What is a term sheet? How to read one before you sign

What is a term sheet? It is a short document that sets out the proposed terms of an investment before lawyers draft the agreements that actually bind the parties. It is usually the first piece of paper that follows a verbal "yes" from an investor, and it exists so that both sides can agree on the shape of the deal, valuation, how much money, what kind of shares, who controls what, before either side pays a lawyer to write the long version.

Most of a term sheet is deliberately not binding. That is the point: it lets people negotiate the commercial bargain cheaply, in plain English, before the expensive part starts. But "mostly not binding" is not the same as "safe to sign without reading", and a few clauses inside it usually do bind you the moment you sign.

What is actually binding, and what is not

The headline investment terms, valuation, amount, share class, are normally expressed as proposals: subject to due diligence, subject to board approval, subject to definitive agreements. Either side can walk away from those without being sued for breach of contract, although walking away late and without good reason can damage a reputation that matters more than any single deal.

A small number of clauses are different. Confidentiality, exclusivity (a promise not to shop the deal to other investors for a set period) and who pays costs if the deal falls through are routinely drafted to be binding from signature, even inside a document whose other nine pages are not. A UK court has held that a document labelled a "term sheet" can be enforceable as a whole, depending on its actual wording and what the parties objectively intended, so the title on the front page proves nothing by itself. Read every clause for its own status rather than assuming the document has one status throughout.

The economic terms

These decide how much of the company you own and what you get back, and in what order.

Valuation and investment amount. The pre-money valuation is what the company is agreed to be worth before the new money arrives. Add the investment to get the post-money valuation, and the new investor's stake is simply the investment divided by the post-money figure. A higher headline valuation is not automatically a better deal for existing shareholders once the other terms are factored in, which is the whole reason the rest of this list exists.

Type of security. A priced equity round issues a defined class of shares with its own rights, set out in the term sheet. Many early rounds instead use a SAFE or a convertible note, which defer the valuation question to a later round; those documents have their own short-form term sheets, simpler than a full priced round but still worth reading clause by clause.

Liquidation preference. This decides who gets paid first, and how much, if the company is sold or wound up. The most common structure is a 1x non-participating preference: on a sale, the investor can take back the amount they put in before anyone else is paid, or convert to ordinary shares and take their percentage instead, whichever is worth more to them. A participating preference lets them do both, take the preference and then share in what is left, which is more favourable to the investor and correspondingly less favourable to founders and employees in a modest exit.

The control terms

Two term sheets with an identical valuation can still produce very different outcomes because of what sits underneath the price.

Board seats and protective provisions. Investors often ask for a board seat, information rights, or a list of major decisions, a new funding round, taking on debt, selling the company, that need their consent. These matter more in practice than most of the economic terms, because they decide who can act and who can block.

Pre-emption and pro-rata rights. An investor may ask for the right to maintain their percentage ownership in a future round. In the UK, existing shareholders already have a statutory right of first refusal on most new share issues under section 561 of the Companies Act 2006, subject to exceptions and to the company's articles disapplying it. In the US there is no equivalent statute for private companies, so a term sheet instead creates a contractual pro-rata right that does the same commercial job without the same legal footing.

Anti-dilution and vesting. Anti-dilution provisions protect an investor's effective price if the company later raises money at a lower valuation. Vesting schedules, more often applied to founders' own shares than to investors, spread ownership over a period so that someone who leaves early keeps only part of their stake.

A worked example

The figures below are an illustration built for this article, not a real transaction, and they show how the same deal looks very different depending on how it ends.

The headline numbers, a £6 million valuation and a 20% stake, are identical in both outcomes. What changes the result for everyone else is a single clause most people skim past on page three.

UK and US differences worth knowing

The vocabulary shifts slightly by country and by deal type. UK acquisitions of an established business more often use the term "heads of terms" for the equivalent preliminary document, while "term sheet" is the usual label for an early-stage investment on either side of the Atlantic. In the US, venture rounds led by a professional investor frequently start from a standard-form template, such as the suite of model financing documents published by the National Venture Capital Association, which the term sheet then customises for the specific deal. UK angel rounds are less standardised and more often drafted from scratch or from a platform's own template, so there is more value in having someone who has seen several of them look at yours before you sign.

Anyone eligible to be shown a deal in the first place has usually already completed separate paperwork confirming their investor category; our guide to becoming an angel investor covers what that involves. If the round qualifies for SEIS or EIS relief in the UK, that is a separate compliance process that runs alongside the term sheet rather than inside it, covered in our plain-English guide to SEIS and EIS.

What to do before you sign

Read the whole document once for the economics and once for control, because the two can tell different stories about the same deal. Identify which clauses bind you immediately and decide whether you are comfortable with those specifically, separately from the rest. Model at least one disappointing outcome, not just the one everyone hopes for, using real numbers from the cap table rather than the headline valuation alone. If anything is unfamiliar, ask before you sign rather than after; our guide to what an angel investor actually does describes the kind of groundwork experienced investors do before they commit, and the Republic of Investors community is a reasonable place to ask how a specific clause compares with what others have seen. None of this replaces a qualified lawyer reading the actual document, but it means you go into that conversation knowing what to ask.

Common questions

Is a term sheet legally binding? Mostly not, on the main investment terms, but confidentiality, exclusivity and cost clauses are routinely drafted to bind from signature, and courts look at the document's actual wording rather than its title. Read each clause for its own status.

What is the difference between a term sheet and heads of terms? They do the same job, a short, mostly preliminary statement of a deal's main points, but "heads of terms" is the more common label in UK business acquisitions, while "term sheet" is the usual term for an early-stage investment in a company.

Do SAFEs and convertible notes use a term sheet too? Often a short one. Because a SAFE or convertible note defers the valuation decision to a later round, its term sheet is simpler than a priced equity round's, but it still sets out the discount, any valuation cap, and what happens if the company is sold before it converts.

Who normally writes the first draft? Usually whoever is leading the round or the deal: the lead investor in a venture financing, often starting from a standard template, or either the buyer or the seller's adviser in a business acquisition. Either side can propose changes before it is signed.

Can I negotiate a term sheet, or is it take-it-or-leave-it? It can usually be negotiated, particularly on control terms rather than valuation, and investors expect some back-and-forth. The practical limit is leverage: a company with several interested investors has more room to push back than one with a single offer on the table.