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.
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.
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:
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:
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.
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:
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.
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:
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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 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.
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.
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:
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:
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:
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:
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).
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.
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.
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.
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.
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.
