Term Sheets Demystified
Why they exist and the two things that matter the most to a negotiation.
đ€ Is the legal language in your term sheet a mystery? You can now navigate legal terms with ease by using Term Sheet Wiki. Itâs an app I spun up to help founders and investors navigate term sheets like a pro. Get in touch if you have any feedback!
Most venture deals and investment offers start with a term sheet. Small angel rounds sometimes skip this step and go straight to the final investment documents prepared by the companyâs lawyers. However, almost all institutional investors use a term sheet to formalise an investment offer.
Whatâs a term sheet?
A term sheet is a short document that summarises the key terms of an investment offer. It can be as short as one page (see this example of a YC Series A Term Sheet) or as long as a dozen pages or more.Â
Term sheets are usually not legally binding, except for a few clauses like confidentiality and exclusivity periods. The binding elements are always explicitly described. Although both parties to a term sheet can walk away from the non-binding elements without legal consequences, you canât ignore the reputational impact of abandoning a deal without good reason.
Whatâs the purpose of a term sheet?
A venture capital ecosystem without term sheets would have longer investment processes and higher legal costs. Why? If you donât agree upfront on the most important terms of a deal, you risk spending more time disagreeing about points that could have been resolved earlier.
This is why investors use a term sheet. Itâs an early checkpoint that outlines the key terms and conditions of a deal. It provides a framework for drafting the final long-form investment documents. These include the shareholdersâ (or stockholdersâ) agreement, the share subscription agreement (also known as the stock purchase agreement), and articles of association (or Bylaws in the USA).
As long as a term sheet covers the most critical points of a deal, negotiating the final long-form documents should be more efficient than attempting to close an investment without any blueprint.
What are the key terms?
Economics and control are the two most important subjectsâthe âonly two things that VCs really care about when making investments,â according to Brad Feld and Jason Mendelson in their bestselling book Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist.
Term sheets will therefore always have the following:
Economics
Investment amount: The total amount of money that a VC will invest.
Valuation: The companyâs worth before investment.
Share class: The specific type of shares that an investor will get.
Liquidation preference: An economic structure that means an investor can get their money back ahead of other lower-ranked shareholders. (See my earlier post about this.)
Control
Board matters: Who the board directors will be and how many seats the investor can appoint.
Investor consents: Specific company decisions that require an investorâs consent.
Conversion rights: How and when preferred shares can convert into ordinary (or common) shares.
Youâll find lots of other legal clauses but most term sheet negotiations ultimately come down to economics and control.
Where to learn more?
Check out the Y Combinator Series A term sheet template, the British Venture Capital Associationsâ guide, Brad and Jasonâs book, or my term sheet wiki tool below.