Term Sheet

An investment agreement runs to dozens of pages and takes lawyers on both sides several weeks. Start that work first and discover midway that a central term doesn't match, and every hour and dollar spent up to that point is wasted.

It happened often enough. A founder and an investor would talk for weeks, move into drafting on good terms, and then find while writing the clauses that they had understood things differently. One side took a valuation of $11,250,000 to mean the value before the money arrived while the other meant after; or one assumed the multiple for recovering the investment in a sale was one times and the other assumed two. Nobody lied, and the negotiation went back to the beginning, several weeks of legal fees along with it.

A term sheet reverses that order. Before the long contract gets written, the terms that carry the most value are pulled out onto a page or two and both sides sign. If that page holds, the lawyers' job is turning it into contract language. If it doesn't, the parties part there. That is also why most of the items carry no legal force: the document exists to clear away misunderstandings in advance, not to bind anyone.

A page or two holds five groups, ordered by how much value rides on them.

1. The amount and the valuation. The investment, the pre-money valuation — the value before the money arrives — and the ownership percentage that falls out of the two. Stating explicitly whether the number is pre or post is the point of this line, because the same figure read the other way moves the ownership percentage by several points.
2. The share class and its rights. What the investor receives is usually preferred stock, and this section carries the multiple on the liquidation preference, whether the investor also shares in what remains after recovering the investment, and whether a provision compensating earlier investors in a lower-priced round is included.
3. Governance. How many seats the board has and how many belong to the investor, plus a list of decisions requiring investor consent, such as selling the company or issuing new shares.
4. Founder provisions. Founder shares often get put on a schedule that confirms the rights over time in office, and what happens to those shares if a founder leaves is settled here too.
5. Process and timing. How long diligence will take, the expected closing date, and the exclusivity period. Who pays the legal costs also sits in this section, and it is usually the company, capped at an agreed amount.

Usually only two items are binding: the exclusivity clause promising not to negotiate with other investors for a set period, and the confidentiality clause covering the material exchanged.

The draft comes from the investor, not the company. After clearing it internally, the associate at the venture capital firm leading the round fills the numbers and terms into their firm's standard form and sends it over. Even when several investors participate, one lead issues the term sheet and the others join on the same terms. A company can also receive competing term sheets, which is the one situation where it has real leverage on the terms themselves.

On the receiving side are the founders. The company's lawyer reads it, and so do existing shareholders from earlier rounds — they need to see how much their ownership dilutes and whether an investor arriving after them is being placed ahead of them in the payout order.

The way to read it is not to start with the amount. The amount and the valuation have already been discussed, so nothing there is new; the terms are the part being seen for the first time. The liquidation preference multiple, whether it participates, and the length of the consent list change what anyone actually collects later.

A fixed sequence follows signing. Due diligence verifies that the numbers the company presented are accurate, a definitive agreement gets drafted if nothing turns up, and then the money moves. One to two months is typical. The document used to explain the company to investors before any of this is the IR deck; the term sheet arrives after that explanation has done its work.

"Term sheet's in. Two and a quarter million at nine pre, 1x non-participating."

The pre-money valuation, the amount, and the liquidation preference in one line.

"Exclusivity runs four weeks, so we can't talk to other investors in that window."

Signing closes the other options for a while.

"The term sheet isn't binding, but reversing something agreed here in the definitive agreement breaks trust."

What is legally possible and what is actually available are different things.

Pagedeck's Series A term sheet was two pages. The line Grace spent longest on wasn't the amount but the list of consent rights. The first version required consent for approving the annual budget and for any hire above a certain salary, which would have meant checking with the investor every time the company wanted to add a person.

After negotiation the list narrowed to three items: selling the company, issuing new shares, and taking on large debt. The valuation never moved from the number first proposed. That is why Grace describes the round as one where negotiating terms took longer than negotiating price.

The most common belief is that signing a term sheet means the investment is settled. Both parties signed it, so it looks like a contract, and people get congratulated. But most of it isn't binding and diligence is still ahead. If revenue was recognized incorrectly, or contracts about to expire were counted in, the agreed valuation comes down or the deal stops. Posting job listings and signing an office lease on the day of signature is early. Counting from the day the money lands is safer, and a plan that assumes closing can slip by a month rarely regrets it.

The other mistake is judging a term sheet by amount and valuation alone. Those two numbers stand out and are the easy part to repeat to other people. What determines the amount actually collected, though, is the terms. Agreeing on a $9,000,000 pre-money valuation still leaves founders with far less in a mid-sized sale if the liquidation preference is two times and the investor also shares in what remains, compared with a 1x non-participating deal. Taking a slightly lower number in exchange for simpler terms is often the better trade.