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For founders and CFOs

What is a term sheet, and what actually matters in one

A term sheet is the document that sets out the proposed terms of an investment before the binding legal paperwork is drafted: how much, at what valuation, and under what conditions. It is non-binding on price, which is why founders relax about it. The governance terms inside it are the part that rarely moves once signed.

By Last updated 6 min read

A term sheet sets out an investor's proposed price, structure and rights ahead of the binding legal documents. The valuation is negotiable up to signing; the governance terms underneath it, board seats, liquidation preference and pro-rata rights, are usually locked in for the life of the company.

What a term sheet actually is

A term sheet is a short document, usually two to five pages, that sets out an investor’s proposed deal before the lawyers draft binding agreements: the amount, the valuation (pre-money and post-money), the security type (equity, a convertible note or a SAFE), and the rights that come with it. It is a statement of intent, not a contract. Either side can walk away before signing the binding documents, though a signed term sheet usually carries an exclusivity clause that stops you shopping the deal elsewhere while lawyers finish the paperwork.

The five terms worth reading twice
Valuation capThe ceiling price a convertible note or SAFE converts at, regardless of where the priced round lands.
Liquidation preferenceWho gets paid first, and how much, if the company sells or winds up. A 1x non-participating preference is standard in AU deals.
Pro-rata rightsThe investor's right to keep their ownership percentage in the next round, before new investors get a look.
Board compositionWho gets a seat, and what needs board approval. This is where control actually changes hands, not the cap table percentage.
Option pool top-upWhether the new ESOP pool is carved out of the pre-money valuation. It dilutes founders and existing holders, not the new investor.
A term sheet is non-binding on price but the governance terms rarely move once signed. Get a lawyer on it before you sign, not after.

Why founders under-read it

Most founders spend their attention on the headline number, the valuation, because that is the figure that gets talked about. The governance terms sitting underneath it, who sits on the board, what needs board approval, what happens on exit, are the parts that actually shape how the company gets run for the next five to seven years. A slightly lower valuation with clean governance terms is very often the better deal.

I hear this constantly from founders mid-raise: they are waiting on a term sheet before they can make the hires the round is meant to fund.[1] That sequencing makes sense commercially, but it also means the first real read of the governance terms often happens under time pressure, right when a founder least wants to be parsing a liquidation preference clause for the first time.

I go through the full capital raising process, term sheet included.

Get it reviewed before you sign, not after

A term sheet is non-binding on price. It is very often binding in practice on governance, because renegotiating a board seat or a liquidation preference after signing is a fight most founders do not have the standing to win. Get a lawyer who has actually done venture deals to read it before you sign, and ask specifically about the option pool top-up: whether the new ESOP allocation is carved out of the pre-money valuation, because that detail dilutes founders and existing holders, not the incoming investor.

The option pool top-up is one of the clearest places a term sheet reshapes your cap table.

Common questions

Is a term sheet legally binding?

The price and headline terms are generally non-binding, so either party can walk away before the lawyers draft the final legal documents. A couple of clauses, usually confidentiality and exclusivity, bind you even at this stage. Governance terms like board composition and liquidation preference stay technically open too, but in practice they almost never move once signed.

What is the most important term in a term sheet?

Founders focus on valuation, but liquidation preference and board composition matter more over the life of the company. Liquidation preference determines who gets paid first and how much if the company sells or winds up; board composition determines who actually controls major decisions. Both usually outlast the headline valuation in how much they shape the business.

What is a valuation cap on a term sheet?

A valuation cap sets the maximum price at which a convertible note or SAFE converts into equity, regardless of where the next priced round actually lands. It protects early investors from being diluted if the company's valuation rises sharply before the note converts.

Should a founder get a lawyer to review a term sheet?

Yes, before signing, not after. The valuation is negotiable up to the point of signature, but the governance terms are very hard to renegotiate once a term sheet is signed and the binding documents are drafted around it. A lawyer experienced in venture deals, not a generalist, is worth the cost at this stage.

References

  1. What I hear from founders mid-raise: they are waiting on a term sheet before they can make the hires the round is meant to fund.

These guides set out how we see it, drawn from the searches we run and the finance leaders we place. They are general information about the market, not financial, accounting or legal advice, and they are no substitute for advice on your own circumstances.

Term sheet on the table and building out the team behind it?

Tell us where the round is at. We will give you an honest read on the finance hire the round is meant to fund.

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