A term sheet is one of the most important documents that every startup has to deal with for raising capital. After receiving interest, an investor extends a term sheet, which gives an outline to both parties and sets the base for future discussions. Understanding the term sheet is very important to ensure a startup gets the best benefit from the deal. 

Most of the VC Firms have begun to trim the size of the term sheet, reduce jargon and improve readability. This ensures that the documents are startup friendly, and both the parties can focus on executing the deal. However, even after all the efforts by VC Firms, a first time founder might find it overwhelming, since term sheets aren’t dealt by startups on a daily basis. 

A startup founder might discuss with the legal team and understand the essential terms, but it’s easy to get lost in minutiae. Few terms might be there just to throw you off the scent, and you might lose focus on the important parts. It’s important that a startup understands what’s important and what’s not, to get the best out of the deal.

Understanding Core Aspects

Brad Feld, in his book Venture Deals, says that every term sheet, irrespective of the terms used, and the size of the document, focus majorly on two fundamental aspects, namely Economics and Control. Let’s discuss both of them in detail below:

Economics: It refers to the economic benefit an investor can gain from the startup. In general, an investor can get returns in different exits, i.e. by selling shares in the next round of funding, or making an exit during IPO, etc. To ensure maximum benefit, an investor will focus on including terms that can maximize the firm’s return. 

Many terms included in the term sheet relate to addressing the investor’s economics, i.e. pre/post money valuation, liquidation preferences, pay-to-play provisions, ESOPs, etc. Few of the important terms are explained below:

1. Price: It shares details on the valuation at which the startup is being funded. Price refers to the current price per share of the company. Based on the number of shares, we can calculate the startups’ pre-money valuation. When the funds raised in this round are also included, it is called as post-money valuation.
2. Liquidation Terms: These terms give details of the payout to investors in the case of an exit, i.e. in the event of liquidation, or raising another round of funding, etc. For example, let’s say that an investor has invested 5 million dollars at 20 million post money valuation at 2x multiple. If the company is receiving an exit at 40 million, it means that the investor will receive 10 million dollars. The remaining will be shared within the founding team.
3. Participation Terms: Including this term in a deal would mean that the investor will get to ‘double-dip’ in the event of an exit. For example, if an investor has invested 5 million dollars at 20 million post money valuation with 2x multiple, it means that the investor holds 25% stake in the company. At an exit value of 40 million dollars, the investor will receive 10 million dollars first (2x multiple, liquidation preference). Of the remaining 30 million dollars, 25%, i.e. 7.5 million dollars will go to the investor, and the remaining 22.5 million will go to the founders. 
4. ESOPs: To ensure that the startup has enough equity available to compensate for future roles, the investor sets a requirement for ESOPs in the cap table. Carving out a chunk of stake for ESOP ensures that the investors won’t have to dilute their equity for scaling the team in future. 

We have explained a few terms to give an idea of how these terms influence the economics of the deal. The rest of the terms will be covered in the upcoming articles. 


Control: It refers to the control the investors have over the company. In a few situations, a VC Firm and startup might have differing opinions. For example, a startup might take risky decisions which can break the company. Likewise, a VC Firm might find an exit with a favorable investor’s outcome, but the founders’ may not like it. 

Though a VC Firm would prefer to give autonomy, it would choose to have enough control for critical decisions. To prevent any unforeseen circumstances, an investor would add relevant clauses and ensure funds’ safety. 

Different terms like Composition of Board of Directors, Protective Provisions, Drag Along, Conversion Terms, etc. provides more control to the investors. Few of the important terms are explained below:

1. Board of Directors: This clause provides a brief of the composition of the board of directors in the company. An VC Firm will ensure that they have enough seats on the board to have controlling power over crucial decisions taken by the company.
2. Protective Provisions: It refers to different clauses included by the investor to secure their investment from any unforeseen situations. There are many clauses like anti-dilution that prevents investors’ stake from dilution on a down-round, drag-along where the majority of investors gets to take a call, conversion terms, etc.

There are many other terms that cover different aspects in terms of control. Rest of the terms will be covered in the future articles. Overall, every term sheet, in fundamental terms, revolves around these two aspects. Understanding them will help the startups’ understand the term sheet well. 

In the Final Analysis

A term sheet for the first time founder can be quite intimidating. However, focusing on the core aspects can ease the process. 

Most of the clauses in the term sheet can be categorized under economics and control. Focusing on how each term influences one of the categories can be an easy way to understand the offer at hand. Moreover, it will also give an insight into the investor’s perspective, based on which terms are highlighted in the sheet. 

With this, a startup can always ensure that it never loses sight of the goal at hand, and secure a favorable deal.