VC Term Sheets: Definition, Key Components & More

VC Term Sheets: Definition, Key Components & More

It’s all too common for founders to be confused by portions of the venture capital term sheet. A lot of us are often being introduced to certain terms for the first time when raising seed money. On the other hand, investors see term sheets all the time. 

If you’re currently fundraising, or planning to, it can be helpful for you to get a head start on your knowledge of VC term sheets. Having a basic understanding—plus the help of a lawyer who is familiar with startup and venture deals—can make closing a deal less daunting.

In this article, we’re going to cover the main components of a term sheet and how to identify what a “good” term sheet looks like. Additionally, we’re going to discuss the legally binding aspects, who specifically authors the document, whether or not it expires, and what happens after it’s signed. 

This knowledge, paired with the help of a lawyer who is familiar with startup and venture deals, can make closing a deal less daunting.

What Is a VC Term Sheet?

A VC term sheet is an important document in the venture capital investment process. It acts as a nonbinding agreement that outlines the terms and conditions between a company, its founder(s), and a potential venture capitalist investor or venture capital firm. 

Term sheets serve as a precursor to more detailed and legally binding agreements that follow in the investment process. Even if you’re working with other types of investors, you will typically receive a term sheet before closing a financing round.

Think of it like the initial position in a negotiation. The term sheet will lay out the groundwork for the relationship between a founder and an investor, outlining where the drafter wishes to start the negotiation. When done correctly, it clearly defines the expectations for both parties involved.

Angel, seed, and venture capital (VC) investors all use term sheets to summarize the major aspects of an investment agreement. These documents define what the startup will provide in exchange for the investor’s funding, explaining how the investment’s upsides and risks are divided among the founder(s) and investor(s).

A significant part of a good term sheet involves risk allocation, as well as financial concepts. It helps all parties involved sort out any issues or differences before executing the legal agreements and undergoing time-consuming due diligence. For instance, the founder’s ownership over the company’s intellectual property is a common topic addressed in a term sheet.

When an investor presents a term sheet, it usually signals their readiness to proceed with the deal. Most investors will agree to provide some kind of funding after presenting a term sheet to a founder or co-founders.

Many startups initially rely on the founder’s savings or financial support from friends and family. This type of bootstrapping typically doesn’t involve serious investment documents compared to receiving funding from a venture capital firm. As a result, term sheets are most commonly encountered at the Seed and Series funding stages. The content and complexity of these term sheets will vary depending on the round, the amount at stake, and the other parties involved.

The first term sheet you sign can also set a precedent for the terms and conditions of any future rounds you raise. Understanding the key components of the term sheet, including the most important terms, should be your number one priority when you finally start receiving offers. This will help you when it comes time to, ideally, compare term sheets and even negotiate with the investor. A good deal and partnership is a huge factor when it comes to the long-term success of your startup.

Key Components of a VC Term Sheet

A term sheet is not the investment contract itself, but it lays out the groundwork to ensure that all parties involved in the transaction agree on the major components of the deal. They can range from a single page to several, or even a dozen pages.

Simply put, they typically consist of three main things:

  1. The economics of the deal (i.e., the economic rights of the shareholders)
  2. Who is involved in the key decisions and to what extent
  3. Other items like deal fees and the period of exclusivity

Over the years, many investors—especially VC firms—have started shortening their term sheets to make them more “user friendly” for founders. These documents are often a single-page term sheet that aims to streamline the deal-closing process by avoiding complicated legal jargon.

However, term sheets can still vary in length. The content depends on the participants, the funding stage, and the perceived upsides and risks. For example, a term sheet you receive during a seed round might look quite different from one you receive during a Series A round.

Here is an example of what a simple Seed or Series A term sheet might include:

  • Company Name: The name of the company receiving the investment.
  • Securities: The type of shares or equity being issued.
  • Investment: The total dollar amount from the lead investor.
  • Amounts: The total dollar amount from other investors.
  • Company Valuation: Methods for determining the company’s valuation.
  • Liquidation Preference: Terms that outline investor repayment in case of liquidation.
  • Dividends: Details on dividend payments to investors.
  • Participation Rights: Rights allowing the investor to benefit alongside shareholders.
  • Conversion Rights: Terms under which preferred shares can be converted to common shares.
  • Anti-Dilution Clauses: Provisions to protect investors from dilution.
  • Voting Rights: Voting powers granted to investors.
  • Drag-Along Rights: Provisions that force minority shareholders to join in the sale of the company.
  • Board Representation: Rights of investors to have seats on the board of directors.
  • Founder & Employee Vesting: Terms regarding the vesting schedule for founders and employees.
  • No-Shop Provision: Clause preventing the company from seeking other offers once the term sheet is signed.

There may be other provisions or clauses involved as well, but the items listed above are typically the most common and important details to know.

Key Components to Focus On

If you are uncertain about which terms to prioritize, work with a trusted advisor or an experienced startup lawyer to identify those that will help you the most. Typically, however, the most salient points are:

  • Valuation/Dilution: First, determine your startup’s value and recognize that a lower valuation from a respected investor may be a better deal than a high valuation from one with a less than stellar reputation. Second, understand the importance of negotiating for a minimal option plan reserve in the fully diluted pre-money valuation. It could enable you to get a higher price per share for your company at the exit.
  • Liquidation Preference: This defines the return an investor receives when you sell your company and can significantly impact your return. Take the time to model various anticipated exit values to understand the actual dollar differences between liquidation preference options.
  • Protective Provisions: These are veto rights that investors have over specific corporate actions. Some make sense, particularly for early-stage startups, but others that limit where you can raise funds or how you can amend your certificate of incorporation may cause problems in the future.
  • Founder Vesting: The important things to consider include: What date does vesting commence? Does vesting accelerate upon termination without cause? Does vesting accelerate (in whole or in part) upon a change of control?
  • Anti-Dilution Protection: Nearly all deals have some provisions to protect the VC from dilution and most are reasonable. However, if it is a “broad-based anti-dilution protection” or “full ratchet,” you may want to get advice from an expert and even reconsider the deal.
  • Exclusivity: This is a standard condition that requires that you don’t talk to other investors for a specific period after you sign the term sheet and while the investor is doing their due diligence. But be sure the time period isn’t too long — 30-45 days is about right.

Ideally, the term sheet should be founder-friendly. The investor(s) you are partnering with should be interested in building long-term value rather than merely reducing perceived risks. A well-structured term sheet reduces the chances of misunderstandings or disputes going forward.

This document also helps create a foundation and precedent for terms in future rounds. Settling on terms and conditions you find optimal is key, which may sometimes involve negotiating the term sheet.

Why Do VC Term Sheets Matter for Founders?

VC term sheets are an important part of the fundraising journey of any startup. If you’re going to try and raise money, you’re going to receive a term sheet first. Here are the key reasons why we think VC term sheets should matter to founders, and should be seen as more than just another document to sign on the way to securing money for your startup:

It Establishes Initial Terms of Investment

The term sheet lays the foundation for the investment relationship between the startup and the investor. It outlines the initial terms and conditions, setting expectations for both parties. This clarity is essential for avoiding misunderstandings and ensuring both sides are aligned from the start.

It Provides a Framework for Negotiation

A term sheet serves as the starting point for negotiations. It allows founders to understand the investor’s initial offer and provides a basis for discussions on various aspects of the deal. This framework helps founders negotiate better terms and secure favorable conditions for their company.

It Clarifies Ownership & Control

One of the most important aspects of a term sheet is how it addresses ownership and control of the company. It details the equity distribution, voting rights, and board representation, helping founders understand how much control they will retain post-investment. This clarity is crucial for making informed decisions about the future of the company.

It Outlines Risk Allocation

Term sheets outline how risks and rewards will be shared between the founders and the investors. This includes liquidation preferences, anti-dilution provisions, and other clauses that protect both parties' interests. Understanding these risk allocations helps founders gauge the potential impact on their equity and the company’s valuation.

It Sets Precedents for Future Rounds

The terms agreed upon in the initial term sheet often set precedents for future funding rounds. Having a well-negotiated term sheet can simplify subsequent rounds of investment, making it easier to attract new investors and secure additional funding. It helps establish a track record of fair and favorable terms that can benefit the company in the long run.

It Signals Serious Investor Interest

Receiving a term sheet is a strong indicator that an investor is serious about investing in the company. This can boost a founder’s confidence and provide a sense of validation for their business model and growth potential. It also signals to other potential investors that the company is gaining traction.

It Facilitates Legal & Financial Due Diligence

Once a term sheet is signed, it triggers the due diligence process, where investors thoroughly review the company’s legal, financial, and operational aspects. This process ensures that all parties are fully informed before finalizing the investment. A clear and comprehensive term sheet can streamline this process and reduce potential roadblocks.

It Builds a Strong Foundation for Partnership

A well-crafted term sheet not only outlines the financial terms but also sets the tone for the future partnership between the founders and investors. It helps establish mutual trust and respect, which are essential for a productive and long-lasting relationship. Founders can leverage this foundation to gain valuable insights, mentorship, and support from their investors.

The VC Investment Process & the Role of the Term Sheet

While timelines can differ from case to case, we find that there are a series of steps in the VC investment process that can be outlined here. This hopefully gives you a better idea of how a fundraise may go and what the role of the term sheet is during this process.

Reach Out to Investors

Build investor relationships well in advance of fundraising. Seek warm introductions to potential investors through your network to increase your chances of success. Start building these relationships at least 6-12 months before you plan to raise funds. Attend industry events, join startup communities, and leverage LinkedIn to connect with potential investors.

Share Your Pitch Deck

Send your pitch deck to interested investors to provide an overview of your business, vision, and financials. This document is crucial in capturing investor interest. Ensure your pitch deck is concise, visually appealing, and includes key information such as market opportunity, business model, traction, team, and financial projections.

Pitch to Investors

Conduct initial pitches to interested investors, followed by follow-up meetings if scheduled. These meetings are opportunities to delve deeper into your business and answer investor questions. Be prepared to discuss your business in detail, including your competitive landscape, customer acquisition strategies, and long-term vision.

VC Investment Committee (IC) Meeting

The internal investment committee reviews and evaluates the potential investment. This step is critical as it determines whether the investor will proceed with an offer. The IC typically consists of senior partners who make the final decision on investments. Be prepared to provide additional documentation and insights as requested.

Term Sheet Issuance

If the IC meeting goes well, a term sheet is generally issued. This document outlines the key terms and conditions of the investment and is negotiated and signed by both parties. Key terms include valuation, equity stake, liquidation preferences, and board composition. It’s essential to consult with legal and financial advisors during this negotiation phase.

Due Diligence & Investment Agreements

After signing the term sheet, due diligence is conducted, and comprehensive investment agreements are drafted. These include articles of association, shareholders' agreements, and other essential documents. Due diligence involves a thorough review of your business operations, financials, legal status, and market position. Be transparent and cooperative to facilitate this process.

Final IC Meeting

If necessary, a final IC meeting is held to wrap up and confirm the due diligence findings. This step ensures that all aspects of the investment are satisfactory. The final meeting may involve addressing any last-minute questions or concerns and confirming the investment terms.

Funds Raised

Over the next 3-12 months, the funds are raised and transferred to the company's bank account. This period involves finalizing all legal and financial arrangements to complete the investment process. During this time, continue to maintain communication with your investors and keep them updated on your progress and milestones.

The Term Sheet’s Role

The term sheet plays a crucial role by setting the preliminary terms and conditions, guiding the due diligence process, and laying the foundation for the final investment agreements. Properly understanding and negotiating the term sheet can significantly impact the success of your fundraising efforts and the future growth of your startup.

Tips for Negotiating a Term Sheet

Don’t hyperfocus on a “perfect” deal. There are numerous venture capital term sheet samples available online. Be careful that you understand these samples from the web; some are old copies, oddball cases, or pertain to a certain stage of company growth. VCs, angel investors, and accelerators providing capital to early-stage companies often provide sample term sheets for startups to review, so they have a better understanding of what they might expect. 

That said, whomever you receive a term sheet from, it should act as the foundation of the terms you will agree to in order to receive an investment. It should set a precedent for any future rounds that will be raised. 

Starting off with a “good” term sheet means the next term sheet and financing round will be quick and easy. The terms should also help you confirm whether the investor is trustworthy. Even after confirming investor trustworthiness, you should identify the terms that are most important to you and your team. Knowing the terms you are comfortable with and the ones you can negotiate will raise your confidence when interacting with investors.

In fact, It's important to know that negotiation is possible! But, it takes legal knowledge and an understanding of term sheets, in addition to a certain amount of leverage and civility, to accomplish negotiations. 

If you receive what you feel to be a “good” term sheet, try and close the deal. Don’t spend too much time trying to negotiate the “perfect” deal. No one ever built a successful company simply by winning a Seed or Series A negotiation. Even if you don’t believe you got everything right or exactly how you want, you will, hopefully, always have the power to execute. Investors are often a great source of advice, so listen carefully if the investor is pushing back on a certain topic. The credibility you build can establish some leverage to help you renegotiate later. 

Don’t lose sight of your number one goal when looking over term sheets or negotiating: getting back to work and building your business.

Are You Ready to Fundraise? Do Your Due Diligence First

Before you start reaching out to investors, it's crucial to ensure that your startup is ready for fundraising. Doing your due diligence can help you determine if investors will be interested in your company and set you up for a successful fundraising round. Here’s how to prepare:

Assess Your “Business Readiness”

  • Solidify Your Business Model: Ensure you have a clear and scalable business model. Investors want to see that your startup has a viable path to profitability. Validate your business model through market research and initial sales or pilot projects.
  • Demonstrate Traction: Show evidence of market demand and product-market fit. This can include user growth metrics, revenue figures, customer testimonials, and retention rates. Traction is a key indicator that your business has potential for growth.
  • Build a Strong Team: Investors look for a capable and experienced founding team. Highlight the skills and backgrounds of your team members, and ensure you have the necessary expertise to execute your business plan.
  • Develop a Detailed Business Plan: Create a comprehensive business plan that outlines your strategy, target market, competitive landscape, marketing and sales plans, and financial projections. This document should clearly articulate your vision and how you plan to achieve it.

Prepare Your Financials

  • Financial Statements: Prepare detailed financial statements, including profit and loss statements, balance sheets, and cash flow statements. These should be up-to-date and accurately reflect your financial position.
  • Financial Projections: Develop realistic financial projections for the next 3-5 years. Include assumptions behind your revenue and expense forecasts, and be prepared to discuss these in detail with potential investors.
  • Unit Economics: Understand and articulate your unit economics, such as customer acquisition cost (CAC), lifetime value (LTV), and gross margins. Investors want to see that your business can be profitable at scale.

Conduct Market Research

  • Competitor Analysis: Perform a thorough analysis of your competitors. Understand their strengths and weaknesses, market share, and strategies. Be prepared to explain how your startup differentiates itself and plans to compete effectively.
  • Market Size: Determine the size of your target market. Investors want to know that there is a significant market opportunity for your product or service. Use credible sources and data to back up your estimates.
  • Customer Insights: Gather insights from your existing customers or potential customers through surveys, interviews, or focus groups. Understanding your customers' needs and pain points can help you refine your product and market approach.

Legal & Compliance Readiness

  • Legal Structure: Ensure your company is legally structured and compliant with all regulations. This includes having all necessary licenses, permits, and intellectual property protections in place.
  • Founders’ Agreements: Have clear agreements among the founding team regarding equity ownership, roles, responsibilities, and vesting schedules. This helps prevent conflicts and demonstrates professionalism to investors.
  • Documentation Readiness: Organize all your legal documents, contracts, and agreements. Investors will conduct due diligence, and having your documentation in order will facilitate this process.

Understand What Investors Look For

  • Market Potential: Investors are interested in large and growing markets. Ensure you can articulate the market opportunity and your strategy to capture a significant share.
  • Scalability: Show that your business can scale efficiently. This means having a product or service that can grow rapidly without a proportional increase in costs.
  • Risk Mitigation: Identify potential risks and have a plan to mitigate them. Investors appreciate founders who are aware of the risks and have strategies in place to address them.
  • Clear Exit Strategy: Provide a clear exit strategy for investors, such as potential acquisition or IPO. Investors want to know how they will eventually realize a return on their investment.

Resources for Founders

Here we’re going to include some valuable resources and recommendations to help you get started and continue learning about term sheets, and fundraising in general. By leveraging these resources and seeking professional guidance, you can better understand VC term sheets and confidently navigate the fundraising journey:

Sample Term Sheets

  • Y Combinator Series A Term Sheet Template: Y Combinator, one of the most well-known startup accelerators, provides a simple and founder-friendly Series A term sheet template. This resource can help you understand the typical components and structure of a term sheet.
  • Visible Term Sheet Templates: Visible.vc offers various term sheet templates that can be useful for understanding different stages of funding. These templates provide a practical guide to the essential elements and clauses commonly found in term sheets.

Accelerators & Educational Resources

  • Biotech Startup Accelerators: Startup accelerators play a crucial role in the growth and success of early-stage companies. They provide a structured environment where startups can receive intensive support, mentorship, and resources over a fixed period, typically ranging from a few weeks to several months.
  • Startup School by Y Combinator: Y Combinator’s Startup School offers free online courses covering various aspects of building and funding a startup, including term sheets and fundraising strategies. The courses are taught by experienced entrepreneurs and investors, providing valuable insights and guidance.

Legal Advice & Professional Guidance

  • Cooley GO: Cooley GO provides a comprehensive library of legal resources and guides for startups. Their section on term sheets offers detailed explanations and examples of common terms and provisions, helping founders navigate the complexities of investment agreements.
  • StartupPercolator: The StartupPercolator offers resources and tools for early-stage companies, including information on term sheets, legal templates, and articles on various aspects of startup law. They also provide opportunities to connect with experienced legal professionals.
  • HSBC’s Venture Capital Term Sheet Guide 2024: The HSBC Venture Capital Term Sheet Guide 2024 analyzes 426 final, signed term sheets to provide founders with an objective view of market standards, empowering them to negotiate with confidence. Key trends include increased seed investments, surging interest in CleanTech, Health Tech, and AI, and significant cross-border investments in later-stage UK companies.

Seeking Professional Guidance

Navigating a term sheet and negotiating favorable terms can be complex. It’s highly recommended to seek professional legal advice to ensure you fully understand the implications of the terms and conditions. Here are some steps to take:

  • Consult with a Startup Lawyer: Engage with a lawyer who specializes in startup and venture capital law. They can provide personalized advice and help you negotiate terms that align with your business goals.
  • Work with Experienced Advisors: Consider working with advisors who have experience in fundraising and venture capital. They can offer valuable insights and support throughout the negotiation process.
  • Join Founder Networks: Participate in founder networks and communities where you can share experiences and seek advice from peers who have gone through similar fundraising processes. Here are some good places to start: Growthmentor’s “20 Best Startup Communities for Founders in 2024” and ProductHQ’s “15 Best Founder Communities and Networks to Meet Entrepreneurs and Startup Founders.”

VC Term Sheet FAQs

You might be looking for a common question regarding VC term sheets. As a leasing company and capital provider dedicated to supporting biotech startup founders, we’ve heard our fair share of questions from early-stage companies; those founders who are just starting off and we’ve come across through our shared networks. So, we decided to include some of those questions here:

Is a Term Sheet Legally Binding?

A term sheet is a non-binding document, however, it does include binding conditions, such as confidentiality and exclusivity (or No-Shop) provisions. They go into effect after the document has been signed and are a legally enforceable agreement.

Confidentiality and exclusivity provisions allow both the company’s founders and the investors to keep the terms of the negotiations confidential, and, once the term sheet is signed, ensure the founders cannot shop around until a definitive agreement is reached (i.e. the deal either goes through or doesn’t).

Who Provides the Term Sheet?

If you are raising a Seed or Series Round through equity financing, the investor—be it a traditional VC firm or seed fund—will typically provide the term sheet. Some business incubators, accelerators, or other programs teaching founders how to pitch to investors will include training on drafting a term sheet. 

However, it has become more common for founders to serve up a term sheet, specifically when no one is stepping up to pitch the company during a seed round composed of a large group of investors. This is often referred to as a “party round.” Outside of party rounds, founders usually do not provide the term sheet. 

Does It Ever Expire?

A term sheet can expire. Not every document includes an expiration date. However, some do include a provision stating that the term sheet will expire a certain date unless signed. The time frame, or “fuse”, is usually somewhat short, ranging from 2-5 days. This range can often include up to 10 days, especially if the term sheet is founder-drafted. The provision makes sure the deal won’t sit on the table in perpetuity. 

However, depending on the relationship you have between yourself and the investor, they may not include such a provision. If they do, they will likely give you an extension in order to help you get comfortable with the terms. The extension can be anywhere from a few extra days to an entire week so long as you are working with the investor in good faith. When you get an extension—or an expiration date is not included at all—it’s usually a good sign that you’re working with someone who will be an excellent business partner in the long-run. 

Ultimately, it’s somewhat unusual for an investor to pull the term sheet just because a “fuse” expired. When a term sheet is offered, the investors are typically very committed to closing the deal. It’s important to briefly note so-called “exploding term sheets”. Exploding term sheets are any term sheets with a very short fuse that have no extensions. They are associated with high-pressure negotiations and impulse decisions. If you receive an exploding term sheet, ask the investor why the time limit is so short. 

Investors like Mike Collett and Michael Arrington recommend leaning towards saying no to any high-pressure deal. If a potential partner doesn't want to give you the time you need to understand the terms and be comfortable with them, protect yourself and seek another investing partner.

Can You Actually Negotiate a Term Sheet?

Yes, term sheets are negotiable. Founders often negotiate terms related to valuation, control rights, and other key provisions. It's important to identify which terms are most critical for your business and negotiate those points effectively. Leverage is highest before signing the term sheet and agreeing to a no-shop clause.

What Happens After You Sign a Term Sheet?

Once the term sheet has been signed and both parties have agreed to move forward, due diligence is performed and definitive, legally binding documents are drafted. The investment agreements are based on the term sheet but are much longer, often 100 pages or more. 

These documents serve as the binding contracts that control the actual exchange of money, binding promises, and authority within the company. Importantly, once parties sign the term sheet, any nondisclosure or non-shop clauses become enforceable. Signing the term sheets marks the beginning of a period of caution and diligence.

How Long Does a Deal Take to Complete?

The duration from the first meeting with an investor to the completion of a deal can vary significantly, typically ranging from eight to twelve weeks. The complexity of the transaction and the number of parties involved can affect this timeline.