What Is Actually in a Term Sheet and Why Should I Use One?
A term sheet is a short summary of the terms two parties plan to put into a deal. Terms sheet can be used in any deal where the parties are close to an agreement, but not have not hashed out the contract yet.They are typically non-binding, although not always. In the context of this article, we’ll be talking about terms sheets between investors and founders.
This picks up where our primer on SAFEs, convertible notes, and priced rounds left off. That post covered the instruments you raise with. This one is about the initial document, how to read it, and how to use it. A priced round has the most moving parts, so most of the examples come from one. The same thinking works on a SAFE or a note, there just tends to be fewer terms.
Most of it is non-binding. Some of it is not.
A term sheet is not the deal. It is a summary of the deal the parties mean to sign later. Almost all of it is non-binding, and signing it does not lock anyone into closing.
The exceptions are the part to slow down on. Exclusivity, sometimes called a no-shop, stops you from talking to other investors for a set window. Confidentiality stops you from repeating the terms. There may be a line on who eats the legal fees if the deal falls apart. Those bind you the day you sign. Binding term sheets are rare, and should be discussed with counsel if you encounter one.
The money
Two numbers set the economics: how much is being invested and the valuation. One means little without the other, because together they decide how much of your company the investor ends up owning.
On valuation, learn two words. Pre-money is what the company is worth before the check lands. Post-money is that plus the new money. Your slice after the round runs off the post-money figure, so a valuation with no label attached tells you close to nothing. The term sheet ought to specify.
The option pool changes your real price, and not in your favor. Investors usually want a pool of shares set aside for future hires, and they usually want it carved out of the pre-money valuation. That pool dilutes you, not them. Same headline number, bigger pool, lower real price for the founders. Do that math before you shake on anything.
The liquidation preference decides who gets paid first if the company sells. A one time non-participating preference means the investor takes their money back, then converts to common and shares the rest by ownership. That is standard and generally fair. Two versions are not your friend: a multiple over one times, and participating preferred, which lets the investor take their money back and then share in what is left on top of that. Know which one you are being handed.
Who runs the company
The money is half the term sheet. These terms decide who runs the company.
Board composition is who holds the seats. An investor seat is normal. A board that flips to investor control is a different company than the one you woke up owning. Count the seats and know who picks each one.
Protective provisions are the investor's veto list. Sell the company, raise another round, change the charter, take on real debt, and you need their sign-off. Some of that is standard. The question is how long the list runs and how low the triggers sit.
Voting thresholds set how much of the preferred has to agree before those vetoes and future changes go through. A high threshold keeps one investor from blocking everything. A low one hands that investor leverage.
The rights that stick around
Some terms are not one-time events. They ride along with the investor into every round after this one. Pro rata rights let them buy in later to hold their percentage. Information rights mean you send financials on a schedule. A right of first refusal and co-sale right shape what happens when anyone tries to sell shares down the line. None of it is unusual. Just know it is there, because you live with it for years.
Two terms worth reading twice
Anti-dilution protection adjusts the investor's price if you later raise at a lower valuation. The fair, standard version is broad-based weighted average, which cushions the hit in proportion. The one to push back on is full ratchet, which resets the investor's price all the way down to the new low, no matter how few shares sold there. Full ratchet can move a big piece of the company in one bad round.
The option pool is the other one. Growing it before the money goes in lowers your effective valuation, even when the headline number holds or climbs. If an investor bumps the valuation and enlarges the pool in the same breath, run your real post-money ownership before you celebrate.
What a term sheet is for
The point of a term sheet is timing. You argue out valuation, board seats, and preferences on two or three pages, before anyone runs up a bill drafting forty pages of final agreements. By the time counsel opens the stock purchase agreement, the hard calls are already made. That is cheaper and faster than fighting over the same points inside the definitive documents, where one change moves five others.
A signed term sheet does two more things. It shows both sides are serious, which is why investors trade exclusivity for it. And it sets a clock everyone closes against. Handled right, it is the cheapest, lowest-risk stage of the whole financing to get the deal right.
Term sheets on a SAFE round
Raising on a SAFE? This still applies, there are just fewer negotiated terms…. usually. A side letter can easily complicate the deal.
A SAFE is short, but it does not fill itself in. The terms that get decided are the valuation cap, the discount, whether there is a most-favored-nation clause, and whether the investor gets a pro rata side letter. Settle those up front, even in a one-page term sheet or a plain email, and you have done the same work. A SAFE writes down a deal. It does not make one for you.
How we price this
We price SAFE and financing work differently depending on whether you show up with a signed term sheet.
When you have the basic terms of the deal hashed out, our job is to paper the agreed deal and close it. Defined scope, short road, lower quote.
No term sheet, and the scope is wide open. We’ve seen this time and time again. Client tells us that everyone is in agreement, we draft up the agreement, and the counter-party now wants to change the terms. Now we are negotiating and advising against terms that are still moving, usually across rounds of back-and-forth with the other side. More hours, and more chance the deal shifts or stalls halfway. Open scope costs more than defined scope. That is true of most legal work and truer of financings. We bill hourly for this work for two reasons: first, it allows us to charge a lower flat fee for deals that are already mostly negotiated; second, it keeps costs down for those deals that don’t actually close. Better to walk away having paid some percentage of the anticipated cost, rather than pay a flat fee for a deal that never completed.
The useful part for a founder watching the budget is this. A term sheet is one of the cheapest ways to bring your own legal bill down. Settle the deal points between the principals first, in a document that costs almost nothing to produce, and the expensive stage that follows gets shorter.
Read it before you sign, even when it says non-binding
Non-binding is not a reason to sign blind. The binding clauses can lock you out of the market for weeks. The non-binding ones set the anchor for everything after. Once you sign, you negotiate away from those terms, not toward them. A short review up front beats clawing back a term you gave away on page two.
TL/DR
The amount invested and the valuation set the economics, but read pre versus post-money and the option pool together to find your real price. Read the liquidation preference, board composition, protective provisions, and anti-dilution terms to learn who runs the company and who gets paid first. Most of a term sheet is non-binding, except exclusivity and confidentiality, and its real value is settling the deal on cheap paper before anyone pays to draft the final documents. Same logic on a SAFE round, where the cap, discount, MFN, and pro rata terms are what you nail down. Because a signed term sheet defines the scope of the work, we price SAFE and financing engagements lower when you have one and higher when the terms are still open. Read it before you sign, even when it says non-binding.
This post is general information, not legal advice, and does not create an attorney-client relationship. Financing terms are deal-specific, vary by jurisdiction, and change. Talk to counsel about your situation.