Fremont: The startup, WeWork Labs’ lead investors pulled out of a $500,000 round, and another entrepreneur who raised between $3 and $4 million invested the fund, but due to a draw-back clause on the term sheet, the investor retracted all of the money 30 days later. No startup would like to see himself standing in the same circumstances.

When a starup grow, it looks forward for venture capital and needs to structure the tern sheet along with the VC for investment by the VC in the company. A term sheet or a letter of intent is a key document in a venture capital transaction. It is a letter of intent to invest in a given opportunity on specific terms and conditions. The investors prepare the first draft of a term sheet, which sets forth the principal terms and conditions of investing, including the rights, preferences and other special features that the investors require.

80 to 90 percent of the key issues and negotiating points between the company and the investors with the purpose to enable the company and investor to view the totality of the financing transaction is done while preparing the first draft of the term sheet.  A term sheet contains valuation, form of investment, liquidation preference, and anti-dilution provision.

Valuation of the Company: The venture firm will place a valuation on the company who needs funding. The valuation will be based on the comparisons to other similar companies in the marketplace and recent transactions along with other factors. It also includes the price of the company pre and post valuation.

Form of Investment: “The investors often prefer to invest in convertible preferred stock that comes with specific rights,” says Rahul Khanna, Managing Partner, Canaan India. The VCs are more inclined to invest in convertible preferred stock as it gives them preference over common shareholders in dividends and upon a sale of the company. It also gives them an option of converting into common stock if the company is successful.

Liquidation Preference: Liquidation is something neither the VCs nor the CEOs are reluctant to. Therefore the VCs want to safeguard themselves. A term sheet may contain the condition as to when the company goes for liquidation; the investors will get back their money before the common shareholders.

Anti-dilution Provision: It contains the exits to give some benefits to the current investor if the next round of money is raised at a price lower than the investor’s entry price. The VC will ask for some sort of price-based anti-dilution protection, such that the price for the company’s stock will be reduced if the company does a subsequent financing at a lower price.

By focusing on the term sheet, the company and the VC can direct their attention to the major business and structural issues involved in the proposed investment. The process of preparing and negotiating a term sheet helps to concrete the transaction and create a sense of momentum between the parties, thus minimizing the time and effort required to draft and negotiate the final agreements. “The term sheet should provide that it is not, in and of itself, binding upon either the company or the investor. All obligations must be made contingent upon the negotiation and execution of the final agreements and the prior satisfactory completion by the investor of additional due diligence,” adds Khanna.