In the investment and business world, every startup or company that attracts funding needs to formalise key agreements with investors. For this purpose, a term sheet is used — a document that agrees on the deal's main terms and helps structure the future partnership. It is a key tool that helps avoid misunderstandings, speeds up the negotiation process and protects the interests of all parties.

What is a term sheet?

A term sheet is a preliminary agreement between an investor and a startup which defines the basic terms of a future investment treaty. This document is not legally binding (except for certain clauses such as confidentiality or exclusivity). However, it serves as a basis for the signing of a more detailed document.

Why do we need a term sheet in business and investment?

The term sheet plays a key role in the investment attraction and business development process. Its main purpose is to create a clear and structured basis for a future deal between the company and the investor. Thanks to this document, both parties can align their expectations at an early stage, avoid possible contradictions and simplify the negotiation process.

Defining the key terms of the deal

When raising investment, it is important to agree in advance on the key terms of the deal, such as the amount of investment, the valuation of the business, the financing structure and the rights of the investor. A term sheet allows you to capture all these details to avoid disagreements at a later stage.

Speed up the investment process

Without a pre-agreed term sheet, negotiations can take a long time as each party makes changes and refinements throughout the process. Clearly defined terms of agreement help to minimise time costs and move quickly to the signing of legally binding documents.

Protecting the interests of all parties

Both the startup and the investors want to protect their interests. The term sheet provides for certain protections, such as investor voting rights or rights of first refusal, protection against dilution of an investor's stake if additional funding is raised, and restrictions on founders selling shares or starting a competing business.

Ensuring transparency in negotiations

Successful investment deals are based on trust. A term sheet helps to make the negotiation process transparent by formalising all the key parts of the future deal in a structured way. This avoids misunderstandings and creates a favourable climate for further co-operation.

Simplification of the legal handling

Once the term sheet has been agreed upon, drafting the final legal documents becomes much easier. The basic terms have already been defined, so lawyers can focus on detail and legal compliance rather than resolving disputes between the parties.

Flexibility and the ability to change

Unlike a definitive agreement, the term sheet remains a flexible document. The parties can make changes and adjustments to reflect new circumstances or additional wishes of the investors and the startup.

Main elements of Term Sheet

Parties involved in the deal

There are usually two main parties involved in the term sheet process: the investor and the company. Each has its objectives, interests and obligations, which are set out in the document. Other contributors, such as legal advisers and financial analysts, may also be involved.

Company (startup)

A company seeking investment has the following objectives.

Prepare a business plan and financial projections for investors; Present its vision and strategic goals; Agree on terms of the investment agreement that will be mutually beneficial; Fulfil the commitments made once the final agreement is signed.

Investors

Investors can be venture capital funds, business angels or companies that invest in promising projects. Their main objectives are.

Evaluate the company's potential and growth opportunities; Negotiate favourable investment terms; Obtain a stake in the company and associated rights (e.g. voting rights, right of first refusal to buy back shares, etc.); Protect their investment and provide exit mechanisms.

Key terms of the agreement

The term sheet contains key provisions that define the structure of the agreement and the mechanisms for cooperation between the investor and the company. Key terms include.

• Valuation of the company. Determines the market value of the company before and after the investment. The share that the investor will receive depends on this;
• The size of the investment. Determines the amount the investor is prepared to give in the company and the order in which it is provided (all at once or in stages);
• Type of financing. The investment may take the form of direct investment in shares, convertible bonds or other financial instruments;
• Corporate governance. Regulates voting rights, investor participation in decision-making and the ability to appoint directors;
• Protection against share dilution in the event of new rounds of financing;
• Investor rights. Includes provisions on the right of first refusal to repurchase shares, access to financial statements and the ability to block certain company decisions;
• Exit conditions. Define how an investor can sell its stake and realise a profit;
• Restrictions on founders. Provide for prohibitions on selling shares, setting up a competing business, etc.

Rights and obligations of the parties

The term sheet sets out the rights and obligations of each party. This is necessary to avoid future conflicts and ensure effective cooperation.

Company rights

To obtain funding on agreed terms, retain control of operations, and use funds raised to develop the business.

Responsibilities of the company

To provide investors with up-to-date financial and legal information; to meet the agreed terms of the transaction; to fulfil the strategic development plan.

Investor rights

To receive a stake in the business; to influence key decisions of the business; to be able to exit on favourable terms.

Investor responsibilities

Provide investment within the agreed timeframe; maintain confidentiality of the transaction; do not interfere with the operation of the business (unless otherwise agreed).

Legal effect of term sheet

This document is usually not legally binding, but there are certain exceptions.

Non-binding provisions

Basic business terms (investment amount, deal structure, corporate governance) are typically advisory and cannot be enforced without signing the final agreement.

Legally binding provisions

Some term sheet clauses may be legally enforceable, such as confidentiality (prohibiting disclosure of deal details), exclusivity (the company cannot negotiate with other investors for an agreed period) and closing obligations (conditions that must be met before the final agreement is signed).

Consequences of breaching the term sheet

If either party breaches the mandatory provisions, it may be held liable under the law.

Is the term sheet binding?

A term sheet is a preliminary document that sets out the key terms of an agreement between investors and a company. It is an important step in the process of raising investment, but whether it is legally binding remains open.

There are cases where the term sheet may be enforceable.

• If the document clearly states that some or all of its provisions are binding;
• Both parties have signed the document, stating that it has the force of a legal contract;
• If, in the course of fulfilling its terms, one of the parties has acted in bad faith, contrary to the agreement.

Although this document is not always legally binding, it has influential practical implications.

• It helps the parties to agree on key terms without having to expend resources on complex legal documents at the outset;
• It protects both parties from future misunderstandings and conflicts;
• It allows the parties to determine quickly whether they can find common ground on key aspects of the transaction.

To avoid risk, the document should make clear which provisions are legally binding and which are not.

How to compose a term sheet correctly?

Key steps to consider when drafting a term sheet

Define the key terms of the agreement

Before you start working on a term sheet, you should clearly define the key terms that will govern the relationship between the parties. These include.

• Valuation of the business before and after the investment is raised;
• The amount of funding the investor will provide;
• Type of investment. Direct investment, convertible notes, SAFE, or something else.

Consider the interests of all parties

To successfully sign a term sheet, the interests of the investor and the company founders must be balanced. The investor wants to obtain favourable terms and reduce risk, while the company wants to retain flexibility in decision-making and minimise the loss of control.

Clearly articulate the rights and obligations of the parties

One of the most important aspects is to spell out the rights and obligations of each party, such as the investor's voting rights on the board of directors, preferential rights to repurchase new shares and dilution protection mechanisms.

Define the exit mechanism for the investor

The term sheet should outline the investor's exit strategy, including options such as an IPO, M&A, or share buyout.

Protecting investors from risk

Additional terms may be included in the term sheet to mitigate potential risks. These include.

• Protection against share dilution if new capital is raised at a lower valuation;
• Restrictions on the founders selling their shares or setting up a competing business;
• Confidentiality clauses, i.e. prohibiting the disclosure of information about the transaction.

Flexibility

Because the term sheet is a preliminary document, it should remain flexible and allow for changes to the final agreement. The parties must understand which provisions are binding and which can be revised in the next stages of negotiations.

Legalisation

Although a term sheet is not normally a legally binding document, it provides the basis for the preparation of the final investment agreement. It should, therefore, be drafted with all legal aspects in mind to avoid potential disputes and speed up the signing process.

Risks when concluding a Term Sheet

If the parties fail to consider the potential pitfalls, it can lead to financial losses, legal problems or even the collapse of the deal. Let's look at the main risks that can arise when entering into a term sheet and how to avoid them.

Legal uncertainty

A term sheet can confuse because it is not binding. Investors or the company can unilaterally change the terms or even walk away from the deal, resulting in financial and reputational losses.

Dangerous restrictions for founders

Some term sheets contain provisions that significantly restrict the rights of the founders. For example, prohibitions on working for competing firms after leaving the company, restrictions on selling shares, and excessive investor control over operations.

Financial risks and hidden costs

A company may face additional costs if the term sheet does not provide clear financial terms. For example, an investor may insist on high dividends or hidden commission payments.

Common mistakes and how to avoid them

Failure to clearly define key terms

Inadequately specific or vaguely defined terms can lead to future conflicts. For example, an incorrectly defined valuation of the company or a lack of clear provisions on investor rights.

How can you avoid this? Define all terms and conditions as precisely and unambiguously as possible; agree on key financials and commitment principles at the negotiation stage of the term sheet; and use legally correct language.

Ignoring legal aspects

The term sheet may contain legal traps that restrict the company's rights or give excessive benefits to investors.

How can you avoid it? Ensure that an experienced lawyer analyses all the provisions of the document; also carefully review the veto provisions, exit mechanisms and obligations of the parties.

Lack of mechanisms to protect against share dilution

Founders can lose a significant shareholding by attracting the next investors at a lower valuation.

How can this be avoided? Provide anti-dilution protections that protect the interests of existing shareholders in the event of future investments; also, carefully spell out the terms of subsequent funding rounds.

Unequal distribution of rights between the parties

The investor may gain excessive control over the company, restricting the founders' freedom of action.

How can this be avoided? Clearly define the corporate governance structure, avoid excessive investor influence on strategic decisions, and limit veto power over key decisions.

Lack of exit strategy

Failure to identify possible exit options for an investment can lead to difficulties in the future.

How can this be avoided? Define the terms of the investor's exit (IPO, share buy-back, sale of the business); agree on timing and exit procedures at the outset.

Lack of attention to confidentiality

The terms of the term sheet may become known to competitors or other potential investors, which could harm the business.

How do you avoid the above? Include a confidentiality and non-disclosure clause; restrict access to the document to key people.

Rushing to sign the agreement

Insufficient analysis of the terms and conditions can lead to adverse consequences.

How do you avoid this? Take sufficient time to review each clause; do not sign the document until all details have been disclosed and understood.