If a PE fund, family office, or angel investor has expressed serious interest in your business, the next thing you will receive is a term sheet. If you have never seen one before, it can feel like a legal document written in another language. This guide translates it — clause by clause — into plain English, so you know what you are agreeing to before you sign.
Who this guide is for: Indian SME owners who have received — or are expecting to receive — a term sheet from a PE fund, family office, or angel investor for the first time. It assumes no prior legal or investment banking knowledge. Fund-raisers advising SME clients on equity fundraising will also find it useful as a plain-English reference.
A term sheet is a short document — typically 8 to 15 pages — that sets out the headline commercial terms on which an investor proposes to invest in your business. You will receive it after initial meetings and financial review, and before the investor formally begins due diligence on your company.
For most Indian SME owners, this is the first time they have seen a document like this. The instinct is often to focus on the valuation number at the top and treat everything else as standard legal language. That instinct is expensive. The clauses that follow the valuation — liquidation preference, anti-dilution, reserved matters, drag-along, put options, warranties — will shape how much control you retain, how much you receive when you eventually exit, and what personal financial exposure you carry for years after the deal closes.
Most commercial terms in a term sheet are non-binding on the parties. However, certain clauses are typically expressed as binding immediately on signing — most commonly exclusivity, confidentiality, costs and expenses, governing law, dispute resolution, and provisions relating to public announcements. Some term sheets also include a break fee. The specific clauses that are binding depend on the drafting, so read the term sheet carefully before signing to identify which provisions carry immediate legal effect.
Once a term sheet is signed, both sides have invested credibility in the deal. The investor has presented it to their investment committee, and you have likely told your CA, family, and advisors that the deal is moving forward. Practically speaking, materially reopening commercial terms after signing is uncommon — which is why reviewing every clause before you sign is the most important thing you can do in the entire fundraising process.
The term sheet is the first document you will sign in a fundraising. It is followed by two definitive legal agreements that give binding legal force to the terms you agreed at term sheet stage. Understanding what each document does, and how they relate to each other and to the term sheet, prevents surprises later in the process.
The Share Subscription Agreement (SSA) governs the actual issuance of new shares or instruments to the investor. It records what is being issued, at what price, under what conditions, and what representations and warranties the company and promoters make about the business. The SSA is legally binding.
The Shareholders' Agreement (SHA) governs the ongoing relationship between the company, the promoters, and the investor after the investment closes. It covers board rights, reserved matters, transfer restrictions, drag-along and tag-along rights, information obligations, and exit mechanics. The SHA is what you will live under for the next five to seven years.
The Articles of Association (AoA) is the constitutional document of the company, registered with the Registrar of Companies. Investor rights that need to be enforceable against third parties — pre-emption rights, transfer restrictions — must be incorporated into the AoA, not just the SHA. Amending the AoA requires a special resolution of shareholders and a ROC filing, which forms part of the closing process.
In practice, the SSA and SHA are negotiated simultaneously and executed on the same day as part of a single closing. The AoA is amended at or around the same time.
A typical PE or growth equity term sheet for an Indian SME covers the following areas in roughly this order:
| Section | What it covers | What it means for you |
|---|---|---|
| Issuer and investor | Who is investing, in what vehicle, through what entity | Confirm which legal entity is investing — this affects your future dealings and any FEMA compliance if the investor is foreign |
| Investment amount and instrument | How much, in what form — equity shares, CCD, or CCPS | The instrument type affects who gets paid first if the business is wound up or sold at a low valuation |
| Valuation | Pre-money valuation and resulting post-money stake | Check the maths yourself — pre-money and post-money are different numbers. Also check if the ESOP pool reduces your share before or after valuation is set |
| Use of proceeds | What the capital is for | Some investors treat this as loosely binding — be specific about what you intend to use the money for |
| Conditions precedent | What must be true or done before funds are transferred | These are the tasks between signing and receiving money. Negotiate a long-stop date so the investor cannot hold you in limbo indefinitely |
| Board and governance | Seats, reserved matters, information rights | The reserved matters list determines which business decisions you need the investor's approval for. This affects your day-to-day operational freedom |
| Economic rights | Liquidation preference, anti-dilution, distributions | These clauses determine how much you actually receive when the business is sold — which may be significantly less than your equity percentage suggests |
| Transfer restrictions | Lock-in, ROFR, tag-along, drag-along | These clauses restrict when and how you can sell your own shares, and whether the investor can force you into a sale you do not want |
| Exit | IPO drag, put option, mandatory exit timeline | The investor must exit eventually — these clauses define when and how, and what happens if no exit is available. A personal put obligation is the most financially dangerous provision here |
| Promoter obligations | Warranties, lock-in, salary, related-party restrictions | You personally warrant the accuracy of everything you have said about your business. If something turns out to be wrong, you may be personally liable |
| Exclusivity | Duration and scope — typically binding immediately on signing | Once you sign, you cannot negotiate with any other investor for the exclusivity period — even if this investor walks away |
| Confidentiality | Who can be told what — typically binding immediately on signing | Do not announce the deal to staff, customers, or suppliers until the SSA is signed and money is in your account |
| Governing law | Almost always Indian law for domestic investors | For domestic investors this is straightforward. For foreign investors, confirm jurisdiction carefully with your lawyer |
The term sheet will state a pre-money valuation — the value attributed to your business before the investment. The investor's ownership percentage is: investment amount ÷ (pre-money valuation + investment amount).
Many founders confuse pre-money and post-money. If the pre-money valuation is ₹20 crore and the investor puts in ₹5 crore, the investor owns 5 ÷ 25 = 20% — not 25%.
Many term sheets require an Employee Stock Option Pool to be created as a condition of closing. The critical question is whether the ESOP pool is carved out of the pre-money or the post-money valuation. If the term sheet requires a 10% ESOP pool to be created pre-closing, it comes out of the founder's share, not the investor's.
On the same ₹20 crore / ₹5 crore example, a 10% pre-money ESOP pool reduces the founder's effective ownership from 80% to 72%, while the investor still gets 20%. Always establish whether the ESOP is pre- or post-money before agreeing the valuation number.
Most sophisticated investors in Indian PE and growth equity deals do not subscribe for ordinary equity shares. They subscribe for Compulsorily Convertible Debentures (CCDs) or Compulsorily Convertible Preference Shares (CCPS).
CCDs are debt instruments that mandatorily convert into equity at a pre-defined event — a subsequent round, an IPO, or after a fixed period. They carry a nominal coupon, often 0.001%, which is largely irrelevant economically.
CCPS are preference shares that mandatorily convert into equity. They rank above ordinary equity shareholders on liquidation — which is where the liquidation preference mechanics in the next section apply. CCPS are the most common instrument in Indian PE minority deals.
Why investors prefer these over ordinary equity: CCDs and CCPS give investors preferential treatment on a liquidation or wind-down before conversion. They are also structurally useful for FEMA compliance in foreign investment scenarios and can carry tax and accounting advantages depending on the structure.
What this means for founders: The instrument must be genuinely and compulsorily convertible — not optionally convertible. Optionally convertible instruments are generally treated as ECB-type instruments rather than pure FDI equity under FEMA, which attracts a different and often more complex regulatory regime — this should always be confirmed with your legal and FEMA advisors. Always confirm the conversion ratio, conversion trigger, and what happens to preference rights on conversion. These must be explicit in the term sheet.
The liquidation preference determines who gets paid first — and how much — when the company is sold, wound up, or undergoes a liquidity event. It is the clause most Indian SME founders underestimate most severely.
1x non-participating: The investor chooses the higher of (a) their 1x liquidation preference amount, or (b) what they would receive if they converted into ordinary equity and participated pro-rata. They do not receive both. On a strong exit, the investor converts to equity and participates with everyone else. On a weak exit, they take their preference and the founder gets what remains. This is the most founder-friendly structure.
1x participating: The investor receives 1x their invested amount first, then also participates in the remaining proceeds pro-rata on their equity stake. They receive both — the preference and the equity upside. This is significantly less favourable to founders.
2x non-participating: The same optionality as 1x non-participating, but the preference floor is 2x the invested capital. At lower exit values this is heavily weighted toward the investor.
Illustrative example only — ₹5 crore invested for 20% ownership. Actual outcomes depend on the full cap table and any senior obligations.
| Structure | Exit at ₹15cr — investor receives | Founder receives | Exit at ₹50cr — investor receives | Founder receives |
|---|---|---|---|---|
| 1x non-participating | Chooses higher of ₹5cr or 20% of ₹15cr = ₹3cr. Takes ₹5cr preference. | ₹10cr | Chooses higher of ₹5cr or 20% of ₹50cr = ₹10cr. Converts to equity, takes ₹10cr. | ₹40cr |
| 1x participating | Takes ₹5cr first, then 20% of remaining ₹10cr = ₹2cr. Total: ₹7cr. | ₹8cr | Takes ₹5cr first, then 20% of remaining ₹45cr = ₹9cr. Total: ₹14cr. | ₹36cr |
| 2x non-participating | Chooses higher of ₹10cr or 20% of ₹15cr = ₹3cr. Takes ₹10cr preference. | ₹5cr | Chooses higher of ₹10cr or 20% of ₹50cr = ₹10cr. Both equal — takes ₹10cr. | ₹40cr |
"On a modest exit, a 2x preference leaves the founder with significantly less than their equity percentage suggests. On a strong exit, a non-participating investor converts to equity and the founder's upside is preserved. A participating structure is always more expensive to the founder than a non-participating one at the same multiple."
Push for 1x non-participating as your starting position. Resist participating structures. Any preference multiple above 1x should have clear commercial justification.
Anti-dilution provisions protect the investor if you raise a subsequent round at a lower valuation than the current round — a "down round." They work by adjusting the investor's conversion ratio so that they effectively pay less than they originally did, which dilutes the founder's stake proportionally.
Broad-based weighted average is the standard and most founder-friendly form. It adjusts the conversion price based on a weighted average of the old price and the new lower price, taking into account how many shares are issued in the down round. The impact is proportional to the severity of the down round and the size of the new issuance.
Full ratchet is the most investor-friendly and most punishing for founders. If any share is issued at a lower price than the investor's entry price — even a single share — the investor's entire holding reprices to that lower level. This can cause severe founder dilution on even a modest down round. Full ratchet is generally considered very unfavourable to founders and is uncommon in balanced deals. Resist it.
For a stable, cash-generative SME raising a single round of PE capital with no anticipated future dilution events, anti-dilution provisions may be less material in practice — but the mechanism should be understood and the drafting checked before signing.
Board composition. A PE investor taking a minority stake will typically ask for one board seat — sometimes two if they hold above 26% or the deal is larger. The term sheet will specify how many directors the investor can nominate and whether investor approval is required to appoint or remove the CEO.
Reserved matters are decisions the company cannot make without investor approval, regardless of what the board or majority shareholders decide. They are one of the most negotiated areas of any term sheet, because the list of reserved matters determines how much operational freedom the founder retains after closing.
Common reserved matters in Indian PE term sheets include: capital expenditure above a defined threshold; incurring new debt above a defined amount; related-party transactions; acquisition or disposal of material assets; changes to the business plan or annual budget; key management hires and terminations at CXO level; issuance of new shares; and changes to constitutional documents.
PE investors will specify the founder's salary in the term sheet or require it to be set in the SHA. This is standard practice. The investor needs to separate the founder's economic return as a shareholder from their remuneration as a manager, because EBITDA — the basis for the company's valuation and the investor's return — is calculated before salary. An inflated salary suppresses EBITDA and reduces the investor's return. Agree a market-rate salary, specified clearly, with a defined process for annual review.
If your business pays rent to a property owned by you or a family member, buys inputs from a family-owned supplier, employs relatives at above-market salaries, or has any other transactions with promoter-connected entities, expect these to be scrutinised and restricted. The term sheet will typically require all related-party transactions to be conducted at arm's length, disclosed to the board, and approved by the investor director above a threshold. Some investors require existing arrangements to be terminated or restructured as a condition of closing.
If multiple family members are active in the business in informal or undocumented roles, the investor will want clarity on their roles, remuneration, and authority. Identify and address these before the term sheet is signed — not during due diligence.
Standard provisions include: monthly MIS reports within 15 days of month close; quarterly unaudited financials within 45 days; annual audited accounts within 120 days of financial year end; and an annual budget submitted to the board before each financial year begins. Observer rights at board meetings are common. These are standard — accept them.
Push back on real-time data access, weekly reporting, and any provision allowing the investor to share financial data with third parties without restriction.
If the promoter sells shares to a third party, the investor has the right to sell their shares on the same terms alongside the promoter. This protects the investor from being left behind when the promoter exits. Standard — accept it.
If a specified majority of shareholders vote to sell the company, they can compel remaining minority shareholders to sell on the same terms. The risk is in who controls drag and at what threshold. If the investor holds 30% and the drag threshold is "shareholders holding more than 25%," the investor can drag the founder into a sale without the founder's agreement.
Negotiate the threshold so drag requires alignment between both the investor and the promoter — typically a majority of both groups must agree. Also negotiate a minimum price floor so drag cannot be exercised at a distressed valuation that recovers the investor's capital at the founder's expense.
Before transferring shares to a third party, the selling shareholder must first offer them to existing shareholders at the same price and terms. Standard on both promoter and investor shares — accept it. Negotiate the offer period to be no longer than 30 days to avoid delaying legitimate secondary transactions.
Pre-emption rights require the company to offer new shares to existing shareholders pro-rata before issuing to a third party. Standard — accept it. Ensure pre-emption does not apply to ESOP grants.
Most PE term sheets impose a lock-in on the promoter's shares — typically two to four years from closing. During this period the founder cannot sell, transfer, or pledge shares without investor consent. This is standard. Negotiate that the lock-in includes permitted transfers to immediate family members or family trusts for estate planning purposes.
Some term sheets include good leaver and bad leaver provisions that determine what happens to the founder's shares if they leave during the lock-in period. A good leaver — death, disability, or termination without cause — typically retains or is bought out at fair value. A bad leaver — resignation or termination for cause — may be required to sell shares at cost or a discount. Negotiate the definitions carefully; the category into which a departure falls has significant financial consequences.
The investor's exit timeline is not merely aspirational. Most PE and growth equity investors negotiate contractual exit rights, and founders must understand what obligations arise if an IPO, strategic sale, or secondary sale does not materialise within the agreed period.
After a defined period or once the company reaches a defined scale, the investor can require the company to pursue a public listing. Negotiate the minimum IPO size, the minimum valuation at which an IPO can be demanded, and the timing. Do not agree to an IPO drag that can be exercised at any time without conditions.
If the investor has not exited by a defined date — typically 5 to 7 years from closing — many term sheets include a put option: the investor's right to require the company or the promoter personally to buy back their shares at a formula price. The formula is typically the higher of cost plus a minimum return (often expressed as an IRR floor) or fair market value.
This is the provision that can create significant personal financial liability for the promoter if an exit does not materialise. Negotiate the put option carefully — specifically the formula, the trigger date, and whether the obligation falls on the company or the promoter personally. If the put falls on you personally, ensure you can actually satisfy it. A personal put obligation without a cap or formula ceiling is one of the most financially dangerous provisions a founder can sign.
When you sign the SSA, you will be asked to confirm — in writing and under legal obligation — that everything you have told the investor about your business is true. These statements are called representations and warranties. If any of them turn out to be wrong after the deal closes, the investor can make a legal claim against you personally to recover their losses. For many Indian SME owners, this is the first time in their business life they have carried this kind of personal legal exposure on a commercial transaction. It deserves careful attention.
This is not about catching you out. It is about ensuring that what the investor paid for matches what they actually received. The best protection is accurate disclosure — not optimistic warranty-giving.
Use a disclosure schedule. This document, attached to the SSA, qualifies your warranties. A properly disclosed item reduces or eliminates warranty liability for that specific matter. An undisclosed item that surfaces post-closing can result in a claim years after the deal is done. It is the most important document a founder prepares during the legal phase of closing.
Negotiate a warranty cap — typically 25–100% of the investment amount for general warranties, with higher or uncapped exposure only for fraud and title.
Negotiate a time limit — 18 to 24 months post-closing for general warranties; longer for tax warranties, typically aligned to the relevant limitation period.
Negotiate a de minimis threshold and basket — claims below a minimum amount should not be individually claimable, and aggregate claims should need to exceed a basket before the investor can recover anything.
Never warrant something you cannot verify. If you are uncertain about a matter, disclose it in the disclosure schedule rather than hoping it does not surface. Undisclosed issues discovered post-closing are more damaging than disclosed issues that were known going in.
If your business carries bank loans, NBFC facilities, or overdraft facilities — which most Indian SMEs do — the arrival of a new investor may trigger obligations to existing lenders that you are not aware of.
Change-of-control clauses. Many standard loan agreements contain a clause requiring the bank's prior written consent if there is a material change in ownership or management. A PE investor taking a significant minority stake may or may not constitute a change of control under your specific loan agreement — the definition varies by lender. Failure to notify when required can constitute a technical default even if no payment has been missed.
Restrictive covenants. Loan agreements often restrict what the company can do without lender consent: incurring additional debt, paying dividends, making capex above a threshold, or providing guarantees. A new investor's reserved matters and your new SHA may conflict with existing covenants. These conflicts need to be identified and resolved before closing.
What to do before signing the term sheet: Review all existing loan agreements with your lawyer. Identify any change-of-control provisions, any covenants affected by the investment, and whether the new investor's governance rights conflict with existing lender rights. If bank consent is required, factor the timeline for obtaining a No Objection Certificate into your conditions precedent.
Personal guarantees. If you have given personal guarantees on company borrowings — the norm for Indian SME bank loans — consider how those guarantees interact with the new governance structure. The investor's reserved matters may limit your ability to manage the company in ways that affect the guaranteed facilities. Discuss this with your lender and lawyer before closing.
This section covers the compliance requirements triggered specifically by who the investor is and what instrument is being used. The Tax Considerations for SME Fundraising guide covers these topics in greater depth; this section flags the issues that arise at term sheet stage.
If the investor is non-resident — a foreign fund, NRI, or overseas corporate — the investment must comply with FEMA, the FDI policy, and RBI's pricing guidelines. A key implication: shares, CCDs, or CCPS issued to a foreign investor must be priced at or above fair market value. You cannot issue to a foreign investor at a price below certified FMV. If the term sheet specifies a valuation below what the FMV certification would produce, you have a compliance problem. Identify this before signing.
The instrument must be genuinely and compulsorily convertible to qualify as FDI equity under FEMA rather than being treated as an ECB-type instrument. Optionally convertible instruments attract a different and often more complex regulatory regime. The precise classification depends on the instrument's terms, the investor type, and the transaction structure — always confirm with your legal and FEMA advisors before the term sheet is finalised.
For pricing and valuation compliance — whether under the Companies Act for resident investors or under FEMA pricing rules for foreign investors — an appropriate valuation certificate or report from a qualified professional will be required. The exact requirement depends on the investor type, the instrument being issued, and the specific transaction structure. Confirm this with your CA, company secretary, or legal advisor before signing the term sheet.
Formal due diligence begins after the term sheet is signed. The investor will issue a document request list within a few days of signing, covering financial, legal, tax, and operational information. Expect 6 to 10 weeks of active diligence for a typical Indian SME fundraising. The most important thing during diligence is consistency — every number in your pitch deck, IM, and financial model must reconcile with your audited accounts, GST returns, and bank statements.
Conditions precedent (CPs) are obligations that must be satisfied before the investor transfers funds. Common CPs include: completion of due diligence to the investor's satisfaction; board and shareholder approvals; AoA amendment; execution of the SHA and SSA; resolution of identified legal or regulatory issues; and any specific restructuring required such as termination of related-party arrangements or transfer of IP to the company.
Negotiate a materiality qualifier on the diligence CP — more founder-friendly drafting specifies that this CP is satisfied unless the investor identifies issues that are material to the investment, rather than leaving it entirely at the investor's discretion. Also negotiate a long-stop date — the date by which all CPs must be satisfied or the term sheet lapses. This prevents the investor from holding you in exclusivity indefinitely.
Exclusivity means that for the duration specified — typically 30 to 60 days — you agree not to solicit, entertain, or negotiate with any other investor regarding the same financing. This is binding immediately on signing. Do not sign exclusivity while actively negotiating with other investors. Negotiate the period to be as short as is practically feasible given the due diligence timeline.
Confidentiality is also binding immediately. Do not announce a fundraise before the SSA is signed and funds are received. If the deal subsequently falls through, premature announcements cause real damage with customers, suppliers, and employees.
| Stage | What happens | Typical duration |
|---|---|---|
| Diligence | Document review, management Q&A, site visits, issues log compiled | Weeks 1–8 |
| Legal drafting | SSA, SHA, AoA amendment negotiated between lawyers | Weeks 6–12 |
| Approvals | Board resolutions, shareholder EGM if AoA amendment required | Weeks 10–14 |
| Filings and closing | ROC filing, FEMA filing if foreign investor, consideration received, shares allotted | Weeks 12–16 |
| Post-closing | SHA operative, first board meeting under new governance, information rights begin | From closing |
Most delays arise from inconsistent financial records discovered in diligence, slow legal negotiation, or FEMA and ROC filing timelines for foreign investors.
Use this before signing. Every item should have a clear written answer. If you need help working through the checklist with a qualified M&A advisor or corporate lawyer, MergerDomo's advisory network can connect you with professionals who specialise in PE and growth equity transactions for Indian SMEs.
This guide is based on publicly available regulatory frameworks and standard market practice for Indian PE and growth equity transactions. Key references:
Regulations are updated periodically. Always verify the current version of any regulation with qualified legal, tax, or FEMA advisors before acting.
MergerDomo connects established Indian SMEs with PE funds, family offices, and strategic investors — and provides access to M&A advisors and lawyers who can help you review a term sheet before signing.