote in favor and cannot block the transaction.

Why It Exists: Prevents minority shareholders (including founders) from blocking favorable exits due to personal reasons. Acquirers require 100% shareholder approval for clean transactions.

✅ ACCEPTABLE with proper safeguards:

1. Minimum price floor: 2x liquidation preference ensures founders receive meaningful proceeds
2. Supermajority threshold: Requires 60-66% approval, not simple majority
3. Qualified Sale definition: Excludes acqui-hires and distressed sales
4. Common consent required: Not just preferred holders

What to Negotiate:

• Higher minimum price (3x preference vs 2x)
• Separate majority requirement for common stock holders (founders can't be dragged by only preferred vote)
• Exclusion of acqui-hires explicitly

Tag-Along Rights (Co-Sale Rights)¶

Standard Tag-Along (Founder-Protective):

"If any holder of more than [10%] of the outstanding Common Stock (on an as-converted basis) proposes to sell shares to a third party, each other stockholder shall have the right to participate in such sale on the same terms and conditions, pro rata based on their stockholding.

The selling stockholder must provide [30] days' written notice to all stockholders of the proposed sale terms before proceeding."

What This Means: If a founder or major shareholder sells shares, other shareholders (especially investors) have the right to "tag along" and sell proportionally at the same price and terms. This prevents founders from getting liquidity while investors remain illiquid.

Why Investors Want This: Protects against founder secondary sales to acquirers without company sale (e.g., founder sells personal stake to competitor, leaving investors stuck).

✅ ACCEPTABLE and standard. Provides mutual protection.

What to Negotiate:

• Exclude small secondary sales below threshold ($500K-$1M) to allow founders modest liquidity
• Exemption for estate planning transfers (to spouse, trust, family members)
• Tag-along doesn't apply to employee option exercises or founder gifts to charity

Right of First Refusal (ROFR) and Co-Sale¶

Standard ROFR:

"Before any holder of Common Stock may sell, transfer, or otherwise dispose of shares to a third party, such holder must first offer the shares to: (i) The Company (at the price and on the terms set forth in the third-party offer) (ii) If the Company declines, pro rata to all existing investors

The Company and investors shall have [15] days to accept. If all decline, the holder may sell to the third party within [60] days on the same terms."

What This Means: Founders cannot sell shares without first offering to the company and investors. This prevents cap table dilution to unwanted third parties and gives investors option to increase ownership opportunistically.

✅ ACCEPTABLE and standard for maintaining cap table control.

What to Negotiate:

• Strict time limits (15 days company, 15 days investors, 60 days to close with third party)
• ROFR lapses in acquisition scenarios
• Fair market value determination process if company exercises but parties disagree on price
• Exemptions for estate planning and charitable transfers

7.5 Clause-by-Clause Breakdown: Other Provisions¶

Founder Vesting¶

Standard Founder Vesting (Common in US, Increasingly Common in India):

"All shares of Common Stock held by Founders shall be subject to vesting over [four (4)] years, with a [one (1)] year cliff and monthly vesting thereafter. Vesting shall commence as of the Closing Date (or earlier date as agreed)."

What This Means:

• Founder shares vest (become non-repurchaseable) over 4 years
• 25% vests after 1 year (the "cliff")
• Remaining 75% vests monthly over following 3 years
• If founder leaves before cliff, company can repurchase 100% of unvested shares at cost
• If founder leaves after cliff, company can repurchase unvested shares at cost

Why Investors Require This: Ensures founders remain committed long-term. Without vesting, a founder could leave month 2 and retain 40% equity while remaining founders build value.

✅ ACCEPTABLE at Series A and beyond. Increasingly expected even at seed stage.

Acceleration Provisions (Critical):

Single-Trigger Acceleration:

"In the event of a Change of Control, 100% of unvested Founder shares shall immediately vest."

Investors typically resist single-trigger because acquirers discount purchase price if key team members can leave immediately post-close with fully vested equity.

Double-Trigger Acceleration (Standard Compromise):

"If within [12] months following a Change of Control, a Founder is terminated without Cause or resigns for Good Reason, 100% of unvested shares shall immediately vest.

'Good Reason' includes: (i) material reduction in duties or responsibilities, (ii) reduction in base salary exceeding [10]%, (iii) relocation exceeding [50] miles from current principal place of business."

✅ ACCEPTABLE and founder-protective. Ensures founders aren't trapped post-acquisition with "stay bonus" of unvested shares.

Information Rights¶

Standard Information Rights:

"The Company shall deliver to each holder of at least [1-5]% of the Series A Preferred Stock:
(a) Annual financial statements (audited) within [120] days of fiscal year end.
(b) Quarterly unaudited financial statements within [45] days of quarter end.
© Monthly unaudited financial statements within [30] days of month end.
(d) Annual operating budget within [30] days of approval by Board.
(e) Prompt notice of material events affecting the Company"

✅ ACCEPTABLE. Investors deserve visibility into company performance.

What to Negotiate:

• Threshold for information rights: 5% ownership vs 1% (reduces distribution burden)
• Quarterly reports instead of monthly (less administrative burden)
• Confidentiality obligations on investors receiving information
• Information rights terminate upon IPO or sale

No-Shop Period (Exclusivity)¶

Standard No-Shop:

"For a period of [30-45] days from the date of this term sheet (the "No-Shop Period"), the Company and its shareholders agree not to, directly or indirectly:
(i) solicit, encourage, or facilitate any offers from other investors,
(ii) furnish information to other investors, or,
(iii) negotiate or enter into agreements with other investors regarding financing."

What This Means: Once you sign the term sheet, you cannot talk to other investors for 30-45 days while lead investor completes due diligence and documentation.

✅ ACCEPTABLE for 30-45 days. Investors deserve exclusive negotiation window.

Employee Stock Option Pool¶

Already covered in pre-money vs post-money section. Reiterate:

Standard:

"Prior to the Closing, the Company shall reserve [15]% of its fully diluted capitalization (calculated on a post-Closing basis) for issuance to employees, directors, consultants, and advisors under the Company's Stock Option Plan."

Critical Point: "Post-Closing basis" means the pool percentage is calculated AFTER the Series A investment. However, pool is typically created PRE-CLOSING (before investment), meaning founders bear the dilution, not investors.

Always clarify: Is the 15% pool pre-money or post-money? Pre-money is standard but post-money is increasingly common in competitive deals.

Pay-to-Play¶

Pay-to-Play Provision (Rare, Down-Round Protection):

"In the event of a Qualified Financing at a price per share less than the Series A Original Purchase Price, each Series A holder who does not purchase its pro rata share of the new financing shall have its Series A Preferred Stock converted to Common Stock and lose all special rights (anti-dilution, liquidation preference, etc.)."

What This Means: If there's a down round and an existing investor doesn't participate pro-rata, they're punished by losing preferred stock status and converting to common.

Why It Exists: Ensures existing investors support the company in difficult times rather than letting other investors dilute them. Prevents "free rider" problem where investor gets anti-dilution protection without putting in new money.

Not standard in seed/Series A term sheets. More common in down rounds or distressed situations.

7.6 Indian-Specific Term Sheet Considerations¶

CCPS Structure (Compulsorily Convertible Preference Shares)¶

Standard CCPS Provision:

"The Series A CCPS shall mandatorily and compulsorily convert into equity shares of the Company upon the earliest of:
(a) Qualified IPO (public offering of at least Rs [X] crore with listing on recognized stock exchange)
(b) Sale of the Company resulting in Change of Control
© [10-20] years from the date of issuance
(d) Written election by holders of at least [66]% of Series A CCPS"

Key Differences from US Preferred:

1. Mandatory conversion: CCPS must convert (can't remain preferred indefinitely)
2. Maximum tenure: Typically 10-20 years maximum before forced conversion
3. RBI pricing compliance: CCPS issuance price must comply with RBI Fair Market Value guidelines
4. FEMA reporting: FC-GPR filing within 30 days mandatory

What to Negotiate:

• Longer conversion period (20 years vs 10 years) for flexibility
• Clear definition of "Qualified IPO" threshold
• Conversion mechanics preserving liquidation preference until actual conversion
• Anti-dilution protection during CCPS period (before conversion)

RBI Pricing Guidelines and Valuation Certificate¶

Practical Implications:

• Engage CA/valuer before finalizing term sheet to ensure price meets RBI guidelines
• Down rounds require fresh valuation justifying reduced price
• RBI can challenge pricing below FMV; non-compliance requires compounding

Timeline Impact: Add 1-2 weeks to transaction timeline for valuation report preparation and review.

Press Note 3 Compliance (Chinese and Land-Bordering Country Investors)¶

Founder Action Items:

• Request investor representation on Press Note 3 compliance in term sheet
• Conduct due diligence on investor's LP base and beneficial ownership
• Build extra time into close timeline if government approval needed

DPIIT Recognition Benefits in Term Sheet¶

Leveraging DPIIT Recognition:

If company has DPIIT Startup India recognition, highlight in fundraising:

1. Section 80-IAC tax exemption: 3 years of zero income tax (if IMB-approved)
2. Angel tax exemption: Complete exemption post-April 2025 (universal, but DPIIT historically provided exemption earlier)
3. Faster compliance: Self-certification for labor and environmental laws reduces regulatory burden
4. IP benefits: 80% rebate on patent filing fees, fast-track examination

These benefits can be negotiation leverage: "We're DPIIT-recognized with 3-year tax exemption, enabling faster path to profitability."

Entity Structure and Flip Considerations¶

If company contemplating Singapore or Delaware flip, address in term sheet:

Flip Provision:

"The Company may, with consent of holders of at least [66]% of Series A CCPS, reorganize into a holding company structure with parent entity incorporated in [Singapore / Delaware], provided that Series A investors receive equivalent securities in parent entity with same rights and preferences."

Practical Considerations:

• Flip adds 3-6 months and Rs 50 lakh-Rs 2 crore in costs (legal, accounting, regulatory)
• Some investors prefer Indian entity for LTCG tax benefits
• Many late-stage Indian companies reverse-flipping back to India for IPO (PhonePe, Groww, Zepto, Meesho)
• Discuss flip strategy early in investor conversations; don't surprise investors post-term sheet

7.7 Action Items¶

1. Review your current term sheet line-by-line (if applicable): Compare every provision against this chapter's "standard" vs "red flag" examples. Create written list of concerning provisions for lawyer review.

2. Model liquidation preference scenarios: Use Excel to calculate payout distributions at 5 different exit values ($10M, $25M, $50M, $100M, $200M) under different liquidation preference structures (1x non-participating, 1x participating uncapped, 1x participating 3x cap). Visualize when founders receive meaningful proceeds.

3. Calculate anti-dilution impact: Model potential down round scenarios (20%, 40%, 60% down) and calculate dilution under broad-based weighted average, narrow-based, and full ratchet. Quantify percentage points of founder ownership at risk.

4. Assess board composition power dynamics: Map current and future board seats through Series C. Calculate whether founders maintain control, parity, or minority position. Identify points where control shifts.

5. Red-flag checklist audit: Review protective provisions list. Count how many operational decisions require investor approval. If >3 operational vetos (beyond standard protective provisions), prepare negotiation strategy to remove or increase thresholds.

6. Engage Indian startup lawyer for term sheet review: Budget Rs 50,000-Rs 2 lakh for comprehensive term sheet review and negotiation support. Lawyer should have 10+ Indian funding rounds closed and familiarity with FEMA/RBI compliance.

7. Request cap table model from investor: Ask investor to provide Excel cap table showing ownership evolution through hypothetical Series B and C rounds. Verify dilution assumptions and option pool treatment match your understanding.

8. Prepare FEMA compliance documentation: If foreign investor, engage CA for RBI valuation certificate (1-2 weeks lead time). Prepare FC-GPR filing checklist. Verify investor Press Note 3 status if applicable.

9. Negotiate founder vesting commencement date: If you've been building for 2+ years pre-Series A, push for vesting commencement backdated to company incorporation or earlier date. This effectively accelerates your vesting and recognizes sweat equity contributed.

10. Review comparable term sheets: Request anonymized term sheets from other founders in your network who raised at similar stage/sector. Validate whether your terms are market-standard or outlier. Leverage comps in negotiation.

7.8 Key Takeaways¶

• Liquidation preference structure determines exit economics: 1x non-participating is standard and balanced. Participating preferred (especially uncapped) heavily favors investors and can leave founders with minimal proceeds even in successful exits. Always model payout scenarios at multiple exit values.

• Anti-dilution protection ranges from balanced to predatory: Broad-based weighted average is market standard and acceptable. Narrow-based is more investor-favorable but negotiable. Full ratchet is a "founder killer" that should trigger immediate rejection of entire term sheet.

• Board composition is proxy for control: Balanced boards (equal founder and investor seats plus independent) preserve operational autonomy. Investor-majority boards at seed/Series A signal distress or founder weakness. Maintain at least board parity through Series B.

• Protective provisions: distinguish standard from overreaching: Standard provisions (no senior securities, no dividends on common, board size, major exits, significant debt) are reasonable investor protections. Operational vetos (hiring, contracts, budgets, minor business decisions) paralyze execution and should be strongly resisted.

• Option pool treatment creates 5-10% dilution difference: Pre-money option pools dilute founders before investment; post-money pools dilute investors proportionally. Clarify treatment explicitly in term sheet. Post-money is increasingly common in competitive fundraising markets.

• No-shop and exclusivity limit leverage: 30-45 day no-shop is acceptable for focused diligence. Longer periods or auto-renewal provisions give investors free option to shop your deal while you're locked. Negotiate clear termination rights if investor delays.

• Indian CCPS and FEMA compliance add complexity: CCPS mandatory conversion, RBI pricing guidelines, FC-GPR filing deadlines, and Press Note 3 restrictions require specialist legal guidance. Budget extra 2-4 weeks for Indian regulatory compliance vs US deal timelines.

7.9 Red Flags to Watch¶

🔴 CRITICAL: Full ratchet anti-dilution Complete conversion price reset to down round price, regardless of magnitude. Catastrophic founder dilution in any down round scenario. This is a deal-breaker—walk away if investor insists. Cost at 40% down round: Founders lose 10-20 percentage points vs 1-2 points with broad-based.

🔴 CRITICAL: Participating preferred without cap Investor receives preference PLUS pro-rata share of remaining proceeds with no limit. "Double-dipping" leaves founders with disproportionately less than ownership percentage suggests. Model impact: In $50M exit with 20% ownership and 1x participating uncapped, investor receives 32%+ of proceeds vs 20% with non-participating.

🔴 CRITICAL: Investor board control at seed/Series A Board structure giving investors 3+ seats vs 1-2 founder seats. Investors can fire founders, block exits, force pivots without founder consent. Only acceptable in distressed situations with no alternatives.

🔴 CRITICAL: 2x or 3x liquidation preference multiples Investor receives 2-3 times investment before founders see proceeds. Predatory and rare outside distressed financings. Example: $10M investment with 3x preference requires $30M exit before founders receive anything.

🟡 CONCERNING: Cumulative compounding dividends Dividends accrue and compound annually whether or not declared. Silent equity drain reducing founder proceeds at exit. 8% cumulative over 5 years adds 47% to investor preference ($10M becomes $14.7M preference).

🟡 CONCERNING: Redemption rights at early stage Investors can force company to buy back shares after 5-7 years. Startups lack cash for redemptions; triggers fire sales. More acceptable at late-stage with cash flow. Negotiate for "subject to legally available funds" language.

🟡 CONCERNING: Operational protective provisions Veto rights over hiring, contracts <$100K, budget variances, minor business decisions. Micromanagement that slows execution to crawl. Push back hard; accept only strategic protections (no senior securities, major M&A, board size).

🟡 CONCERNING: No-shop period >60 days Extended exclusivity gives investor free option while founder cannot talk to alternatives. Compounds if renewal provisions allow automatic extension. Negotiate 30-day maximum with clear termination rights.

🟡 CONCERNING: Narrow-based anti-dilution Excludes option pool from denominator, creating more investor protection and founder dilution than broad-based. Difference is typically 10-20% more dilution vs broad-based in down rounds. Negotiate for broad-based standard.

⚠️ WARNING: Founder vesting without acceleration Four-year vesting with no single or double-trigger acceleration upon company sale. Founders can be terminated post-acquisition and lose unvested shares. Insist on double-trigger minimum (terminated without cause within 12 months of sale = immediate vesting).

⚠️ WARNING: Pay-to-play provisions Existing investors who don't participate pro-rata in future rounds lose preferred rights. Can force investors into bad rounds or concentrate ownership. Not standard in early rounds; more common in down rounds.

7.10 When to Call a Lawyer¶

LAWYER REQUIRED (MANDATORY)¶

Term Sheet Review Before Signing: Engage experienced startup lawyer to review term sheet before signing. Cost: Rs 50,000-Rs 2 lakh for comprehensive review and negotiation support. Lawyer should identify: predatory terms, non-standard provisions, and negotiation priorities. Provide market comparables and alternative language.

Shareholders' Agreement Drafting and Negotiation: SHA contains 50-100 pages of binding legal terms based on term sheet. Lawyer ensures term sheet provisions properly translated into SHA, handles edge cases and contingencies, negotiates investor counsel proposed changes. Cost: Rs 2 lakh-Rs 10 lakh depending on round size and complexity.

Foreign Investment and FEMA Compliance: If raising from non-resident investors: RBI pricing guidelines require valuation certificate, FC-GPR filing has 30-day deadline with penalties, Press Note 3 compliance critical for Chinese/land-bordering investors. Lawyer coordinates CA valuation, files FC-GPR, obtains government approvals if needed. Cost: Rs 1 lakh-Rs 3 lakh.

Down Round or Distressed Financing: Any financing below previous round valuation requires legal expertise: Anti-dilution provisions trigger and require calculation, existing investor consent may be contractually required, valuation defensibility under RBI guidelines critical. Cost: Rs 3 lakh-Rs 5 lakh.

LAWYER HELPFUL BUT POTENTIALLY OPTIONAL¶

Standard Seed Round with Experienced Lead Investor: If raising from top-tier VC (Peak XV, Accel, Blume) using their standard seed docs with minimal customization, founder with prior fundraising experience may be able to self-review with lawyer consultation (2-3 hour review) rather than full engagement. Cost: Rs 25,000-Rs 50,000 for consultation.

Term Sheet Comparison and Benchmarking: If you've received multiple term sheets and need objective analysis of which is most favorable, lawyer can provide comparative analysis with recommendation. Cost: Rs 30,000-Rs 75,000 for multi-sheet analysis.

Recommended Startup Lawyers (India)¶

Top-Tier Firms (Rs 5 lakh-Rs 50 lakh+ per transaction):

• Trilegal - Premier startup and VC practice
• Khaitan & Co - Leading venture capital firm
• AZB & Partners - Top-tier M&A and corporate
• IndusLaw - Strong startup ecosystem

Mid-Tier Startup-Focused (Rs 2 lakh-Rs 10 lakh):

• Argus Partners - VC and startup specialist
• Ikigai Law - Emerging company focus
• Touchstone Partners - Startup-friendly boutique

Startup Affordable (Rs 50,000-Rs 3 lakh):

• Independent practitioners with 10+ funding rounds closed
• Look for deferred fee arrangements (pay at close)
• Verify India ecosystem experience and FEMA expertise

Red Flags in Legal Representation:

• Lawyer without startup funding experience (corporate generalist)
• Unfamiliarity with FEMA/RBI compliance for FDI
• Inability to provide market comparables or alternative language
• Hourly billing without cap (negotiate fixed fee for term sheet review)

7.11 Indian Context: Regulatory Compliance and Market Norms¶

RBI Pricing Guidelines and Valuation Requirements¶

Fair Market Value Mandate: All foreign investments (including CCPS issuance) must be priced at or above Fair Market Value determined through internationally accepted methodologies. RBI accepts three methods:

1. Discounted Cash Flow (DCF)
2. Comparable company multiple analysis
3. Recent funding round pricing (if within 6-12 months)

Valuation Certificate Process:

1. Engage Chartered Accountant or SEBI-registered Merchant Banker (lead time: 1-2 weeks)
2. Provide financial statements, business plan, comparable companies
3. CA issues valuation certificate using accepted methodology
4. Certificate submitted with FC-GPR filing to RBI
5. RBI can challenge if pricing appears below FMV; may require compounding (settlement)

Down Round Implications: Down rounds require fresh valuation demonstrating current FMV justifies reduced price. Factors CA will consider: market conditions, business performance, competitive landscape, changed assumptions. Cannot simply accept investor's proposed price—independent professional valuation mandatory.

Cost: Rs 25,000-Rs 1 lakh depending on company complexity and methodology required.

FEMA Compliance and FC-GPR Filing¶

Critical 30-Day Deadline: Form FC-GPR (Foreign Currency - Gross Provisional Return) must be filed within 30 days of share allotment date. Filing through authorized dealer (AD) bank with RBI.

Required Documents:

• Declaration form
• Valuation certificate
• Company Secretary certificate
• Board resolution authorizing share issuance
• Investor FIRC (Foreign Inward Remittance Certificate) and KYC
• Press Note 3 declaration (if applicable)
• Term sheet and SHA (in some cases)

Penalties for Late Filing:

• First 6 months delay: Rs 5,000 or 1% of investment amount (whichever higher)
• Delay >6 months: Penalties doubled
• Continued non-compliance: Up to 300% of investment amount
• Late fee: Rs 7,500 flat

Processing Time: AD bank has 5 working days to review and approve/reject submission. Revisions may be required.

Founder Action Items:

• Set calendar reminder for 30-day deadline immediately upon share allotment
• Engage CA/lawyer to prepare FC-GPR filing in parallel with SHA drafting
• Do not use investor funds until FC-GPR filed and acknowledged (2024 amendment to Companies Act)

Press Note 3: Land-Bordering Country Investment Restrictions¶

Mandatory Government Approval Required If:

• Investor is entity from China, Pakistan, Bangladesh, Myanmar, Afghanistan, Nepal, or Bhutan
• Investor has beneficial ownership from land-bordering country
• Existing investment undergoes ownership transfer creating land-bordering country beneficial ownership

Beneficial Ownership Definition: Not clearly defined in FDI Policy or NDI Rules. Companies Act 2013 uses 10% threshold; Prevention of Money Laundering Act uses 25% for companies, 15% for unincorporated. Creates ambiguity—conservative approach: treat any meaningful land-bordering country ownership as trigger.

Approval Process:

1. Application through Foreign Investment Facilitation Portal (FIFP)
2. Inter-ministerial review involving multiple departments
3. Timeline: 8-12 weeks typical (can extend longer)
4. Approval not guaranteed; government has wide discretion

Practical Implications for Founders:

• Conduct investor due diligence: Request representation on beneficial ownership
• Ask about LP base: US VC with significant Chinese LPs may trigger Press Note 3
• Build 8-12 week buffer into fundraising timeline if government approval needed
• Include Press Note 3 compliance representation in term sheet and SHA

2024-2025 Context: Despite Economic Survey 2024 suggesting potential liberalization, Press Note 3 remains fully enforced. Chinese investments face particular scrutiny. Plan accordingly.

DPIIT Startup India Recognition Leverage¶

How Recognition Benefits Term Sheet Negotiation:

1. Tax Exemption Positioning: "We're DPIIT-recognized with Section 80-IAC eligibility. Once approved by IMB, we'll have 3 consecutive years of zero income tax on profits, accelerating path to profitability and extending runway."

2. Compliance Simplification: "Self-certification for 6 labor laws and 3 environmental laws reduces regulatory inspection risk and administrative burden for next 5 years."

3. Angel Tax Exemption (Historical, Pre-April 2025): "DPIIT recognition provides complete angel tax exemption under Section 56(2)(viib), eliminating taxation on premium over FMV." (Note: Universal exemption effective April 1, 2025, but DPIIT recognition historically provided this earlier.)

4. Credibility Signal: "DPIIT has recognized 157,000+ startups. We're among companies validated by government as innovation-driven businesses."

Application Timing: Apply for DPIIT recognition 3-6 months before fundraising begins. Recognition process takes 3-9 months. Section 80-IAC application (separate process through IMB) takes additional 3-9 months.

Eligibility Requirements:

• Incorporated <10 years ago
• Annual turnover <Rs 100 crore
• Private Limited Company, LLP, or Partnership Firm
• Working toward innovation, development, or improvement of products/processes/services
• Not formed by splitting or reconstruction of existing business

Application:

Indian Market Norms for Key Terms¶

Liquidation Preference:

• Standard: 1x non-participating (90%+ of seed/Series A deals)
• Acceptable: 1x participating with 2x-3x cap (competitive situations, 5-10% of deals)
• Red flag: Participating uncapped or 2x+ multiples (distressed situations only)

Anti-Dilution:

• Standard: Broad-based weighted average (95%+ of deals)
• Less common: Narrow-based weighted average (distressed or highly competitive)
• Reject: Full ratchet (predatory, <1% of deals outside distressed situations)

Board Composition (Series A):

• Standard: 2 founder, 2 investor, 1 independent (5-person balanced board)
• Founder-friendly: 3 founder, 2 investor, 1 independent (rare, exceptional founder leverage)
• Investor-friendly: 2 founder, 3 investor, 1 independent (concerning unless late-stage)

Valuation Multiples (2024 Normalized):

• SaaS B2B: 15-20x ARR at Series A (down from 25-40x in 2021-22)
• Fintech: 3-5x revenue at Series A
• Consumer tech: 2-4x GMV at Series A (unit economics dependent)

Round Sizes:

• Seed: Rs 4 crore-Rs 16 crore ($500K-$2M)
• Series A: Rs 24 crore-Rs 80 crore ($3M-$10M)
• Series B: Rs 80 crore-Rs 200 crore ($10M-$25M)

Fundraising Timeline:

• Average closing time: 115 days (4 months) from first pitch to funds received
• Seed to Series A: 18-24 months between rounds
• Success rate: 30-40% of seed-funded companies successfully raise Series A

7.12 References¶

1. Feld, Brad, and Jason Mendelson. Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist. 4^th ed., Wiley, 2019.

2. National Venture Capital Association (NVCA). Model Legal Documents. Retrieved from https://nvca.org/model-legal-documents/

3. Y Combinator. Safe Financing Documents. Retrieved from https://www.ycombinator.com/documents

4. Cooley GO. Understanding the Valuation Cap and Liquidation Preference. Retrieved from https://www.cooleygo.com/

5. Reserve Bank of India. (2025). Master Direction on Foreign Investment in India. Retrieved from https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11200

6. Carta. Cap Table and Dilution Basics. Retrieved from https://carta.com/learn/startups/cap-table-dilution-basics/

7. Holloway. The Holloway Guide to Equity Compensation. Retrieved from https://www.holloway.com/g/equity-compensation

8. Inc42. (2024). Indian Startup Funding Touches $12 Bn+ In 2024. Retrieved from https://inc42.com/features/indian-startup-funding-touches-stabilises-to-2020-levels/

9. Bain & Company and IVCA. (2025). India Venture Capital Report 2025. Retrieved from https://www.bain.com/insights/india-venture-capital-report-2025/

10. ClearTax. Private Placement – Section 42 of Companies Act 2013. Retrieved from https://cleartax.in/s/private-placement-section-42-companies-act-2013

Navigation¶

Previous: Chapter 6: Preparing to Fundraise
Next: Chapter 8: Due Diligence Process
Back to: Table of Contents

Related Chapters:

• Chapter 11: Dark Patterns - Predatory Terms to Avoid
• Chapter 2: Valuation Fundamentals
• Chapter 9: Negotiating Your Best Deal
• Appendix A: Legal Templates Library

Disclaimer¶

This chapter provides educational information about startup funding and is not legal, financial, or investment advice. Every startup situation is unique. Consult qualified professionals (lawyers, accountants, financial advisors) before making any funding decisions.

Last Updated: November 2025