What is a Term Sheet?

Raising capital involves a lot of conversations, pitch decks, and coffee meetings. Eventually, if an investor is interested, the conversation shifts from vision to logistics. This transition is marked by the arrival of a Term Sheet.

A Term Sheet is a non-binding agreement setting forth the basic terms and conditions under which an investment will be made. It serves as the blueprint for the legal documents that will follow. It is not the final contract. It is an agreement in principle.

receiving a term sheet is a significant milestone. It means an investor is serious. However, it is not a guarantee that the money will hit your bank account. Deals can and do fall apart after a term sheet is signed.

The clauses in a term sheet generally fall into two buckets: economics and control.

Economics refers to the financial return. This includes:

• Valuation: The pre-money and post-money value of the company.
• Option Pool: The percentage of equity reserved for future employees, which usually comes out of the founder’s slice.
• Liquidation Preference: This dictates who gets paid first and how much if the company is sold or goes bankrupt.

Control refers to who steers the ship. This includes:

• Board Seats: How many seats the investor gets versus the founders.
• Voting Rights: What creates a quorum and who can vote on specific issues.
• Protective Provisions: Specific actions the company cannot take without investor approval, such as selling the company or changing the primary line of business.

Most of the term sheet is non-binding. This means that if the investor discovers something concerning during due diligence, they can withdraw the offer without legal penalty.

However, there are usually two specific clauses that are legally binding:

1. Confidentiality: You cannot run around showing the specific terms to the press.
2. Exclusivity (or No-Shop): You agree not to talk to other investors for a set period, usually 30 to 60 days, while this specific investor finishes their due diligence.

New founders often confuse the term sheet with the final deal. They are distinct.

The term sheet is often just a few pages long. It outlines the logic of the deal. The Definitive Agreements are the actual legal contracts that follow. These can be hundreds of pages long.

The term sheet guides the lawyers. If a point is agreed upon in the term sheet, it is very difficult to renegotiate it later when drafting the definitive agreements. You cannot assume you will fix unfavorable terms later. You must negotiate the logic now.

When you receive a term sheet, the clock starts ticking. Investors often put an expiration date on the offer to create urgency.

This is a critical moment for a founder. You must determine if the valuation justifies the loss of control. You must model out the liquidation preferences to see what happens in a downside scenario. Does the math work if you sell the company for less than you hope?

Signing a term sheet effectively takes you off the market. Ensure you are ready to marry this investor before you sign the engagement letter.