Term Sheet Checklist for Indian Startup Founders: Valuation, Liquidation Preference, ESOP, SHA and Closing Conditions
Indian startup founders should review a term sheet for valuation, security type, investment amount, dilution, ESOP pool, liquidation preference, anti-dilution, board rights, reserved matters, founder vesting…
Direct answer for founders
Indian startup founders should review a term sheet for valuation, security type, investment amount, dilution, ESOP pool, liquidation preference, anti-dilution, board rights, reserved matters, founder vesting, transfer rights, information rights, exclusivity, confidentiality, closing conditions, FEMA and tax implications before accepting it.
The biggest mistake is treating the term sheet as a friendly summary and leaving the hard points for the shareholders agreement. A weak term sheet can quietly lock the founder into harsh economics, slow closing conditions or investor rights that are difficult to renegotiate later.
The official legal base is spread across company, contract and foreign investment rules. The Companies Act, 2013 governs company approvals, share capital, board process and ROC filings (https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf). The Indian Contract Act, 1872 governs enforceable agreements (https://www.indiacode.nic.in/handle/123456789/2187). RBI’s foreign investment resources matter where non-resident investors participate (https://www.rbi.org.in/). Startup founders should also keep Startup India and DPIIT recognition records updated where relevant (https://www.startupindia.gov.in/).
What a term sheet really does
A term sheet sets the commercial and governance direction for the full investment documents. It is usually followed by due diligence, valuation report, board approvals, shareholder approvals, amended Articles, subscription agreement, shareholders agreement and ROC or FEMA filings.
| Term sheet item | Founder question | Risk if ignored |
|---|---|---|
| Pre-money valuation | What is the company valued at before investment? | Founder celebrates valuation but misses dilution |
| Instrument | Equity, CCPS, CCD or convertible note? | Tax, FEMA and exit economics change |
| ESOP pool | Is it pre-money or post-money? | Founder dilution may be higher than expected |
| Liquidation preference | Who gets paid first on sale or liquidation? | Founder exit proceeds shrink |
| Anti-dilution | What happens in a down round? | Future financing becomes painful |
| Board rights | Who controls board decisions? | Founder loses operating flexibility |
| Reserved matters | Which actions need investor consent? | Routine decisions get blocked |
| Closing conditions | What must be completed before money comes in? | Funding timeline slips |
Clause-by-clause checklist
1. Valuation and dilution
Check whether the valuation is pre-money or post-money. Ask for the fully diluted cap table after the round, including ESOP pool, existing convertibles, advisors and any promised equity. The number that matters is not only valuation; it is what percentage each founder owns after closing.
2. ESOP pool
Investors often ask for an ESOP pool before closing. If the pool is created pre-money, existing shareholders usually absorb the dilution. If it is created post-money, dilution is shared after investment. Founders should model both outcomes before agreeing.
3. Liquidation preference
A common structure is one-time non-participating liquidation preference. Participating preference, high multiples or unclear priority can materially affect founder returns. The term sheet should explain whether the investor first recovers investment and then participates again, or chooses between preference and conversion.
4. Anti-dilution
Anti-dilution protects investors in a down round. Founders should understand whether it is broad-based weighted average, narrow-based weighted average or full ratchet. Full ratchet can be harsh for founders and employees.
5. Founder vesting and leaver terms
Founder vesting may be reasonable where the company depends on continuing founder contribution. But good leaver, bad leaver, vesting schedule, acceleration, repurchase price and dispute process must be clear.
6. Board and reserved matters
Investor consent rights should have sensible thresholds. For example, investor consent for changing business line or issuing new shares may be normal. Investor consent for every hiring decision, vendor contract or small spend may be operationally difficult.
7. Exclusivity and confidentiality
Exclusivity should be time-limited. Founders should avoid long exclusivity periods without clear investor timelines, diligence scope and closing commitment.
8. Closing conditions
Closing conditions should be specific. Typical items include due diligence, valuation report, board and shareholder approvals, amended Articles, SHA, SSA, updated cap table, founder IP assignment, ESOP approvals, FEMA readiness and no material adverse change.
Documents to prepare before signing
| Folder | Documents |
|---|---|
| Corporate | COI, PAN, MOA, AOA, master data, board minutes, shareholder resolutions |
| Cap table | Current shareholding, fully diluted cap table, ESOP pool, convertibles |
| Securities | PAS-3, share certificates, valuation reports, subscription records |
| FEMA | FIRC, KYC, FC-GPR, FLA, pricing documents where foreign investment exists |
| IP | Founder IP assignment, employee IP clauses, contractor assignments, trademarks |
| Contracts | Customer agreements, vendor contracts, leases, loans, related-party contracts |
| Tax | GST, TDS, income-tax filings, notices, payroll and reimbursement records |
Common founder mistakes
- Negotiating only valuation and not investor rights.
- Missing whether ESOP dilution is pre-money.
- Accepting participating liquidation preference without modelling exits.
- Agreeing to vague reserved matters.
- Signing long exclusivity without a clear closing timetable.
- Not checking FEMA before accepting foreign investment.
- Promising clean diligence before checking ROC records.
- Leaving founder IP assignment until the investor asks.
Practical example
Suppose a startup accepts a Rs 8 crore investment at a Rs 40 crore pre-money valuation, with a 10 percent pre-money ESOP pool and 1x participating liquidation preference. The founder may think dilution is only 16.67 percent. In reality, the pre-money ESOP pool and participating preference can change both ownership and exit proceeds. This is why the term sheet should be modelled in a spreadsheet before signing.
Founder next steps
- Ask for a fully diluted post-money cap table.
- Model founder ownership at two future rounds and three exit values.
- Review liquidation preference and anti-dilution in plain English.
- Check which rights must be reflected in the Articles.
- Prepare closing documents before the investor diligence request.
- Keep tax, FEMA, ROC and IP documents ready.
- Do not sign exclusivity until the investor timeline is clear.
Sources
- Companies Act, 2013 on MCA: https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf
- Indian Contract Act, 1872 on India Code: https://www.indiacode.nic.in/handle/123456789/2187
- RBI foreign investment resources: https://www.rbi.org.in/
- Startup India official portal: https://www.startupindia.gov.in/
FAQ Section
Is a term sheet legally binding in India?
Some parts may be binding and some may be non-binding depending on drafting. Confidentiality, exclusivity, governing law and costs are often binding even when investment economics are subject to final documents.
What is the most important term sheet clause for founders?
Valuation matters, but liquidation preference, ESOP pool, anti-dilution and reserved matters can affect founder economics and control just as much.
Should founders negotiate the ESOP pool before signing?
Yes. Founders should know whether the ESOP pool is pre-money or post-money and how it changes the fully diluted cap table.
What documents come after a term sheet?
Usually due diligence, valuation report, board approvals, shareholder approvals, amended Articles, share subscription agreement, shareholders agreement and ROC or FEMA filings.
Can a founder accept two term sheets at once?
Founders should be careful. If one term sheet has exclusivity or no-shop obligations, accepting or negotiating another term sheet may breach the agreed process.
Founder / Business Takeaway
A term sheet is a business decision, a legal roadmap and a cap table event in one document. Founders should model the economics, check investor rights and prepare closing records before signing. The Best CS Firm In India approach is to make funding documents understandable before they become binding pressure.
Need expert support?
BSA helps Indian founders review term sheets, cap tables, ESOP pool dilution, SHA clauses, Articles alignment, FEMA readiness and closing documentation before funding rounds.
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