What is a term sheet? Key clauses founders should understand
How a term sheet is structured, which parts are binding, liquidation preference, anti-dilution, governance rights and a checklist before you sign.
By Editorial Team
When an investor decides to back your startup, the parties agree the main terms in a term sheet before the full legal agreements are drafted. It is only a few pages long, but it shapes how the company is run for years.
Is a term sheet binding?
Most of a term sheet is usually non-binding: it does not oblige anyone to invest. Some clauses, however, normally are binding:
- Confidentiality: the terms and talks are not shared with third parties
- Exclusivity (no-shop): a commitment not to negotiate with other investors for a period
- Costs and governing law
Make sure the exclusivity period is reasonable, typically 30–60 days.
Economic terms
Valuation and amount
The pre-money valuation, the investment amount and the investor's stake. How the employee option pool (ESOP) is treated in the valuation should be stated explicitly. See our startup valuation guide for methods.
Liquidation preference
Lets the investor get their money back before other shareholders when the company is sold or wound up.
- 1x non-participating: the investor takes either their investment back or their pro-rata share, whichever is higher. The most common and founder-friendly structure at the early stage.
- Participating: the investor first takes their money back and then also shares in the rest pro rata. Much heavier for founders.
- Multiples above 1x (2x, 3x) are unusual at the early stage.
Anti-dilution
Protects the investor if a later round is priced lower. Broad-based weighted average is market standard; full ratchet is much harsher for founders.
Governance terms
- Board: how many seats and who appoints them
- Veto rights: investor approval for issuing new shares, selling the company or large unbudgeted spending
- Information rights: monthly or quarterly financial reporting
- Vesting: founders earn their shares over time, commonly four years with a one-year cliff. For similar arrangements between founders, see our founders' agreement guide.
Transfer and exit terms
- Right of first refusal: other shareholders can buy first when someone sells
- Tag-along: if founders sell, investors can sell on the same terms
- Drag-along: if a defined majority agrees to sell the company, the others must join
Checklist before signing
- Is it clear whether the valuation is pre-money or post-money?
- Is the liquidation preference 1x non-participating?
- Do veto rights cover only major decisions, not day-to-day operations?
- Is the exclusivity period reasonable?
- Have you had advice from a lawyer experienced in venture deals?
Conclusion
A term sheet is the first document of a long partnership. Do not sign anything you do not fully understand, and remember that terms matter as much as price. Browse our investors page to find the right partners.
This guide is for general information only and is not legal, financial or investment advice. Check official sources and consult professionals for current terms.
