If you’re a founder or a business owner, tracking down finance for your company can be challenging, not least because the world of funding comes with its own set of terminology and standard documents. One such document is the ‘term sheet’.
A term sheet will come into play if you’ve pitched for finance and have investors lined up. The next step will likely be that you are presented with a ‘term sheet’. A term sheet is simply a list of the terms on which an investor (or a lender) is prepared to offer funding.
As a term sheet lays the groundwork for formal legal documents, you should be sure to understand what it says so you can push back against any conditions you don’t agree with.
Let’s take a look at term sheets, and how they evolve over different stages of funding rounds.
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What is a term sheet?
A term sheet is a non-binding document that outlines the key terms and conditions of a potential investment deal. Think of it as a blueprint: it sets the parameters for what the final, legally binding investment documents will contain.
While it's not enforceable in the same way as a contract, signing a term sheet signals serious intent. Both founders and investors typically agree not to negotiate with others once a term sheet is signed, and the headline terms will usually carry through into the final agreements.
For investors, the term sheet helps streamline the deal-making process. For founders, it's a critical opportunity to understand what you’re agreeing to – and to make sure the terms are fair.
If you’ve received a term sheet and are unsure what to do next, our term sheet next step guide walks you through the next steps to take.
Term sheet terminology
Even a short term sheet can be full of jargon. Here's a quick primer on the key terms you're likely to encounter:
- Employee share option plans. These are incentive schemes designed to reward staff with shares or options for shares. Investors are interested in them as they can affect the share structure of the business in which they’re investing
- Dilution. This is where a company issues new shares such that the percentage of the shares owned by existing shareholders goes down or is ‘diluted’ as a consequence of the new share issue
- Pre-money value. This refers to the value of the business before the injection of fresh capital by the investors
- Preference shares. These are a class of shares issued to investors that are ‘preferred’ to other shares in certain circumstances, such as when dividends are issued, or when a company goes into liquidation. Our guide on preference vs ordinary shares will answer any further questions you might have.
- Voting rights. These are the rights that attach to shares and that give the holders a right to vote in company meetings (as distinct from directors’ meetings at which business decisions are taken)
- Reserved matters. These are certain types of decisions in which shareholders may have increased rights to vote because the decision might negatively affect them in some way
- Rights of pre-emption. These are rights a shareholder has to bid for shares if the company decides to issue new shares (to avoid dilution, for example)
- Equity stake: The percentage of your company the investor will receive in return for their investment
- Liquidation preference: Dictates who gets paid first if your company is sold or wound up. A 1x non-participating preference means the investor gets their money back first, but no more.
- Drag-along/tag-along rights: Drag-along allows majority shareholders to force a sale; tag-along lets minority shareholders sell on the same terms.
- Vesting: Founder shares may be subject to vesting to ensure long-term commitment.
How a term sheet should look at different stages of investment
Not all term sheets are created equal. The contents and complexity of your term sheet will vary depending on your funding stage.
Pre-seed/seed
At pre-seed/seed funding level, term sheets are simpler, possibly using instruments like SAFEs or convertible loan notes. Not sure what SAFEs or convertible loan notes are, or how they differ? Read our article to learn more.
Valuations may be uncertain, and negotiations are often more flexible.
Here are some of the most common issues that will be covered in a seed capital or early-stage capital term sheets:
- Whether the funding will be in the form of debt (a convertible loan note) or equity (immediate share issue, SAFE or advanced subscription agreement for example)
- Valuation and the capitalisation table.
- Whether any shares issued will be ordinary or preferred shares, and the terms of any preferences
- What role, if any, the investor expects to play in management of the company and what rights to information they will have
- What discounts will be available to investors if shares are to be issued later, and what, if any, valuation caps will apply
- What anti-dilution provisions will apply
- What conditions, if any, will there be prior to funding being made, for example, that advance assurance has been received from HMRC that the investment will qualify for preferential tax relief under the EIS or SEIS. Read more about how you can apply and use the EIS scheme to attract funding to your business.
- How the investor expects to exit the company, and the terms of that exit
Series A/B and beyond
The main difference between seed and early-stage term sheets and VC and later funding rounds is that these term sheets tend to be much more complicated and detailed and also contemplate what happens in the event of an IPO (floatation).
While the terms that apply to seed and early-stage businesses will equally be included in VC/later stage term sheets, in addition, the following issues are more likely to be covered and in more detail:
At early stages, investors are typically backing you as a founder more than the business. Later on, terms tighten, and investor protections become more prominent.
What needs to be included in a term sheet
A typical term sheet will include the following key sections:
- Investment amount and valuation
- Share class and rights
- Board structure and governance rights
- Founder commitments and vesting
- Liquidation preference and exit terms
- Warranties and due diligence conditions
- Conditions precedent (what must happen before completion)
- Exclusivity and confidentiality clauses
While it’s tempting to rush through these items to keep momentum with an investor, remember: the term sheet is the foundation of your future legal agreements. Don’t skip the details.
Do I need a lawyer to draft a term sheet?
In short: yes. A good start-up lawyer can be your secret weapon in securing a fair deal. Lawyers can also help you spot potential red flags, saving you time and costs in the future. Read our article to uncover the most common term sheet red flags, from aggressive investor rights to hidden dilution, and get practical tips to help you navigate the process with clarity and confidence, no matter which funding round you're in.
Lawyers are especially beneficial for:
- Spot unfavourable terms you might otherwise miss
- Suggest founder-friendly alternatives
- Help you prioritise what’s negotiable and what’s standard
- Ensure the term sheet reflects your commercial goals
While templates can be useful as a starting point, a lawyer’s value lies in tailoring your term sheet to your situation and helping you understand the risks involved.
Getting ready for your first funding round? Watch our free webinar to learn how to prepare, avoid common pitfalls, and approach term sheets with confidence, backed by insights from our experience supporting hundreds of founders.
If you're ready to sign a term sheet, or need help negotiating one, speak to our team using the enquiry form below.
