Documents · Glossary
What is a term sheet?
A term sheet is a short summary of the terms on which an investor proposes to put money into a company. It states the amount, the valuation, the type of security, the rights attaching to it and the governance changes that follow, and it is signed before the long form documents are drafted.
Two pages decide most of what matters in a funding round, and the sixty pages that follow largely implement them. Founders who skim the summary and read the contracts have it exactly the wrong way round.
Indunil Asanka · Co-founder
5 min read · Published
| Heading | What it settles |
|---|---|
| Amount and security | How much is invested and what the investor receives for it |
| Pre money valuation | The price per share, and therefore how much of the company is sold |
| Liquidation preference | Who gets paid first on a sale, and how much before anybody else |
| Board composition | Who sits at the table and how decisions are made |
| Reserved matters | The list of decisions the company cannot take without investor consent |
| Founder vesting | What happens to founder shares if a founder leaves early |
| Anti dilution | How the investor is protected if a later round prices lower |
| Conditions and exclusivity | What must happen before completion, and how long the company stays off the market |
Valuation is the headline and rarely the point
Founders negotiate hardest on the number at the top and it is often the least consequential term on the page. A high valuation with a two times participating preference and a broad reserved matters list can leave a founder worse off in every outcome except a spectacular one than a lower valuation on clean terms. The reason is that valuation sets the split of a sale, while preference sets who is paid before the split happens, and control terms decide who can force or block a sale at all. Read the page from the bottom up once, ignoring the number, and ask what happens in each of three scenarios: a sale for less than was invested, a sale for a modest multiple, and a company that neither fails nor exits for a decade.
Preference, in plain arithmetic
A one times non participating preference means the investor takes back their money first, or converts to ordinary shares and takes their percentage, whichever is larger, but not both. That is the market standard in early rounds and it is fair. Participating means they take their money back and then share in what is left, which at a modest exit can consume most of the founders' proceeds. A multiple, two times or three times, compounds the effect. None of this shows up in the valuation and all of it shows up in the payout, which is why the preference row is where an experienced adviser looks first when a term sheet arrives.
Control, and the list nobody reads
Reserved matters, sometimes called consent rights, list the decisions that need investor approval regardless of shareholding. A short list covering new share issues, borrowing above a threshold, selling the company and changing the constitution is normal and reasonable. A long list reaching into hiring, budgets, contracts above a low threshold and any change to the business plan converts a minority investor into a partner with a veto over daily operations. The number of items matters less than where the thresholds sit, so read it against real figures from the current year rather than as an abstract list. Board composition works the same way: a board of three with one investor seat is very different from a board of two plus an investor appointed chair.
What is binding, and what is not
Almost none of it. The commercial terms are an expression of intention and either side can walk. What binds is the same small core found in every pre contract summary: confidentiality, exclusivity while due diligence runs, and who bears costs if the round does not complete. Investor costs are the one to watch, since a clause obliging the company to pay the investor's legal fees on completion is standard, and a clause obliging it to pay them even if the round fails is not. Cap the number, and state whether it is inclusive of tax, because an uncapped undertaking given by a company with eleven months of runway is a genuine risk rather than a formality.
After signing, and how long it should take
A signed term sheet starts a clock. Due diligence, then the long form documents: a subscription agreement, an amended constitution and a shareholders agreement, all of which should implement the summary rather than reopen it. Four to eight weeks is normal for a seed round and anything much longer usually means something surfaced in diligence. Watch for terms appearing in the long form that were never in the summary, which is common and is not always deliberate, since standard precedents carry provisions the drafter did not think to flag. The summary is the reference point, and every departure from it deserves a question. It is also worth agreeing at signing who keeps the working checklist, because a round with three advisers and no owner of the list drifts. One named person tracking conditions, signatures and the funds flow shortens a raise more than any drafting choice on the page.
Questions people ask
Is a term sheet the same as a convertible note?
No. A term sheet describes terms; a convertible note is one of the things it can describe. Notes and simple agreements for equity postpone the valuation question to a later round, so their term sheets are much shorter, covering the amount, the discount, any valuation cap, the maturity and what triggers conversion. Priced round term sheets are longer because shares are being issued now.
Should a founder sign the first term sheet they receive?
Not without reading the control and preference terms against a bad outcome as well as a good one, and not without knowing whether other conversations are live, since exclusivity ends them. Speed has real value when runway is short, so the answer is often yes with a small number of changes rather than a long negotiation that burns two months.
Does a term sheet fix the price per share?
It fixes the pre money valuation and the amount, from which the price per share follows once the share count is agreed. The trap is the option pool: if the summary says the pool is created before the investment, the dilution falls on the existing holders, and if after, it is shared. That single word moves several percentage points of ownership.
What is a no shop clause?
Exclusivity by another name. The company undertakes not to solicit or negotiate with other investors for a stated period, usually thirty to sixty days, so the investor can spend money on diligence without being outbid at the end. It should have a hard end date and should fall away if the investor withdraws or materially changes the terms.
Can the terms change after diligence?
They can, and a material change is a signal worth taking seriously. Discovering an unregistered liability or a missing assignment of intellectual property is a legitimate reason to reprice. Repricing with no new information, late in the process, when the company is running out of money, is a different behaviour and worth asking about in reference calls before signing.
Who prepares the long form documents?
Usually the investor's lawyers, with the company paying, which is the market convention and puts the pen in the investor's hand. The company's own adviser then reviews. Where the round is small, some investors work from a published standard set of documents, which cuts cost sharply and makes departures from the summary easy to spot.
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