Term sheet

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Definition
A term sheet is a short, mostly non-binding document that sets out the key terms of a proposed investment before the full legal agreements are drawn up.

Why it matters

Almost everything in the final contracts flows from this page, and it is far easier to change before signing than after. Valuation gets the attention, but liquidation preference, board control and veto rights often shape the founder's life more. A weak term sheet can leave a founder discovering, a year later, that a clause nobody explained now decides something they thought was theirs to decide.

How to apply it

  • Read every clause, not only the valuation and the amount raised.
  • Have a lawyer who works with startups explain liquidation preference, anti-dilution and control terms before signing.
  • Negotiate the non-price terms as seriously as the price.
  • Treat exclusivity carefully. A no-shop clause can stop a founder talking to other investors for several weeks.
  • Model the cap table after the round, including dilution from the option pool and any earlier SAFE notes.

What it is

When an investor decides to back a company, the first written offer is the term sheet, usually one to five pages. It does not move any money. It records what both sides intend to agree, so that lawyers can then turn it into the binding contracts. A few clauses are normally binding even so: confidentiality, exclusivity and who pays the legal costs.

The usual contents are the pre-money valuation, the amount invested, the share of the company the investor will own, the size of any option pool, the liquidation preference, anti-dilution protection, board seats, vesting for founders, and the rights the investor gets over big decisions.

Common mistakes

  • Focusing only on valuation. Preference, board control and vetoes often decide who gets what. Read the whole sheet.
  • Signing without a startup lawyer. General lawyers may not recognise what is normal or aggressive in venture terms.
  • Underestimating exclusivity. A long no-shop clause removes your leverage. Keep it short and conditional on the investor moving quickly.
  • Forgetting the option pool. If the pool is created before the investment, it dilutes founders and not the investor. Check the effect on the cap table.
  • Assuming it is all non-binding. Confidentiality, exclusivity and costs often bind. Know which clauses do.
  • Treating the term sheet as final. The long-form documents can add detail. Compare them with the sheet before signing.
Worked example

Suppose a founder receives a term sheet for a €1 million investment at a headline pre-money valuation of €4 million, which would give the investor 20 per cent after the round. The sheet also asks for a 10 per cent option pool to be created before the money comes in. Because the pool is counted in the pre-money figure, it is worth €500,000 on the €5 million post-money, and the founders' effective pre-money falls to €3.5 million. The headline price hid the real one.

The founder reads every clause, asks a lawyer who works with startups to explain the liquidation preference, and pushes back on the pool. The investor agrees to reduce it to 7 per cent. Non-price terms were part of the same negotiation as the valuation, and they were settled before anyone signed.

Related terms

  1. Article

    SAFE

    A simpler earlier instrument that a term sheet often replaces.

  2. Article

    ARR multiple

    One common input into the valuation.

  3. Article

    Bridge round

    A smaller raise sometimes agreed on a lighter sheet.