The Ultimate Guide to Startup Term Sheets

The term sheet is a concise, usually non-binding agreement that outlines all major terms of a funding round or exit. It is the first step of formal deal negotiations and it can be initiated by either party: the company, the lead investor or a group of investors. Key terms are the valuation and all value drivers, but also the special rights of investors and basic deal closing procedures.

Due to the non-binding nature of most term sheets, they come in all shapes and forms. They should always be seen in context to your specific negotiation. The goal of a term sheet is to find consensus on the main terms of a transaction. That’s it. In fact you might not even bother to sign it because, well, its not binding anyways.

Afterwards, still follow substantial part of especially the non-commercial side of the due diligence process. That is followed by drafting of the binding deal agreements and fulfilling all administrative deal requirements. While a term sheet is between 1 and 10 pages, the final deal agreement will be closer to 30-50 pages plus all the approvals and resolutions. This work will require some negotiation around the details, hence you should always keep timing in mind. Drafting your term sheet is only the first step of making a deal happen!

The Purpose of Term Sheets in a Startup Deal Closing

A fund raise or sale of a startup usually follows in a few predictable stages. They can be outlined as follows:

Pitch
Term Sheet
Due Diligence
Drafting of Binding Deal Agreements
Completion (= signing and fulfilling all agreed prerequisites)

The entire process usually takes 3-9 months and speed depends on a host of factors. How professional or bureaucratic are all parties? Do sudden changes happen to the business, the market or the economy? Any unforeseen management changes on the investor side (especially if you are dealing with large strategic investors)? So one major factor to get any deal done is TIME.

One should always keep in mind how fast time goes by in deal negotiations. Even if you are running the hottest new startup, dealing with the most well regarded investors, there is always something unexpected coming up and at some point your deal falls through and you are left without runway.

Hence the term sheet! The term sheet really does build a bridge from pitch to deal closing. Its not binding and its terms might receive some polishing before deal completion, but it signals commitment. It does get you a great deal closer to signature-ready final deal agreements. For that reason always keep its true purpose in mind. If you can’t agree on something less important fast, maybe just postpone that discussion for the deal agreement drafting phase. Or, if you know the other side will flip-flop, be a bit more precise with your wordings upfront.

But never forget: Until you got money on your bank account everything can fall through.

What comes after the Term Sheet?

As mentioned, the term sheet is a bridge between pitch and deal closing. After the term sheet comes drafting the final deal agreements.

So what deal agreements are we actually talking about? Well depending on jurisdiction (and habits of your lawyer) the agreements would look like something below:

Deal Agreements of a Fund Raise:

Shareholders agreement (either new or as a deed of amendment to the old one, if existent)
Share subscription agreement (may be combined with the shareholders agreement)
Approvals (agreements for director and each shareholders based on existing voting rights)
Documentation needed in regards to Conditions Precedent (if applicable)

Deal Agreements of a Company Sale/Exit:

Share Purchase Agreement
Approvals (usually for all director and shareholder approvals, either combined or by individual party)
Documentation needed in regards to Conditions Precedent (if applicable)

Just looking at the lists of documents required, its obvious these documents will take much longer to produce than a term sheet. Hence again the need to watch the time. Also just to populate all these with the right names and sending them to the signing parties, takes a considerable amount of time.

Main Terms of a Startup Term Sheet

The term sheet as mentioned can be between 1-10 pages depending on your various parties’ preferences and negotiation styles. Even a confidentiality clause can take up half a page, if you care about the details. Style wise, either you format everything into paragraphs or go with the also quite common table format. Both is fine, just keep the audience in mind. The term sheet definitely is going to be read by the decision makers while the final agreements are more closely read by the lawyers. Your investor might be some wealthy individual who is doing her first investment and isn’t too familiar with startup term sheets. In that case readability helps a lot. This is why there is a trend to short, to the point term sheets. A table format can definitely help with that.

Below is a detailed list of the main sections of a term sheet. More detailed explanations on the most important and complex sections can be found here.

Investors

This sections lists out the investors by name and their investment amount. This can be rounded, but ideally you calculate the exact investment amount determined by share price. If for example your valuation renders a calculated share price of US$333 and an investor is about to invest US$100,000 then you can either write that or 301 shares amounting to US$100,233.

If you are still in the process of closing the investment, you can also build-in closing stages. For example you can raise US$500k of which US$350k are already allocated to specific investors, and a further US$150k will be open for purchase for lets say 12 weeks after completion. Then you would add a brief sentence about the additional pool of US$150k and mentioning the 12 week timeline here.

Investee Company

As even young startups can consist of multiple legal entities it is important to name the entity that your investors will be investing in. This paragraph can also mention that this specific entity is the sole owner of all group companies, trademarks and IP for further clarity.

Securities to be Issued

Since there are usually multiple share classes in a funded startup it makes sense to give the new shares a name here and state whether these will be ordinary or preferred shares.

In most jurisdictions ordinary shares will have rights pre-determined by law and preferred shares will have rights that are significantly contract based. Likely a fund raise will be for preference shares and you would name them Angel A, B, C.. for angel rounds or Series A, B, C,… for VC rounds.

Capitalization

The capitalization section defines the composition before and after the fund raise.

People tend to say things like “I am raising US$5m at a US$20m valuation.” That sounds impressive, but what does it actually mean? Is your company worth US$20m with or without the US$5m and what about existing shareholders and debt providers? How much do they own?

The capitalization section hence needs to clarify whether the valuation named is pre- or post money, whether there will be a Employee Stock Option Pool (ESOP), what happens to convertible debt and outstanding options.

Usually everything pre-existing will count towards the pre-money valuation and that US$20m valuation that the founder above was bragging about was likely post-money. Hence all outstanding and to be outstanding shares just before deal completion will represent US$15m then.

Please read in our tip section below, why as a founder or existing shareholder you should use pre-money valuation and write out the actual per share price here.

Price per Share/Valuation

In addition to the capitalization section, the price per share/valuation part actually mentions the dollar amount. So here you would say something like US$15m pre-money or US$500 per share. Again its better for you if you use pre-money valuations in the term sheet, because if you happen to later on increase the round due to investor demand, at least your pre-money valuation and share price don’t go down. Investors will of course start with post-money valuations if they send you term sheets.

Also this section could be grouped with the capitalization section under one heading to shorten things a bit.

Closing

The closing paragraph sets out the targeted deal closing deadline. Again, none of this is binding, but the name of the game is keep all players moving and focused. A deadline like this can certainly help making progress, especially with employee investors of larger funds and strategic investors.

Use of Proceeds

This section loosely defines the purpose of the investment round. If your investor doesn’t require detail keep this short! Its hard to enforce in real life anyways.

If the want detail, this could mention a few summarized growth initiatives planned with the funds. It could also be relating to developing new products or exploring new revenue streams. And one might define some metric targets for certain milestones.

Right of First Refusal

The Right of First Refusal (ROFR) entitles its holder to have a first say on a share sale. For example if the company has a Right of First Refusal and one of its shareholders found a buyer for her shares, then the company has the right to buy those shares at the conditions negotiated with that original buyer.

It usually is a right to the company, which enables the surviving company to purchase shares of founders should they be able to sell their shares in a private transaction. But it can also be to investors and to founders themselves. In each case it is a protection that the shares of a startup don’t spread too thinly and its fund raising potential isn’t diminished by too many secondary share sales. Of course, whether this right is actionable depends on whether the right holder has the cash to execute it.

We cover the ROFR in much greater detail here.

Tag Along

The Tag Along right is the right to “tag-along” on a share sale of an individual shareholder. In a startup fund raise, investors will usually get tag along rights to significant share sales of a founder. That means they can sell a part of their shares when a founder wants to sell their shares on a pro-rata basis.

It provides for a safeguard and means of liquidity as the investor will likely have specifically invested in the founding team, not just the business idea. It is also a protection against not being able to participate in a majority sale of the company, if the founders own the majority of shares.

We cover the tag-along in much greater detail here.

Drag Along

The Drag-Along is a right for a group of shareholders to force the rest of shareholders to sell the entire company. Typically this right is awarded to the majority shareholders so that minority shareholders can’t block exits or take negotiations hostage. Think of it this way, when ever you need 100% consent from many parties, any small minority could block or at least stall a negotiation.

Typically it is a right to the majority shareholder, but of course can be separately defined to be held by founders and/or sub-groups of investors.

We cover the drag-along in much greater detail here.

Anti-Dilution Rights

Anti-dilution rights provide for a price adjustment, if subsequent funding rounds are raised at a lower share price. This price adjustment is achieved by issuance of additional shares and is usually based on a weighted-average ratio. That means the amount of shares to be price adjusted and the amount of new shares issued will be weighted against price differentials to determine how many new shares are to be distributed.

Pre-emptive rights

Pre-emptive rights allow their older to buy further shares at future share issuances. For example, if the company issues new shares in the next fund raise, the current round investors could have a right to participate. This works as a protective measure, but also as an incentive. Early stage investors are protected from dilution by being able to participate in future rounds and they also get to participate more in the growing company.

Due to their nature, pre-emptive rights, the right of first refusal and the tag-along can be structured interchangeably and especially the protective parts (participation in future share issuances) can even be grouped under anti-dilution protections.

Conversion

The conversion paragraph hence sets out at what formula preferred shares convert into ordinary shares and under what condition.

Per definition shares issued in a professional fund raise will be preferred shares, meaning a different class of shares than ordinary shares. Latest on exit or in an IPO these will likely convert into ordinary, eliminating their special rights. In addition certain rights, such as the liquidation preference clause require the investor to have the right to convert into ordinary shares.

Registration Rights

Registration rights allow investors to participate in share sales where the sold shares need to be registered with securities regulatory authorities such as an IPO. To be publicly traded, stock exchanges usually require shares to be registered with their governing body. This right forces the company to not forgo preferred shares while they are creating liquidity for ordinary shares (or other preferred share classes). Given that its customary and non-controversial this paragraph can be usually kept short in the term sheet.

Liquidation Preference

Liquidation Preference entitles its holder to receive a payout ahead of other shareholders in a liquidation scenario. This can be for the initial investment amount or at a profit. Its a protective measure so that an investor gets at least her investment back, but can also be hugely beneficial providing returns far greater than regular share returns depending on the terms.

In its most vanilla version it comes as non-participating liquidation preference. That means these preferred shares only get their original money back. To benefit from share returns beyond the original investment, their holder need to convert them into ordinary shares. So the benefit is really in the more negative spectrum of exit scenarios.

The liquidation preference can become much more attractive, and even egregious, by adding multiples to the liquidation preference (e.g. 2x return on investment) or by making them participate (e.g. initial investment plus pro-rata participation on remaining funds as if converted) or by adding a guaranteed dividend return on top.

While the protective aspect is understandable and fairly customary, founders should put high emphasize on this clause in their negotiations as few other aspects of a term sheet can be as detrimental as the liquidation preference. You should definitely make sure you fully understand the consequences of the wordings, and calculate specific scenarios. This should be a protective clause, and not drive a huge value into the pockets of investors.

For early stage investments a common liquidation preference would be a 1x non-participating liquidation preference, which also considers declared but unpaid dividends.

Voting Rights

As preferred shares have various adjustments to their specific rights which differ from ordinary shares, so can also voting rights differ. Typical would be that each preferred share will vote together with ordinary shares on an as-if converted basis. Provided that the conversion rights state that the shares convert on a 1:1 basis, that means all shares generally vote equally. That means one share, one vote. While there shouldn’t be many deviations from this in practice, making it a less significant clause for negotiations, one still must read it carefully to ensure that this is actually the case.

Information Rights

Shareholders, depending on jurisdiction, do have certain rights to information. That said they are not (necessarily) directors, nor are they employees or even founders and naturally can’t have the same level of information at all times.

The information rights section specifies how much information to give shareholders and at what time. Think of how frequently to provide financial statements, user metrics, cash budgets or business plans and specifically what detail level should go into these. Depending on the stage of the company and track record of founders, the detail level might vary as more or less control is needed. Generally speaking, as a founder you should not grant too extensive information rights as all of this takes time. Finishing your account statements every single month on time will not be all that easy, especially if your company is at a very early stage. You should be growing your business instead of discussing metrics with 5 (or sometimes way more) individual angels every month.

A healthy balance is key. First set out healthy information provision rules. For accounting data you may focus on audited year end accounts and quarterly unaudited accounts. And for metrics it gets a bit more flexible. If your systems allow for highly accurate and automatic non-financial metric reporting, well you can offer monthly automatic reports being sent around. Still, it opens the door for (especially inexperienced angels) to panic every time there is a little dip in the numbers. So if you can get away with lean reporting, quarterly is way more convenient for the company and founders.

Another way to limit excessive communication over your performance is to allow only larger investors the full information rights. That could be limited by investment amount (e.g. US$1m or more) or by shareholding (e.g. >5%). That way the people with significant voting power will be in the know and you get to focus more on growing the company.

Protective Provisions/Vetoes

Protective Provisions are a set of voting rules that give the investors special veto powers over key business decisions. These prevent the founders and the management from suddenly changing the course of the business, the overall voting rights or diluting any existing shareholders through new unapproved fund raises.

As investors usually will hold a minority position, regular majority votes can only be used for the direction of the company, but not for protective measures. Special veto arrangements are put in place, to safeguard major operational or company structure changes. While these are usually well understood in the industry and not a huge negotiation issue, they are detailed.

Head over to our dedicated post on the topic for more detailed examples and explanations here.

Employee Stock Option Pool (ESOP)

An Employee Stock Option Pool (ESOP) is the main way for giving startup equity to employees.

Unless your employees joined you so early, there was no formal investment in your business, giving away ordinary shares has a taxable value. For example they might be counted as remuneration for employment and become taxable for personal income tax. Awarding shares is instantly taxable, while options are taxable when exercised. Hence giving someone 5% of highly illiquid startup stock valued at US$1m could increase their personal taxable income by US$50k that year without maybe ever getting that money in cash.

The ESOP is a pre-specified option pool that will be given out to employees as an incentive to hire and retain them. It does require the setup of its own legal agreements and the discussion of formulas to figure out who gets what.

For the term sheet the most important part is how large the pool will be. Common is 5 to 15% of all outstanding shares at the time of the fund raise. As a founder you should try to keep that number low and the reason for that is this excellent article on the option pool shuffle. In essence, untaken options, reduce the overall outstanding share count. Since the pool was created out of pre-money shares (founders and old investors), it benefits new investors. Thus new investors have an incentive to keep the pool as large as possible, while founders and old investors typically don’t.

Exclusivity

Exclusivity is a double-edged sword. Its definitely understandable that an investor who puts significant money and time in the due diligence of your business and negotiating with you wants some guarantee to be able to actually get the deal. However most startups have a limited runway to close their next funding. That means you don’t have the time to go through 2 or 3 consecutive exclusivity periods. As such, if you agree to it, you should try to limit it as best as you can and it should be focused on the time between term sheet and signing of the binding agreements. 1-2 months can be considered here. More than that can seriously risk your ability to close. It might even enable your investor to down negotiate you at end since they know you legally can’t take anyone else’s money anymore.

Confidentiality

Confidentiality is a must-have clause that however can be kept short. Obviously both sides do not want deal terms to be disseminated. Be careful however to actually adhere to it. Founders might get carried away boasting about their impending deal. In a subsequent dispute situation this could be the first area of technical breach of contract your investor might pin point.

Legal Counsel & Expenses

Every significant fund raise should be executed with an experienced lawyer engaged and that costs money. Also, there maybe additional fees such as company secretarial services regarding share transfers and such. The legal counsel and expenses section sets out whether this expense goes to the company or all parties equally or specific parties.

It is quite common that the company has to pay for the deal agreements, while all shareholding parties pay for their own advisers. In smaller rounds (US$100k – US$1m) investors might rely on the professionalism of the party drafting the agreements and their own skill reading the final documents. Once Series A/VC level is reached, the funds may employ their own in-house lawyers or external firms to further evaluate the agreements as the drafting lawyers will usually be leaning their bias towards the party directly employing them. This is even more true when it comes to exits where a transaction becomes even more significant as now liabilities are taken over by the buyer and the deal value gets much larger. Here the buyer might be drafting the agreements and the company is reviewing.

At any stage you would want to employ a law firm that is able to support your level of deal. That of course means ever increasing legal fees. If you are just receiving US$50k from your uncle, by all means take a template convertible note or SAFE agreement from a decent source online and don’t waste money on legal fees. For an angel round you should probably ask around for a decent small or mid-market law firm charging you in the low tens of thousands of US$ for all deal agreements. And once you reach VC level (US$5m or above), custom deal agreements will likely run you US$75-US$150k with a major international law firm.

Governing Law

The governing law clause may sound innocent, but should be located in the jurisdiction of the company and where the founders are based.

Outside of the USA (think Europe or Asia) startups tend to internationalize faster with investors investing cross border more comfortably. If your Singaporean investor convinces your Hong Kong based startup to base deal agreements on Singapore Law any dispute will be just harder to fight. And this is important even if the investor designated jurisdiction is generally up to international standards. You tend to be in a legal fee budget disadvantage to begin with and you don’t want to add to this with more expensive foreign lawyers or potentially having to travel for hearings.

Additionally it goes without saying that you should either-way choose your governing law to be a jurisdiction with well established, court-tested corporate laws and reasonable sized startup ecosystem. Even in the USA, nearly all startups incorporate in Delaware as the courts are just more prepared for your type of case.

Sample Term Sheet Sources

While you can engage a lawyer for drafting term sheets, you can very much make use of free templates found online. The reason is that term sheets are not binding anyways and many clauses follow common business practices. When searching for a template you will generally want to focus on reputation of the source and relevance to your deal. In addition there can be differences among the various startup ecosystems. Below we list a couple good sources to start your research.

Y-Combinator Term Sheet Template

Y-Combinator is the most well regarded startup incubator in the world with hundreds of alumni companies. Some of the most famous unicorns went through the program so any templates they put out will likely have been used extensively in deal negotiations. What we like about their term sheet is its conciseness: Essentially 1 page without leaving anything out. Unless you know your investor will renegotiate a lot later on, this is a great term sheet to use. You can find it here.

Things to Avoid when Negotiating a Term Sheet

Redemption Rights/Put Options

Redemption rights, also known as put options, allow their holder to “sell back” their shares to the company for a predetermined price. The advantage to an investor is that they now always got an exit option even if the company never gets to a real exit.

The argument that an investor would bring up to justify a put is the high risk and illiquidity. Startup investments are highly uncertain and selling their shares is very difficult. Besides the limited market there are all the selling restrictions of the shareholder agreements themselves. Hence, investors might say to the founder things like “I don’t even know, if you want to sell the company even if it gets successful”. Or: “My fund’s investment time horizon is 3 years so I need to have an exit guarantee by then”.

All of this is of course highly toxic. It creates significant asymmetry of interests among shareholders. But most importantly it is very dangerous for the cash flows of the company. Think of when an investor would exercise their put? Of course when the company is failing! That means right at the time when all cash is needed. Plus, startups often don’t have significant cash revenues early on. So the investor funds are a very substantial part of total funds available. Of course there can be lots of variations to puts. Especially regarding timing and whether there will be a built in guaranteed return.

Investors will of course try to frame their put as harmless and as a risk management tool. But depending on how this right is structured it can become a total deal breaker. It might be so detrimental that you might as well choose not to waste your time on your startup the next few years and declare bankruptcy right now. Or at least take a much worse valuation from another investor with better general terms.

Call Options/Warrants

A call option is a shareholder’s right to buy more shares of your company at a predetermined strike price for a predetermined exercise period. It essentially allows your investor to buy more shares later at a cheap price.

You investor will say: “I like your company so much, I want to support your company further in the future”. That’s sweet of him, but it’s a huge value you are giving to the investor. If your company performs well, it will be easy to raise funds and the valuation will go up. Your investor then will exercise his option at a potentially much lower price than what your shares are worth now. And if your company doesn’t perform well, your investor won’t be forced to invest by a call option.
For the founder and the company it is much better to not accept call options at all. Depending on the conditions however they could be acceptable. At least much more so than redemption rights or put options. The reason being, even if you have to sell shares at a not optimal price, you at least get more investment. Puts, as discussed above, can get you close to bankruptcy in a worst case scenario.

Tranches

Tranches are installment payments of investments. If your investor wants to split his investment in several tranches, it means you will get the money over various predetermined payments. While sounding reasonable at first glance, this should be definitely avoided and is also not that common among professional investors.

The reason for requesting tranches is that the investor would like to reduce his cash risk. The tranches can be triggered by metric milestones or simply by reaching a predetermined date. Both arrangements should be avoided. This is because it is incredibly difficult to set reasonable metric targets, and swaying off your targets can immediately send your company into bankruptcy.

Remember how even a fast fund raise takes 3-6 months? Given a typical runway for the funds from one round is only 12-18 months, splitting this runway into several tranches will mean you will be totally out of options to get money from somewhere else, if one tranche doesn’t get paid on time. Even if tranches are triggered solely by deadlines: You still don’t know if your investor himself will run out of money by the time the tranche is due.

Furthermore, the party paying money always has an upper hand in legal disputes. Should there be what ever dissent among investor and startup, the investor can simply refuse to pay and wait for the startup to go bankrupt before it can launch a meaningful lawsuit. That means, no matter what is written in the documents, the investor can withdraw its commitment to invest relatively easily.

Finally, even if all tranches work out perfectly, what is the difference to re-investing at each tranche timing? The investor gets the same reduced risk of a lower initial cash outlay, but he also gets a way cheaper valuation. If he would invest lets say once every six month the price of shares would likely go up.

So definitely avoid tranches as much as you can as there are just downsides. And if you accept them at least negotiate for an escrow arrangement to ensure the investor is actually capable of payment.

Random Fees and Consulting Agreements

As a first time founder you need to be very cautious reading a term sheet. Its certainly exciting to finally get that document valuing your hard work at likely millions of dollars. However, share price is not the only thing that determines value. There are many clauses that determine payouts and on the face of it look harmless.

Investors love to sneak fees for fund raising or consulting services in to term sheets. E.g. “Investors earn a 5% commission if they help you find your next round investor”. While innocent sounding, it is really quite an unreasonable gift to them.

First of all, if you got a decent startup you will make connections with investors naturally.
Secondly, your investors are already benefiting from next round’s valuation increase. They are already benefiting directly from increasing values of their own shares!
Thirdly, they will give you their contacts even without that commission anyways, because of point 2 above.

One exception to this is, if you had someone helping you finding that first or lead investor. Its not uncommon to provide a commission in cases where substantial help was provided. What we are warning about are all kinds of extra fees or consulting commissions that suddenly find themselves in your shiny new term sheet.

Unusual Board Structures (multiple seats per round, MD)

When an investor provides you with a large amount of money it is common that the largest investor of a funding round gets a board seat. The reasoning is as a director you get to sit directly at the table when the main decisions are made. Furthermore you get a more direct access to operational and business information. Its a reasonable safeguard and founders usually can even learn a fair bit from such a setup.

One however needs to be careful, if things get a little “unusual”. Starting out usually each founder has a board seat. Once the investors join the table, the lead investor of each round usually gets a board seat. Obviously as you raise more rounds this approach can get out of hand quickly. You don’t want too large boards and once you have more investors than founders on the board, you are loosing significant control even if you own the majority of shares. And if board seats are contractually guaranteed to certain investors you can’t even get rid of them with a shareholders vote (depending on jurisdiction).

A good number of board members is 3-5, with the majority of directors not being investors. As your company matures this could mean 2 investor directors, 2 founder directors and 1 external unrelated industry expert. That additional person can help striking a balance and bringing in new perspectives.

Tips for Drafting Startup Term Sheets

Calculate Value Scenarios

Term sheets are full of clauses that determine value aside from the actual valuation paragraph. It is really impossible to know the full implications of a term sheet until you actually take the time, open Excel and calculate some scenarios for potential outcomes.

For both fund raise and exit term sheets, think of scenarios that can test the following sensitive clauses:

Liquidation Preference: How will it impact the cash payout of an exit? Make a graph for various exit prices.
Anti dilution protections: Will anybody receive extra shares at various valuations?
Conversion of past convertible notes or preferred shares: How are ordinary share equivalents impacted?
Outstanding options: Will they be in the money or lapse?

Use Price per Share and Pre-Money Values in Funding Rounds

When putting in a price into the term sheet of a fund raise, founders often think in terms of valuation. That is probably related to the fascination of big numbers. “I am raising US$5m in my Series A. My company will be worth US$20m then. Hence, lets put US$20m into the term sheet”.

If you know about pre- and post-money you will realize right away, the company itself is only worth US$15m (pre-money). The US$5m investment tops it off to US$20m. You might argue, well does the difference matter that much? Isn’t this just a terminology thing?

The problem with putting post-money valuations in a term sheet is what if the amount of money to be raised changes? Most likely it won’t decrease, but maybe it increases. If you can’t raise the full amount, you’ll likely not close the round at all. That’s because investors know you need the full amount for living up to you plans. But if the market likes your startup you might choose to increase a round to fund a bit more growth. So imagine you increase the round to US$6m. If the round was promised at US$20m post-money, your investors will say “decrease pre-money to US$14m”.

The better approach is to go by pre-money valuations and list out price per share directly in the term sheet. While more shares still mean more dilution, it’s less than if you would have to reduce your pre-Money valuation. Also your price per share stays unchanged.

Long vs. Short Term Sheets

One question that always arises is how long should a term sheet be. As the term sheet is typically non-binding and only meant to get a common ground on the main terms, one might argue to keep the term sheet as short as possible. The flip-side is more potential for renegotiation during the drafting of the binding agreements.

For example, if you anticipate the investor is very familiar with startup deals, a relatively short term sheet could really speed up the deal. Your objective should be to get into deal closing mode ASAP.

In contrast, if you anticipate the investor might haggle a lot or be unpredictable, being a little more precise up front can save you time later on. That is because the wordings in a term sheet are much closer to plain English, while in the binding documents you can so easily get hung up around individual words. Also, you can actually negotiate a term sheet without a lawyer (remember, not binding!?). In contrast, if you are working on a Series A or any more substantial deal, you will likely have at minimum two negotiating parties (if not multiple large investors) plus at least two law firms all talking in circles about the details. Hence, deciding up-front at what deal value the Drag Along triggers can be as easy as a side-note at a coffee meeting. Later on it can be a week of expensive lawyer e-mails.

An example for an extremely short term-sheet is the one proposed by Y-Combinator, probably the leading incubator in the world. Look how individual standard clauses, such as stock restrictions are just named. It acknowledges that professional investors won’t bother to go into to lengthy negotiation games in those areas anyways.

Should you get a Lawyer for a Term Sheet?

Now that is a good question: Should you get a lawyer for your term sheet? While you should always engage your own legal counsel and make up your own mind, our honest recommendation is that you can negotiate term sheets yourself, if you UNDERSTAND the various terms and their language.

The reason being, as long as the term sheet somewhere says “non-binding” individual wordings don’t matter as much. Also you can correct some mistakes in the final deal agreements. Of course you shouldn’t use this a get out of jail card and renegotiate everything 2 months down the road. That will likely kill your deal.

That said, if you are unsure, you should be sure that you need a lawyer.

Conclusion

Receiving your first term sheet is one of the highlights of any Founder’s startup journey. Somebody believes in your business so much they are actually considering investing money into it. And that’s exactly what a term sheet represents: They are CONSIDERING investing.

Hence you need to strike a balance between getting your value, protecting yourself and to hurrying up! Its only the beginning of the deal closing process. You don’t want to be stuck negotiating over details that can be revisited by the lawyers in the final legal agreements. That is especially true when dealing with large (corporate) investors, who have plenty of internal process to go through for every new discussion point you bring up. Likewise, having enough detail in your term sheet will keep even inexperienced investors focused and not have you loose momentum. The name of the game is money in the bank.

Disclaimer
This guide is not intended to and does not constitute legal or tax advice, recommendations, mediation or counseling under any circumstance. This guide and your use thereof does not create an attorney-client relationship with Startupvaluationschool.com or Ed.Pres Limited. The guide solely represents the thoughts of the author and is neither endorsed by nor does it necessarily reflect Ed.Pres Limited’s belief. Ed.Pres Limited does not warrant or guarantee the accurateness, completeness, adequacy or currency of the information in the guide. You should seek the advice of a competent attorney or accountant licensed to practice in your jurisdiction for advice on your particular problem.

Table of Contents