TERM SHEET

[Mr. M. GOVINDARAJAN]

Term sheet

A term sheet is a nonbinding agreement setting forth the basic terms and conditions under which an investment will be made. It serves as a template to develop more detailed legally binding documents.  A term sheet may also be known as a letter of intent, a memorandum of understanding or heads of terms.  It will generally set out the key commercial and legal terms in respect of a proposed transaction.

Term Sheet is the first and foremost document that outlines all the principal commercial, economic and governing terms and conditions of the proposed investment, which typically include the pre-money valuation of the company, the instrument of the transaction structure, investor's rights and obligations, board composition and management control rights, among others. It is entered between the parties to facilitate negotiations for the proposed transaction and is an expression of intention only.

Focus of term sheet

The term sheet should-

• focus on the important commercial issues in the transaction at an early stage;
• allow the parties to address any misunderstandings or problems;
• allow key legal principles to be settled,
• outline any conditions which need to be satisfied before binding documentation can be entered into;
• provide an outline of the process with regard to due diligence;
• outline the timetable for negotiation and completion of the transaction; and
• set out any binding elements which have been agreed between the parties.

The term sheets are not generally legally binding, other than in respect of confidentiality, exclusivity (if applicable), costs and jurisdiction, they evidence the intent of the parties to them.   It is the chief document used by legal counsel to prepare the final agreement and to resolve any disputes that may arise in negotiation.

Contentions of term sheet

An investor prepares for presentation to the company in which the investor states the investment that he is willing to make in the company. This document is usually 5-8 pages in length.

A term sheet will contain certain basic elements, such as-

• information pertaining to the identification of the parties involved i.e., details of the company, the current shareholders and the current directors;
• the valuation of the company and the amount the company hopes to raise
• preferred payments,
• information about all involved assets,
• details of what the invested funds will be used for;
• any restrictions on the activities of the founders
•  initial purchase price including contingencies that may affect that price, a time frame for a response and any other;
• any information rights for investors;

A good term sheet should save you time and money, but a poor one will have the opposite effect. 

The term sheet should be signed to commit the parties to the term sheet themselves.

Term sheet – a contract?

A term sheet is a nonbinding agreement setting forth the basic terms and conditions under which an investment will be made. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is then drawn up.

Series A term sheet

On a Series A term sheet, the voting rights simply states the voting rights of the investor. Generally, Series A investors will likely receive the same number of votes as the number of common shares they could convert to at any given time.

Series B term sheet

Series B financing is the second round of funding for a business through investment including private equity investors and venture capitalists. Successive rounds of financing a business are consecutively termed Series A, Series B and Series C financing. The Series B round generally takes place when the company has accomplished certain milestones in developing its business and is past the initial startup stage.

Term sheet – binding?

The term sheet is non binding as it reflects only the key and broad points between parties under which the investment will be made.

However, the Adjudicating Authority of SEBI vide their order No. Order/KS/VC/2020-021/8265, dated 16.07.2020, in the case of IN RE : EDELWEISS FINANCIAL SERVICES LTD. [2020 (8) TMI 83 - SECURITIES AND EXCHANGE BOARD OF INDIA], held that the term sheet is binding. 

SEBI, upon receipt of the examination report from the National Stock Exchange, conducted investigation in the dealings in the scrip of Edelweiss Financial Services Ltd (EFSL) to examine the possible violations of the PIT (Prohibition of Insider Trading) Regulations for the period between January 2017 and April 2017.  One, Sri Renganathan was the compliance officer and company secretary of EFSL during the investigation period.    During the course of investigation, it was observed that ECap Equities, a wholly-owned subsidiary of EFSL, had acquired Alternative Investment Market Advisors Private Limited (AIMIN), a financial technology company, on April 5, 2017, by entering into a share purchase agreement. The same was disclosed by EFSL to the NSE and the BSE on the same day.   A term sheet in respect of the said transaction was signed between ECap and AIMIN 25.01.2017.  SEBI considered the acquisition of AIMIN by ECap was price-sensitive information that had come into existence on January 25, 2017, upon signing of term sheet.

SEBI alleged that Shri Renganathan, a Compliance Officer failed to close the trading window during the period of January 25, 2017 to April 5, 2017 and therefore violated the provisions of minimum standards for code of conduct to regulate, monitor and report trading by insiders mentioned in the PIT regulations.

SEBI observed in the show cause notice issued to the Compliance Officer that as per Economic Times article dated September 16, 2017,Term Sheet is the first and foremost document that outlines all the principal commercial, economic and governing terms and conditions of the proposed investment; which typically include the pre-money valuation of the company, the instrument of the transaction structure, investor's rights and obligations, board composition and management control rights, among others. It is entered between the parties to facilitate negotiations for the proposed transaction and is an expression of intention only.   It is alleged that the UPSI (unpublished sensitive information) came into existence on January 25, 2017 and the same was published on April 05, 2017. Therefore, the period of UPSI has been considered as January 25, 2017 to April 05, 2017.

It is alleged that as per Clause 4 of Model Code of Conduct under Schedule B to PIT Regulations, compliance officer of a listed entity is responsible for closing of the trading window when he determines that a designated person or class of designated persons can reasonably be expected to be in possession of unpublished price sensitive information. The Designated persons and their immediate relatives shall not trade in securities when the trading window is closed.

The noticee, Sri Renganathan filed a reply to the Adjudicating Officer.  He filed the following replies-

• Edelweiss explored the possibility of the purchase of software developed by AIMIN but later decided to acquire the said company as its subsidiary.
• In order to progress these discussions, a Term Sheet was signed between Ecap, AIMIN and the promoters of AIMIN on January 25, 2017.
• Various critical processes such as reviewing findings from the due diligence report, fulfillment of conditions precedent, transfer of ownership servers and domain names and finalization of the necessary agreements, had to be undertaken before closing of the deal, and after signing of the Term Sheet.
• Given that this share purchase was more akin to a business - technology upgradation, the Compliance Officer was not a party to these discussions.
• The Adjudicating Authority relied on the report published in Economic Times. In a quasi-judicial proceeding of this nature, a definition set out in a media report cannot hold any evidentiary value.
• The Notice selectively relies on the said Article and ignores some crucial statements made therein,  For instance, the article provides that ‘A Term Sheet is a non-binding document which does not constitute an offer, an agreement, agreement in principle, agreement to agree or commitment to provide financing’.
• The Article further provides that signing of a Term Sheet is merely the first step in many steps before a transaction is consummated, i.e., due diligence, definitive agreements and closing. Therefore, the statements made in the Article shall be taken into consideration holistically and not in isolation.
• The reliance on the Article to state that the Alleged UPSI came into existence at the time of signing of the Term Sheet is misplaced.

The Adjudicating Officer noted that the date of signing of the term sheet is on 25.01.2017.  From the perusal of the said term sheet the Adjudicating Officer found that major terms and conditions including consideration of the transactions were already given in the said Term Sheet.

The Adjudicating Officer noted from the email of the Noticee dated February 19, 2018, that EFSL had already commenced its due diligence (transaction) during the period from September 2016 to October 2016. The Adjudicating Officer also noted from Clause 11 of the term-sheet that it is binding in nature and cannot be terminated by parties in any manner whatsoever. This clearly shows that the intent and plans of acquisition by Ecap had concretized at the time of signing of Term Sheet itself. In view of the above the Adjudicating Officer found the general argument that the Term Sheet, prima facie, is non-binding and revocable in nature factually incorrect and not acceptable.

Reference:

1. www.lexology.com 
2. www.google.com
3. www.investopedia.com