Term Sheet
A non-binding (with limited binding provisions) preliminary agreement outlining the principal economic and governance terms of a proposed financing or transaction. Term sheets in VC financings typically include valuation, investment amount, security type, liquidation preference, anti-dilution, voting and protective provisions, board composition, and key closing conditions. While generally non-binding as to deal completion, term sheets typically have binding exclusivity, confidentiality, and expense provisions.
A Term Sheet is a non-binding (with limited binding provisions) preliminary agreement outlining the principal economic and governance terms of a proposed financing or transaction. Term sheets are foundational to deal-making practice, they capture the parties' agreement on key terms before substantial diligence and definitive documentation. In venture capital and growth equity, term sheets typically include valuation, investment amount, security type, liquidation preference, anti-dilution, voting and protective provisions, board composition, and key closing conditions.
Standard term sheet components
Comprehensive VC term sheets typically include: (1) economic terms, investment amount, pre-money valuation, security type (typically Series Preferred); (2) liquidation preference; (3) dividend preference; (4) anti-dilution; (5) voting rights; (6) protective provisions; (7) board composition, investor designees, independent directors; (8) information rights; (9) registration rights; (10) pro rata rights; (11) right of first refusal/co-sale; (12) drag-along; (13) founder vesting; (14) option pool, pre-money or post-money expansion; (15) conditions to closing; (16) no-shop / exclusivity; (17) expenses; (18) confidentiality.
Binding vs. non-binding provisions
Term sheets typically distinguish: (1) non-binding provisions, economic and governance terms; subject to definitive documentation; either party can generally walk away if the document clearly states these terms are not binding; (2) binding provisions, typically: (a) exclusivity / no-shop, issuer cannot solicit competing offers for stated period (typically 30-60 days); (b) confidentiality, terms and discussions remain confidential; (c) expenses, who bears legal/diligence costs; (d) governing law; (e) termination. Clear identification of which provisions are binding vs. non-binding is critical to avoid disputes.
The pre-money valuation negotiation
Pre-money valuation is typically the most negotiated term sheet item. Calculation: (1) pre-money valuation + investment amount = post-money valuation; (2) investor ownership = investment / post-money. Example: $5M investment at $20M pre-money = 20% ownership ($25M post-money). Sophisticated terms: (a) option pool inclusion, pre-money or post-money, substantially affects effective valuation; (b) SAFE/note conversion, typically converts at lower of cap or financing price, affecting cap table; (c) fully diluted vs. issued shares for valuation purposes.
Option pool (the "shuffle")
Option pool sizing and timing is heavily negotiated: (1) pre-money option pool, pool created before investment dilutes existing stockholders only; investor-favorable; (2) post-money option pool, pool created after investment dilutes both existing stockholders and new investor; founder-favorable; (3) top-up, adding shares to existing pool to reach target percentage; analytical framework matters substantially. Pool sizing affects effective valuation, a larger pre-money pool means lower effective valuation for founders.
The drag-along right
Drag-along rights compel common stockholders to participate in sale of company approved by specified threshold of preferred holders (and sometimes board). Standard provisions: (1) triggering threshold, typically majority of preferred or board+majority preferred approval; (2) terms, same terms as the selling holders who triggered the drag-along, with appropriate adjustments for liquidation preference; (3) limitations, minimum sale price, cap on liability for representations, indemnification limits. Drag-along provides liquidity by ensuring all stockholders participate in qualifying sales.
Exclusivity / no-shop
Exclusivity provisions prevent issuer from soliciting or accepting competing offers during stated period: (1) scope, what discussions are prohibited; (2) duration, typically 30-60 days; (3) termination, automatic at expiration unless extended; (4) limitations, typically permits responding to unsolicited offers with notice. Exclusivity is critical for investors investing in diligence and legal costs; without exclusivity, issuers might use term sheets to generate competing offers. Standard provision in venture term sheets.
Term sheet timeline
Standard term sheet to closing timeline: (1) term sheet execution, week 0; (2) diligence and documentation, weeks 1-6; (3) definitive agreement signing, week 6-8; (4) closing, typically simultaneous with signing or shortly thereafter. Total timeline: typically 6-10 weeks from term sheet to closing for typical Series A.
Letter of intent vs. term sheet
"Term sheet" is the standard term for VC and growth equity preliminary agreements; "Letter of Intent" (LOI) is the parallel term for M&A. Functional differences are minimal, both are preliminary agreements with similar binding/non-binding structure. M&A LOIs may emphasize structure (asset vs. stock purchase), purchase price mechanism (cash, stock, earn-out), and indemnification framework. See Letter of Intent.
The NVCA model term sheet is a common starting point for Series A and later rounds. Liquidation preferences and the timing of option pool expansion can shift founder economics substantially, and a cap table model run before signing shows the effect. Any binding provisions, including an exclusivity period, take effect when the term sheet is signed.