Term Sheet

When a young company is supposed to receive money from a financial backer, this is negotiated for weeks. At the end of these discussions stands a document with the most important points: How much money will flow? What is the company worth in the process? And what rights does the backer receive in return? This document is called a term sheet. It is usually only two to five pages long and does not yet replace a finished contract. Nevertheless, what is written here will hardly be changed later on.

What those two pages decide about power within the company

A term sheet is almost always legally non-binding. Only individual points are truly binding, such as the obligation of confidentiality. In practice, however, the document has enormous effect. As soon as both sides have signed, lawyers draft the lengthy contract precisely according to these specifications. Anyone who has accepted a condition in the term sheet can hardly take it back later.

The valuation is especially important. It determines what the entire company is calculated to be worth. From this follows what share the investor receives for their money. An example: if a startup is valued at 8 million euros and the investor puts in 2 million, they then own 20 percent. The founders correspondingly own less than before.

Besides money and shares, the document often also regulates control. Typical elements are a seat on the supervisory board and a list of decisions that the investor may block. These include, for example, the sale of the company or the admission of new backers. This is precisely why experienced founders read a term sheet not just for the headline number, but line by line.

The typical clauses and their fine print

One can think of a term sheet like the preliminary contract when buying a house. Price, timing, and condition are already settled in it. The notary appointment merely fills in the formalities. It works the same way with a financing round: first the key terms document, then the due diligence review of the books, then the actual investment agreement at the notary.

A liquidation preference almost always appears. It regulates who gets money back first if the company is sold. The investor usually receives their investment first, often a multiple of it, and only afterward is the rest distributed. With a high sale price, this hardly matters. With a mediocre sale, it can mean that the founders end up with almost nothing.

Two further points are almost always included. Anti-dilution protection secures the investor in case the company later raises new money at a lower price. An employee program, often called an option pool, reserves shares for future employees. The order matters here: if this pool is created before the investor comes on board, the founders alone pay for it.

Term sheets in startup news and in the AI industry

In reports about financing rounds, one frequently reads that a company has signed a term sheet. This means: the deal is as good as certain, but not yet finalized. Between signing and the actual transfer of funds, there are often two to three months. During this time, investors review the company’s contracts, figures, and patents.

Especially with AI companies, such documents regularly make headlines. When a young company without major revenues is valued at billions, this figure first appears in a term sheet. Special rights of large technology corporations, such as preferred access to a model, are also first fixed in writing there.

A common misconception is that a term sheet is merely a polite statement of intent without consequences. In practice, anyone who signs commits to not continuing negotiations with other backers. This exclusivity often applies for several weeks. If the deal falls through afterward, the company has lost valuable time.