Term sheets: frequently asked questions

The answers

What is a term sheet?

A term sheet is a summary of the key terms an investor offers: the amount, the valuation, the type of shares and the rights the investor wants. It is the starting point for the final agreements. It is written to be short and readable.

Is a term sheet legally binding?

Mostly not. The main commercial terms are usually non-binding, but some clauses, such as confidentiality and exclusivity, can be binding. Check the wording and ask your lawyer which parts bind you.

What are the main clauses in a term sheet?

Typical clauses cover the investment amount, valuation, type of security, liquidation preference, anti-dilution, board seats, voting rights, vesting, option pool, information rights and exclusivity. Each affects who gets what and who decides.

What is liquidation preference?

It decides who gets paid first, and how much, if the company is sold or wound up. A 1x preference means the investor gets their money back before others share the rest. Participating preferences let them also share in the remaining money, so they favour the investor.

What is an anti-dilution clause?

It protects investors if the company later raises money at a lower price. Weighted average is common and gentler, while full ratchet is harsher on founders. Know which one is in your term sheet.

What is an exclusivity or no-shop clause?

It stops you from talking to other investors for a set period, often 30 to 60 days, while the investor completes due diligence. It is usually binding, so keep the period short and make sure it ends if the investor changes terms.

What is a board seat and who gets one?

A board seat gives a person a vote on major company decisions. Lead investors often ask for one. Think about the balance of the board and what matters you cannot decide alone.

What are protective provisions?

These are decisions that need the investor's approval, such as selling the company, issuing new shares or changing the business. Too many can slow you down. Negotiate for a short, sensible list.

What is vesting for founders?

Founder vesting means your shares are earned over time, often four years with a one-year cliff. Investors ask for it so that founders stay committed. It matters if a co-founder leaves early.

What is an option pool?

An employee stock option pool is a share of the company set aside for hiring. Investors often ask that it be created before the round, so it dilutes the founders. Size it by your hiring plan.

What is pro-rata right?

It lets an investor put in more money in future rounds to keep their ownership percentage. It is common for early investors. It helps them, but can limit room for new investors.

What are drag-along and tag-along rights?

Drag-along lets majority holders force minority holders to join a sale. Tag-along lets minority holders join a sale made by the majority. Both appear in shareholder agreements.

Should I use a lawyer for a term sheet?

Yes. A startup lawyer can explain the clauses, spot unusual terms and negotiate. The cost is small compared with the effect of bad terms. Ask for a fixed fee if you can.

Can I negotiate a term sheet?

Yes. Most terms are negotiable, especially if you have more than one offer. Decide your priorities, such as control, valuation or liquidation preference, and focus on those. Be calm and professional.

What happens after I sign a term sheet?

The investor completes due diligence and the lawyers draft the final documents, such as the investment and shareholder agreements. It can take weeks. The deal is not final until money is received, so keep running the business.