What Are Term Sheets? And What Do Founders Need To Know About Drafting Them?

If you’re raising investment for your startup, there’s one document that you need to know about: a term sheet.

Whether you’re in the early stage of your startup growth negotiating with angel investors, or further down the line and looking to lock in a venture capital firm, having a strong understanding of how term sheets work is important.

Here, we lay it all out for you.

What Is A Term Sheet?

A term sheet, put simply, is a non-legally binding agreement that lays out the key terms of an investment deal.

Think of it as a summary of terms that helps investors and founders get on the same before before spending time and money on full legal contracts. It lays out important things like a company’s valuation, how many shares are being sold, how much they are being sold for, who is on the board and the level of involvement investors can have.

Whilst the term sheet isn’t legally binding (mostly), it’s still treated as an official document. Once signed, it’s generally agreed that neither party can go back and change key terms. If they do, it’s seen as a big breach of trust and could tear the deal apart.

Is A Term Sheet Like A Contract?

No, a term sheet is not like a contract – but it’s definitely something to take seriously.

One of the main differences between a term sheet and a contract is that a term sheet is not legally binding, however, there are some clauses in there that might be legally enforceable.

For example, it may be mentioned that neither party can share the deal terms publicly. If this broken by either side, the other could take legal action.

Another legally binding clause might be exclusivity – or an agreement not to take other offers for a set period of time. In this case, breaking this could have legal implications.

The rest of the terms are usually ‘subject to contract’, meaning they only become legally binding when written up formally and signed. Think of a term sheet like a pre-contract agreement, you decide what’s going in the contract before it’s actually drawn up, signed and legally binding.

Why Are Term Sheets Important For Startups?

For founders, a term sheet isn’t just a place to write the details of a deal, it’s also a way to talk through the nitty gritty and find out what an investor actually wants.

A term sheet can be a great way to get a lot of the discussion out of the way before proceeding with the legal process. It means all questions are worked out upfront and can help speed up the process later down the line.

But most importantly, a term sheet shows real commitment from both sides to go ahead with the deal. It means founders know investors are serious before they start the timely and expensive legal process.

What’s Actually In A Term Sheet?

Whilst term sheets can vary slightly, there are a few key elements that most of them have, including:

A valuation: A pre and post-funding valuation, this helps to outline how much of the company you are giving away. For example, if your startup is valued at £2 million pre-money and you’re raising £500k, your post-money valuation is £2.5 million, and the investor gets 20% equity.

Equity: What percentage of the company the investor will own after the deal and any details around equity arrangements.

Sale details: Outlining what an investor gets in a sale or wind-down. For example, it’s common that investors will get a first option to take their money out before other stakeholders are paid. But this usually lays out what would happen if the startup does get sold.

Anti-dilution rights: This protects investors from having their share diluted if you decide to raise down the line. Under these terms, investors will always have a set % stake in the company, so it may mean giving them more shares to stay at this level later down the line if you raise again or having a set amount of shares set aside for employees so their percentage isn’t affected.

Investor involvement: Whether investors have a board seat, rights over key decisions or the ability to attend key meetings and make big decisions.

No shop clause: Stops you from getting other offers once a term sheet is signed, however there is usually an end date to this.

Who Writes The Term Sheet?

A term sheet is usually written by investors, but founders are able to write the first version. This means you can set the key terms and the tone and work out the finer details later on.

Remember, finalising a term sheet is a collaborative process, so it’s not about who starts it, but about finishing it together.

What Happens After The Term Sheet Is Signed?

Once the term sheet is signed, the legal bit commences.

Investors will want to dig deeper into your legal, financial and operations data to do their due diligence.

Then, the legal documents will be drafted based on the term sheet.

Once completed, the money is transferred and the real work begins: helping investors get that return!

The Importance Of Term Sheets

A term sheet is more than just a piece of paper, it’s the start of a long-term partnership between founders and investors. Knowing what goes in it, how legally binding it is and how it might affect your company is important.

And whilst technically it isn’t legally binding, you should still treat it with the same level of care and attention. After all, a good term sheet will help set you and your investors up for a long, collaborative relationship – and who doesn’t want that?