Term Sheets: What They Are, Key Clauses and What to Watch Out For

What Is a Term Sheet?

A term sheet is a non-binding document that outlines the proposed terms and conditions of an investment deal. It is typically issued by a lead investor after initial agreement in principle and before the full legal documentation is prepared.

While term sheets are generally non-binding, certain provisions — such as confidentiality and exclusivity — are legally binding. The term sheet sets the framework for the lawyers to draft the final investment agreement.

Key Sections of a Term Sheet

Valuation and investment amount: Sets the pre-money valuation, the amount being invested, and the post-money valuation. This determines the investor's ownership percentage.

Type of security: Most VC investments use preferred shares (preference shares in the UK) rather than ordinary shares. Preferred shares carry additional rights not given to ordinary shareholders.

Liquidation preference: Specifies how proceeds are distributed in a sale or wind-down. A 1x non-participating liquidation preference means investors get their money back first; a participating preference means they get their money back AND share in remaining proceeds.

Anti-dilution protection: Protects investors if the company raises at a lower valuation (a down round). Full ratchet anti-dilution is the most investor-friendly; weighted average is more founder-friendly and more common.

Board composition: Specifies how many board seats the investor receives. Most Series A deals result in a 2-1-2 board (2 founders, 1 independent, 2 investors) or a 2-1-1 structure.

Pro-rata rights: The right to participate in future funding rounds to maintain ownership percentage. Standard in most VC deals.

Information rights: The investor's right to receive monthly/quarterly management accounts, annual audited accounts, and annual budgets.

Founder-Friendly vs Investor-Friendly Terms

Participating vs non-participating preference: Non-participating is standard at seed and Series A in Europe. Participating (also called "double dip") is more investor-friendly and reduces founder returns in a sale.

Drag-along rights: Allow a majority shareholder to force minority shareholders to accept a sale offer on the same terms. Usually investor-friendly but necessary for deal execution.

Tag-along rights: Allow minority shareholders to participate in a sale on the same terms as the majority. Protects founders and early employees.

Vesting provisions: Founder vesting is standard — typically 4 years with a 1-year cliff. Reverse vesting means the company can buy back unvested shares if a founder leaves.

Exclusivity and Confidentiality

Most term sheets include an exclusivity clause (typically 30–60 days) preventing the company from negotiating with other investors while due diligence is completed. This clause is binding.

Confidentiality clauses are also binding and prevent both parties from disclosing the terms to third parties without consent.

What to Negotiate

Not all term sheet clauses are equally important. Founders should focus on: valuation, liquidation preference structure (participating vs non-participating), board composition, and founder vesting. Secondary terms like information rights and pro-rata are fairly standard and rarely worth fighting over.

Getting experienced legal advice before signing a term sheet is strongly recommended — even though it is non-binding, it sets expectations that are difficult to change later.

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