What Is a Term Sheet?

A term sheet is a nonbinding agreement that shows the basic terms and conditions of an investment. The term sheet serves as a template and basis for more detailed, legally binding documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is drawn up.

Key Takeaways:

  • A term sheet is a nonbinding agreement outlining the basic terms and conditions under which an investment will be made.
  • Term sheets are most often associated with startups. Entrepreneurs find that this document is crucial to attracting investors, such as venture capitalists (VC) with capital to fund enterprises.
  • The company valuation, investment amount, percentage stake, voting rights, liquidation preference, anti-dilutive provisions, and investor commitment are some items that should be spelled out in the term sheet.

Understanding Term Sheets

The term sheet should cover the significant aspects of a deal without detailing every minor contingency covered by a binding contract. The term sheet essentially lays the groundwork for ensuring that the parties involved in a business transaction agree on most major aspects. The term sheet reduces the likelihood of a misunderstanding or unnecessary dispute. Additionally, the term sheet ensures that expensive legal charges involved in drawing up a binding agreement or contract are not incurred prematurely.

All term sheets contain information on the assets, initial purchase price including any contingencies that may affect the price, a timeframe for a response, and other salient information.

Term sheets are most often associated with startups. Entrepreneurs find this document crucial for investors, often venture capitalists (VC), who may offer capital to fund startups. Below are some conditions that a startup term sheet defines:

  1. It is nonbinding. Neither the entrepreneur nor the VC is legally obligated to abide by whatever is outlined on the term sheet.
  2. Company valuations, investment amounts, the percentage of stakes, and anti-dilutive provisions should be spelled out clearly.
  3. Voting rights. Startups seeking funding are usually at the mercy of VCs who want to maximize their investment return. This can result in the investor asking for and obtaining a disproportionate influence on the company's direction.
  4. Liquidation preference. The term sheet should state how the proceeds of a sale will be distributed between the entrepreneur and the investors.
  5. Investor commitment. The term sheet should state how long the investor is required to remain vested.

A term sheet used as part of a merger or attempted acquisition would typically contain information regarding the initial purchase price offer, the preferred payment method, and the assets included in the deal. The term sheet may also contain information regarding what, if anything, is excluded from the deal or any items that may be considered requirements by one or both parties.

Similar Documents to Term Sheets

A term sheet may seem similar to a letter of intent (LOI) when the action is predominately one-sided, as in acquisitions, or a working document to serve as a jumping-off point for more intensive negotiations. The main difference between an LOI and a term sheet is stylistic; the former is written as a formal letter while the latter is composed of bullet points outlining the terms.

Although term sheets are distinct from LOI and memorandums of understanding (MOU), the three documents are often referred to interchangeably because they accomplish similar goals and contain similar information.