Before You Sign the Term Sheet: Control Terms Founders Underestimate

Is a term sheet binding?

Most term sheets state that their commercial terms are not binding, while confidentiality, exclusivity and sometimes costs provisions are. In practice, the commercial terms are rarely reopened. Once a founder has agreed a board structure or a veto list in the term sheet, asking to change it in the final documents is difficult and can delay the round.

The time to negotiate control is therefore before the term sheet is signed, not when the shareholders’ agreement is being drafted.

Which control terms do founders underestimate?

Term	What it does	Questions to ask
Board composition	Decides who sits on the board and who appoints them	Does the board stay founder-led after this round and the next?
Reserved matters	Lists decisions needing investor consent	Are they limited to fundamental matters, or do they reach day-to-day operations?
Liquidation preference	Sets who is paid first on a sale or winding up	Is it 1x, and is it participating or non-participating?
Anti-dilution	Protects investors if later shares are issued at a lower price	Full ratchet or broad-based weighted average?
Drag-along	Lets a majority require others to sell	What threshold, from what date, and at what minimum price?
Founder vesting	Makes founder shares subject to vesting	Is there credit for time served, and acceleration on sale?
Information rights	Sets reporting obligations	Are they proportionate to the company’s stage?
Exclusivity	Prevents talking to other investors	How long, and does it end if the investor slows down?

Board composition and reserved matters

Board seats are visible and usually negotiated. Reserved matters are often accepted as standard. A long list, covering budgets, hiring above a salary level, new contracts or changes to the business plan, can give an investor with one board seat an effective veto over operations. The list should be limited to decisions that genuinely affect the investor’s position.

Liquidation preference

A 1x non-participating preference returns the investor’s money first, after which the investor either takes the preference or converts and shares pro rata. A participating preference lets the investor take its money back and also share in what remains. The difference can be significant on a modest exit.

Anti-dilution

Broad-based weighted average protection adjusts the investor’s conversion price in proportion to the size and price of a later down round. Full ratchet protection resets it to the new lower price, regardless of how small the round is. Full ratchet can transfer a large share of the company to earlier investors in a difficult year.

A worked example (hypothetical)

An investor invests ₹10 crore for 20 per cent of a company with a 1x preference. Three years later the company is sold for ₹30 crore.

With a non-participating preference, the investor chooses the better of ₹10 crore or 20 per cent of ₹30 crore (₹6 crore), and takes ₹10 crore. The remaining ₹20 crore is shared among other shareholders.

With a participating preference, the investor takes ₹10 crore and then 20 per cent of the remaining ₹20 crore, a further ₹4 crore, for ₹14 crore in total. Other shareholders share ₹16 crore. The headline valuation did not change; the preference did.

How does Indian law shape these terms?

Investor rights are usually documented in a shareholders’ agreement, but for many of them to bind the company, they also need to be reflected in the articles of association under the Companies Act, 2013. Shares issued to investors must follow the Act’s procedure for private placement or preferential allotment.

Where the investor is non-resident, pricing and reporting requirements under FEMA and the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 apply to the issue of shares and convertible instruments. These affect how anti-dilution adjustments and conversions can operate.

Non-compete obligations on founders are subject to section 27 of the Indian Contract Act, 1872, which makes agreements in restraint of trade void, subject to narrow exceptions. Restrictions that apply while a founder is a shareholder or employee are treated differently from those that continue afterwards.

What should founders do before signing?

1. Read the term sheet for control, not only for valuation.
2. List every reserved matter and ask what each protects.
3. Model the liquidation preference at several exit values.
4. Prefer broad-based weighted average anti-dilution.
5. Agree drag-along thresholds, timing and a minimum price.
6. Negotiate vesting credit and acceleration together with the economics.
7. Limit exclusivity to a fixed and reasonable period.

Sources

• Companies Act, 2013, sections 42 and 62
• Foreign Exchange Management (Non-debt Instruments) Rules, 2019
• Indian Contract Act, 1872, section 27
• Bare acts are available at India Code