Term sheet

A term sheet is a non-binding document used in the startup ecosystem to outline the key terms and conditions of a potential investment deal between a startup and investors, such as venture capitalists or angel investors. It serves as a blueprint for the investment agreement, summarizing the financial and legal terms before detailed legal documents, like a shareholders' agreement, are drafted. Think of it as a roadmap that helps both the startup founder and the investor agree on the main points of the deal before spending time and money on complex legal work.

The term sheet is especially important for first-time founders because it simplifies the negotiation process and ensures everyone understands the deal's structure. It is not a final contract but a starting point that can lead to a successful partnership if both sides agree.

Purpose

The main purpose of a term sheet is to establish a clear understanding between the startup and the investor about the key aspects of the investment. It helps avoid misunderstandings by putting the agreed terms in writing. For a first-time founder, a term sheet is like a checklist that shows what the investor expects in return for their money, such as how much ownership they will get or what happens if the company is sold.

By setting these expectations early, the term sheet saves time and reduces the cost of legal work later. It also helps founders focus on growing their business while negotiations are streamlined.

Key Components

A term sheet typically includes several key sections that outline the financial and legal terms of the deal. Below are the most common components, explained in simple terms:

• Investment Amount: This is the amount of money the investor will give to the startup. For example, an investor might agree to invest $500,000 in exchange for a share of the company.
• Valuation: This is the estimated worth of the startup before and after the investment. The "pre-money valuation" is the company's value before the investment, and the "post-money valuation" is the value after the money is added. For example, if a startup is valued at $2 million pre-money and receives $500,000, the post-money valuation is $2.5 million.
• Equity: This refers to the percentage of the company the investor will own after investing. If the investor puts in $500,000 for a $2.5 million post-money valuation, they would own 20% of the company.
• Liquidation preference: This term decides who gets paid first if the company is sold or shuts down. For example, an investor might have a "1x liquidation preference," meaning they get their investment back before other shareholders receive any money.
• Anti-dilution: This protects investors if the startup raises more money later at a lower valuation. It ensures the investor's share doesn't lose too much value.
• Pay-to-Play Provisions: These require investors to keep investing in future funding rounds to maintain their benefits, like their ownership percentage. If they don’t invest more, they might lose certain rights.
• Board Representation: This determines whether the investor gets a seat on the startup’s board to influence major decisions.
• Drag-Along and Tag-Along Rights: Drag-along rights allow majority shareholders to force others to sell their shares if the company is sold. Tag-along rights let minority shareholders join the sale to get the same deal.

These terms help first-time founders understand what they’re giving up (like ownership or control) in exchange for the investor’s money.

Types of Term Sheets

There are two main types of term sheets in startups:

• Equity Term Sheets: These are used when investors buy shares in the company, becoming part-owners. This is common in venture capital deals.
• Convertible Note Term Sheets: These are used for loans that can later turn into shares, often used in early-stage startups. They include terms like interest rates and conversion discounts.

Each type suits different stages of a startup’s growth. For example, convertible notes are popular for very early startups that don’t yet have a clear valuation.

Importance for Founders

For a first-time founder without a business background, a term sheet is a critical tool to understand what they’re agreeing to. It’s written in simpler language than final legal documents, making it easier to grasp. However, founders should still consult a lawyer to avoid unfair terms, sometimes called a "dirty term sheet," which might favor the investor too much. For example, a term sheet with a high liquidation preference (e.g., 3x) could mean the investor gets paid three times their investment before the founder sees any money from a sale.

Tools like BuildYourTermSheet.com can help founders create and understand term sheets by breaking down complex clauses into plain English.

Negotiation Tips

Negotiating a term sheet can feel overwhelming, but here are some tips for founders:

• Understand the Terms: Learn what each term means and how it affects your startup. For example, a high valuation might sound great but could make it harder to raise money later.
• Focus on Fairness: Avoid terms that give investors too much control, like excessive board seats or harsh anti-dilution clauses.
• Get Legal Advice: A lawyer can spot potential issues and suggest better terms.
• Build Trust: Show investors you’re transparent and committed to make negotiations smoother.

Recent Trends

In 2025, term sheets remain a vital part of startup funding. Recent news highlights how founders are increasingly seeking investor partners who offer more than just money, such as help with recruiting or going public. Additionally, startups in diverse sectors, like alternative meat or social media moderation, are using term sheets to secure funding, showing their versatility.

See Also

• Startup company
• Venture capital
• Angel investor
• Shareholders' agreement
• Valuation (finance)
• Equity (finance)

External Links

• EquityList: Term Sheets Explained
• Demystifying Startup Term Sheets for Founders