A term sheet is a non-binding agreement between a company and investor (or investors) that outlines the proposed terms under which a potential investment will be made. However, the term sheet is not a legal contract in and of itself. It provides a foundation for negotiations between the issuer and investor.
Once everyone is in agreement regarding the term sheet, legal documents reflecting the agreed upon terms and covering the many nuances of an investment are drawn up. While the existence of a term sheet doesn’t mean that negotiations no longer take place, it does provide assurances that everyone is generally on the same page and that the drawn up legal documents won’t have to be heavily revised (which can potentially save a lot of money in legal fees).
Term sheets are intended to provide a simplified summary of the key terms of the investment, but they still contain a number of technical items. In the world of early-stage investing, term sheets contain information relating to:
- Amount of investment (how much the company is looking to raise)
- Valuation (related to both of these are figures such as ownership percentage being offered to investors as well as the price per share)
- Type of security offered
- Voting rights
- Anti-dilutive provisions and registration rights
- Liquidation preference
- Conversion rights
Term sheets can be used both at the beginning of the fundraising process as well as after the final legal documents have been drawn up. In the beginning, the proposed term sheet essentially reflects the basic terms that one or multiple parties find acceptable. This is used as the baseline for negotiations between that company and a lead investor or group of investors – until a balance between their interests is struck. After final legal documents have been drawn up, the term sheet can provide a handy shortcut to quickly catch up new investors to the terms of the raise – spending a couple minutes reviewing a short outline of the deal as opposed to potentially hundreds of pages of legal documents.