A term sheet is a short document that sets out the main terms of an investment before the full legal documents are drawn up: how much is being invested, at what valuation, and the rights the investor gets with their shares. It’s also called a heads of terms or a summary of terms. Once it’s signed, the lawyers turn it into the documents that make the deal binding.
The valuation is the headline number. The other clauses decide who controls the business after the money goes in, what the founder can do without the investor’s agreement and who gets paid what when the business is sold. They stay in force for as long as the investor holds shares.
I’ve raised £250m+ for my own companies and funded more than 750 businesses with over £1bn, so I’ve seen term sheets as a founder and as an investor.
What a Term Sheet Is and What’s Binding
A term sheet comes after an investor has decided they want to invest and before the legal work starts. By then the investor has usually seen the pitch deck, met the founder and, on many raises, read an investment memorandum. The term sheet lets both sides agree the commercial deal in a few pages before anyone pays lawyers to draft the full documents.
Most of a term sheet isn’t legally binding. Either side can walk away after signing it, and the investor doesn’t have to invest until the final documents are signed. A few clauses are usually binding from the day it’s signed:
- Confidentiality, so neither side shares the terms.
- Exclusivity, sometimes called a no-shop, which stops the founder talking to other investors for a set period.
- Costs, which says who pays the legal fees. The company often pays the investor’s fees up to a cap.
- Governing law, the country whose law applies.
Once the term sheet is signed, the lawyers start drafting and the investor asks for the accounts, contracts and company records. They will then do their due diligence and check what they have been told is true.
The agreed terms go into the subscription agreement, which covers the investment itself, the shareholders’ agreement, which covers how the company is run, and usually new articles of association, the company’s rulebook. A point the term sheet doesn’t cover gets settled between the lawyers during drafting.
Term sheets are used for priced rounds, where shares are issued at an agreed valuation. An early round on a SAFE or an advance subscription agreement often has a shorter summary of terms, because the price is set later and there’s less to agree.
What Goes in a Term Sheet
Term sheets follow a familiar layout, so one term sheet template looks much like another. In the UK, UK Private Capital, formerly the BVCA, publishes model documents for venture rounds that include a summary of terms. In the US, the NVCA model legal documents do the same job. Lawyers on both sides often start from these.
The clauses are much the same in the US, Canada, Australia, Singapore and the UAE. What changes from country to country is the company law behind them, such as how share classes and pre-emption rights work, and whether a tax relief scheme for investors limits the rights their shares can carry.
An investment term sheet for a priced round covers things like:
| Clause | What it covers |
|---|---|
| The investment | The amount, the investors, the price per share and the pre-money valuation |
| Share class | Whether the investor gets ordinary or preference shares, and the rights attached |
| Option pool | Shares set aside for future staff, and whose shares they come out of |
| Liquidation preference | Who gets paid first, and how much, when the business is sold or wound up |
| Anti-dilution | What happens to the investor’s shares if the company later issues shares at a lower price |
| Board | How many directors there are and who appoints them |
| Consent rights | Decisions the company can’t make without the investor agreeing |
| Pre-emption | The right to buy new shares, and shares other shareholders sell, before anyone else |
| Drag-along and tag-along | How a sale of the whole company works when not every shareholder wants to sell |
| Founder shares | Vesting, leaver terms and what happens if a founder leaves |
| Warranties | Statements of fact the company and the founders give about the business |
| Information rights | The figures and reports the investor receives, and how often |
| Conditions | What has to happen before the money goes in, such as due diligence the investor is happy with |
| Exclusivity, costs and confidentiality | The binding clauses |
The clauses fall into three groups. Economic terms decide what the investor gets for their money. Control terms decide what the investor can decide or block. Founder terms are what’s asked of the founders personally.
Economic Terms
Valuation and amount. The term sheet states the amount being invested and the pre-money valuation, which is what the business is worth before the money goes in. The investor’s share is the amount invested divided by the post-money valuation, which is the pre-money valuation plus the investment. £1m invested at a £4m pre-money valuation gives a post-money valuation of £5m, and the investor owns 20%. How the founder arrives at the number is covered in startup valuation.
The option pool. Investors often want a pool of shares set aside for future staff. The term sheet says whether the pool is created before the investment, so it comes only out of the existing shareholders, or after it, so the investor’s shares are diluted by it too. Using the same £1m at £4m, with a 10% pool:
| Pool comes out of existing shareholders only | Pool comes out of everyone, investor included | |
|---|---|---|
| Investor | 20% | 18% |
| Option pool | 10% | 10% |
| Founders | 70% | 72% |
| Value of the founders’ shares at £5m | £3.5m | £3.6m |
When the pool comes out of the existing shareholders only, the founders’ shares are worth £3.5m. For the founders, the pre-money valuation is really £3.5m rather than the £4m on the term sheet. Pre-money vs post-money valuation works through this in more detail. The pool is normally sized to the hires in the plan, and a pool bigger than the plan needs takes more of the founders’ shares than it has to.
Liquidation preference. This sets the order of payment when the business is sold or wound up. With a 1x non-participating preference, the investor gets back either what they invested or their percentage of the sale, whichever is higher. With a participating preference, the investor gets their money back first and then their percentage of what’s left as well. A preference above 1x means a multiple of the money comes back first.
Say the investor put in £1m for 20% and the business is sold for £3m.
- With no preference, the investor gets 20% of £3m, which is £600,000, and the other shareholders share £2.4m.
- With a 1x non-participating preference, the investor takes their £1m back, because that’s more than £600,000, and the others share £2m.
- With a 1x participating preference, the investor takes £1m and then 20% of the remaining £2m, a total of £1.4m, and the others share £1.6m.
A participating preference still takes more on a bigger sale. At £20m, a non-participating investor takes their 20%, which is £4m. A participating investor takes £1m plus 20% of £19m, a total of £4.8m.
Preferences need preference shares, and that matters for UK raises that use tax relief. Under the SEIS rules, and the same applies under EIS, the investor’s shares have to be full-risk ordinary shares with no special rights to the company’s assets. In a round that mixes scheme investors and a fund, the scheme investors often hold ordinary shares and the fund holds preference shares, and a solicitor checks the share rights against the scheme rules before the shares are issued.
Anti-dilution. This protects the investor if the company later issues shares at a lower price than they paid, which is called a down round. The investor is given extra shares, or their shares convert at a better rate, to make up some of the difference.
A broad-based weighted average adjusts by how many cheaper shares are issued compared with all the shares in issue, so a small issue at a lower price makes a small adjustment. A full ratchet resets the investor’s price to the new lower price however few shares are issued, and the extra shares come out of the founders and the other shareholders. Equity dilution explains how each new issue changes everyone’s percentage.
Dividends. Some term sheets give preference shares a fixed dividend. A non-cumulative dividend is only paid if the board declares it. A cumulative dividend builds up every year it isn’t paid and is owed before ordinary shareholders get anything, which adds to what the investor takes on a sale.
Control Terms
A minority shareholding on its own gives an investor very little say over the business. So investors putting in large sums want rights on top of their shares, written into the shareholders’ agreement and the articles.
The board. The term sheet sets the size of the board and who appoints each director. An investor director takes part in every board decision. Some investors take an observer seat instead, which gives them the right to attend meetings and see board papers but no vote. Whoever holds the majority of board seats controls the decisions the board makes, whatever the shareholding.
Consent rights. These are also called investor consents, reserved matters or, in the US, protective provisions. They’re a list of things the company can’t do without the investor’s agreement, such as issuing new shares, changing the articles, selling the business, borrowing above a set amount, changing the business plan or paying dividends.
Consent over major decisions protects the investor’s money. When the list reaches into everyday operations, such as every hire or every contract above a small amount, the investor ends up signing off how the business is run.
Drag-along and tag-along. A buyer usually wants 100% of a company. A drag-along lets shareholders holding a set majority make the rest sell on the same terms, so a small holder can’t block a sale. A tag-along works the other way: if a majority holder sells, the minority can sell their shares on the same terms. With a drag-along, what matters is who can trigger it. If the investor’s shares alone meet the threshold, the investor can force a sale the founders don’t want.
Pre-emption rights. These give existing shareholders the right to buy new shares before anyone else, in proportion to what they already hold. UK company law gives shareholders this right on new shares under section 561 of the Companies Act 2006, but a private company can exclude or disapply it, so the term sheet and the articles set out how it works for that company. A separate right on transfers gives existing shareholders first refusal on shares another shareholder wants to sell.
Information rights. These set the management accounts, budgets and annual accounts the investor receives, and how soon after each month or year end. The reporting needs to be something the business can already produce on time.
Founder Terms
The investor is backing the people as much as the business, so some terms apply to the founders personally.
Vesting. Founder vesting, often called reverse vesting in the UK, means a founder can lose some of their existing shares if they leave within a set period. It protects the investor and the other founders from someone leaving early with a large stake while everyone else carries on building the business. The points to agree are the length of the period, any cliff before the first shares vest, credit for time the founder has already put in, and acceleration, where vesting speeds up if the company is sold.
Good and bad leaver. These decide what a departing founder is paid for the shares they have to give up. A good leaver is usually paid market value.
A bad leaver is usually paid the lower of market value and what they paid, which for founders is often close to nothing. A bad leaver definition limited to things like fraud, gross misconduct or breaking their restrictive covenants is a common position. A definition that treats any resignation, or a dismissal for any reason, as bad leaving puts a large part of the founder’s shares in the board’s hands.
Warranties. These are statements of fact about the business, such as that the accounts are accurate, there are no undisclosed disputes and the company owns its intellectual property. If one turns out to be untrue, the investor can claim. The founders list anything that would make a warranty untrue in a disclosure letter, and the term sheet normally caps how much the founders can be liable for. Uncapped warranties from the founders put their personal money at risk.
Restrictive covenants. These are promises not to compete with the business or poach its staff or customers for a period after leaving. They need to be reasonable in length and scope to be enforceable, so the term sheet sets the period.
What’s Market and What’s Aggressive
“Market” means the position most deals at that stage and in that country use. It shifts with the stage of the business, the sector and how much money investors have to put to work. These are the usual early-stage positions on each clause, set against the versions that go further:
| Clause | Usually treated as market | Usually treated as aggressive |
|---|---|---|
| Liquidation preference | 1x, non-participating | Participating, or more than 1x |
| Anti-dilution | Broad-based weighted average | Full ratchet |
| Option pool | Sized to the hires in the plan | Far bigger than the plan needs, all from existing shareholders |
| Board | Founders keep a majority at early stage, with one investor director | The investor controls the board from its first investment |
| Consent rights | Major decisions: new shares, the articles, a sale, large borrowing | Everyday decisions such as hires and routine contracts |
| Dividends | Non-cumulative, paid only if declared | Cumulative, adding to what’s owed on a sale |
| Founder vesting | Credit for time served, acceleration on a sale | Full re-vesting from day one, with no credit or acceleration |
| Bad leaver | Limited to fraud, misconduct or breach | Any resignation or dismissal |
| Warranties | Capped, with a disclosure letter | Uncapped personal liability |
| Exclusivity | A set period with an end date | Open-ended |
| Costs | Investor’s legal fees paid up to a cap | No cap |
A term that goes further than market isn’t automatically a reason to walk away. An investor backing a business with little to show yet is taking more risk and may want more protection for it, and a founder may agree a participating preference in return for a higher valuation. What each term does to the founder’s share of a sale, and to their control of the business, can be worked out in numbers on the cap table before anything is signed.
How Term Sheets Are Negotiated
Either side can draft the term sheet. In a round led by a venture fund, the lead investor usually sends it. On an angel round, the founder often sets the terms and puts them in the term sheet, and investors who want to come in sign up to them. When several investors come into the same round, they usually invest on the same terms, agreed with the lead.
Terms are traded against each other. A founder might accept a lower valuation in return for a non-participating preference, or a bigger option pool in return for keeping a board majority, because each clause changes the founder’s position in a different way. Interest from more than one investor gives the founder room to hold their terms, because an investor who knows others are ready to invest has less room to push.
Signing starts the exclusivity period, so the founder can’t talk to other investors until it ends. If the deal falls through at that point, the founder goes back to other investors having lost that time. A solicitor who handles investment rounds reads the term sheet before it’s signed, because the costs and exclusivity clauses bind the company from that day and every other clause becomes the basis of the legal documents.
How to prepare for a negotiation like this and run it is what I teach in the Negotiation Masterclass.
FAQs
What is a term sheet?
A term sheet is a short document setting out the main terms of an investment, such as the amount, the valuation and the investor’s rights, before the legal documents are drafted. Most of it isn’t legally binding.
Is a term sheet legally binding?
Mostly no. The investment terms aren’t binding, and either side can walk away until the legal documents are signed. Clauses on confidentiality, exclusivity, costs and governing law are usually binding from the day it’s signed.
Who writes the term sheet?
Either side can. In a round led by a venture fund, the lead investor usually sends it. On an angel round, the founder often sets the terms, and investors joining the round sign up to them.
Can an investor pull out after signing a term sheet?
Yes. Because the investment terms aren’t binding, an investor can walk away, for example if due diligence turns up something they weren’t told. The company is still bound by exclusivity for as long as it runs, and may have to pay the investor’s legal costs if the term sheet says so.
What’s the difference between a term sheet and a shareholders’ agreement?
A term sheet is the short, mostly non-binding summary of the deal. The shareholders’ agreement is one of the binding legal documents drafted from it, and it sets out in full how the company is run and the rights each shareholder has.
Next read
If you’re raising and want it run properly, from making the business investable to getting in front of the right investors, that’s what Capital Raiser does. If you’re earlier than that, join Capital Catalyst for free and learn how every type of funding works before you take any of it.
This is general information on how term sheets work and isn’t legal advice. A solicitor who handles investment rounds should review a term sheet before it’s signed.
