Term Sheet Anatomy

The term sheet is not a legally binding contract (save for confidentiality and exclusivity), but it sets the non-negotiable economic and control framework for the definitive documents.

Economic Terms

These terms dictate how money is distributed in a liquidity event. The primary levers are:

• Valuation (Pre-Money vs. Post-Money): The price of the company. Post-Money = Pre-Money + Investment.
• Liquidation Preference: Defines who gets paid first and how much. The standard is 1x non-participating. Anything else (e.g., 2x participating) is highly punitive to founders.
• Option Pool: Investors usually require the post-money option pool to be created pre-money, meaning the dilution is borne entirely by existing shareholders (the founders).
• Anti-Dilution: Protects investors in a down-round. "Broad-based weighted average" is standard; "Full Ratchet" is toxic.

Control Terms

These terms dictate who runs the company and who has veto power over major decisions.

• Board of Directors: Typically a 3 or 5 person board. (e.g., 2 Founders, 1 VC, 1 Independent).
• Protective Provisions: Veto rights for the preferred shareholders over actions like selling the company, changing the board size, or taking on debt.
• Drag-Along Rights: Forces minority shareholders to agree to a sale of the company if the majority (and the VC) agrees.

Common Mistakes

Founders often focus entirely on valuation and ignore control terms. A high valuation with punitive liquidation preferences (e.g. participating) and harsh protective provisions can result in founders losing control of the company and making zero money in a moderate exit.

FAQ

Is a term sheet legally binding?

Mostly no. The economic and control terms are non-binding. However, the confidentiality and exclusivity (no-shop) clauses are legally binding.

How long is the exclusivity period?

Typically 30 to 45 days. This gives the investor time to conduct due diligence without the founder shopping their offer to competitors.