Term Sheet

A Term Sheet is a non-binding document that outlines the key terms and conditions of a business agreement or investment. Think of it as the blueprint for a deal. Before architects, builders, and electricians spend months building a house, they all agree on the blueprint. Similarly, before investors and entrepreneurs spend a fortune on lawyers to draft hundreds of pages of binding contracts, they first sketch out the most important points in a term sheet. This preliminary handshake-on-paper ensures everyone is on the same page regarding the major issues, like price, ownership, and control. While most of a term sheet is based on good faith, certain clauses, such as confidentiality and 'no-shop' agreements (which prevent the company from seeking other offers for a set period), are typically made legally binding. It's the essential first step in turning a conversation into a formal investment.

The primary purpose of a term sheet is efficiency. It allows all parties to agree on the critical aspects of a deal upfront, saving immense time and money that would otherwise be wasted negotiating fine-print legal details only to discover a fundamental disagreement later on. For an investor, it's the first tangible piece of a potential investment. For a company founder, it’s the first real validation of their business from an outside party. Finalizing a term sheet is a major milestone. It signals that both sides are serious and moves the process into the next stage: formal Due Diligence and the drafting of definitive legal documents. While it's often compared to a Letter of Intent (LOI) or a Memorandum of Understanding (MOU), a term sheet is most commonly associated with Venture Capital and private equity financing rounds.

A term sheet is typically organized into three main categories: the economics of the deal, the rights that protect the investor, and the terms that govern control of the company.

This section is all about the money—who is putting in how much, and what they get for it.

• Valuation: This is the headline number. The term sheet will specify the company's Pre-Money Valuation (its worth before the investment) and its Post-Money Valuation (its worth after the investment is added). For example, a $1 million investment into a company with a $4 million pre-money valuation results in a $5 million post-money valuation.
• Investment Amount: The total cash being invested in the company in this financing round.
• Price Per Share: Based on the valuation, this defines the price the investor pays for each share of stock.
• Option Pool: The term sheet often requires the company to set aside a certain percentage of its equity (an “option pool”) to hire and retain future employees. This pool is usually created before the new investment, which dilutes the founders' stake, not the new investors'.
• Capitalization Table: The sheet includes a summary Capitalization Table (or 'cap table') showing who owns what percentage of the company before and after the financing is complete.

Investors are putting capital at risk, and they use the term sheet to build in some safety features.

• Liquidation Preference: This is one of the most important terms. It dictates who gets their money back first if the company is sold or liquidated. A '1x' preference, for instance, means investors get their original investment back before any other shareholders (like founders or employees) see a penny. More aggressive terms (like 2x or 3x) can be a red flag.
• Anti-Dilution Provisions: These clauses protect investors from Dilution if the company later sells shares at a lower price than they paid. This protection, known as Anti-Dilution, ensures their ownership stake isn't unfairly devalued by a future “down round.”
• Protective Provisions (Veto Rights): These give investors veto power over major corporate decisions, even if they don't have a majority of the shares. These decisions might include selling the company, changing the size of the Board of Directors, or taking on significant debt.

This section outlines how the company will be run and who has a say.

• Board of Directors: The term sheet specifies the composition of the board post-investment, often granting the lead investor a board seat.
• Drag-Along Rights: A provision that allows a majority of shareholders to force minority shareholders to agree to a sale of the company. This prevents a small number of holdouts from blocking a good acquisition offer.
• Tag-Along Rights: This protects minority shareholders. If a majority shareholder sells their stake, Tag-Along Rights allow minority investors to “tag along” and sell their shares on the same terms.

For a value investor, a term sheet is more than just a list of financial terms; it's a window into the character and alignment of all parties. While getting a good valuation is important, the true goal is to structure a partnership built for long-term success. An overly aggressive term sheet, loaded with punitive terms like a high Liquidation Preference multiple or harsh anti-dilution clauses, should be viewed with caution. It might indicate that the investor is focused solely on downside protection rather than fostering upside growth, or that the founders are desperate. A fair term sheet, on the other hand, aligns the interests of both the investors and the founders. It ensures that everyone is motivated to work together to grow the value of the business for all shareholders. The best deals aren't about winning a negotiation; they're about starting a healthy, long-term partnership. The term sheet is the foundation of that relationship.