Anatomy of a Venture Capital Term Sheet

Click to download a PDF of this example term sheet.

A term sheet is simply a non-binding document outlining the terms of a proposed investment. If accepted, it becomes a guide for the lawyers who will draw up the actual legal documents required to complete the financing. As with anything, all of these terms are negotiable. Let’s dive in and understand what the terms mean.

This example is for a venture capital Series A (first equity financing). Remember that venture capital investors are buying stock in your company (it’s not a loan), with the expectation that they will sell the stock at a large profit in the future, either when the company is acquired (by another company), or has an Initial Public Offering (an IPO, when the stock is sold to the public). They also want some protection if things don’t work out and the company has to be wound-down and the remaining assets sold-off. Here are the items on a typical venture capital term sheet, followed by an explanation of each in italics:

• Securities to issue: Shares of a new series of preferred stock of the Company (the “Series A”). This means that in return for their investment, the investors will be issued stock. 

• Aggregate Proceeds: $1,000,000 in aggregae new capital. There may be several invetors in this round, for a total of a million dollars. 

• Price per Share: Based on a pre-money valuation of $2,000,000, including an available option pool of 20% of the post-money fully diluted capital of the Company. This means that the pre-money valuation will be $2M, and that the company is carving-out an option pool in order to recruit and retain great talent by being able to offer stock options to employees. 

• Liquidation Preference: One times the Original Issue Price plus declared but unpaid dividends on each share of Series A preferred stock. A merger, reorganization or similar transaction will be treated as a liquidation. This says that in the case of a future liqidation of the company, the investors will get their original investment back before anything is distributed to the founders, employees, and other common shareholders. This one says “One times the original” investoment, but a more agressive term sheet might say “two times”, meaning that the investors will put $1M into the company, and if liquidated they will get the first $2M before anyone else gets anything. Pay attention to this one!

• Conversion: Each share of Series A is convertible into one share of Common Stock at any time at the option of the holder. Investors want to hold preferred stock until the IPO, when they want to convert to common stock and sell. This gives them the right to do so, on a 1:1 basis.

• Voting Rights.  Votes together with the Common Stock on all matters on an as converted basis.  Approval of a majority of the Preferred Stock required to liquidate or dissolve, including any change of control. This says that the preferred shareholders (investors) get to vote on everything as if they had converted to common stock (ie, their vote counts as much per share as founders and employees), but that selling or liquidating the company requires a majority vote of the investors (ie, you can’t sell the company without their approval).  

• Voting for directors: The holders of Series A Preferred will be entitled to elect two directors. The holders of common stock will be entitled to elect three directors. Any additional directors will be elected by the holders of preferred stock and common stock voting together. This defines the initial Board of Directors as having two seats chosen by the investors and three seats chosen by the founders. This should map closely to the percentage of stock owned. In this example, the investors will hold 41% of the company and have 40% of the board seats.

• Financial Information: Purchasers who have invested at least $100,000 (“Major Purchasers”) will receive standard information and inspection rights. This means that anyone who invested more than $100K can call you anytime and ask for current financial information, etc. But your cousin Sam who put $2K in can’t do that. 

• Proprietary information agreements: The Company will have all employees and consultants enter into proprietary information and inventions agreements. Very standard. They want to make sure that all the IP created belongs to the company, not the founders and employees.

• Future Rights: Major Purchasers will have the right to participate on a pro rata basis in subsequent issuances of equity securities. This means that on your next round (Series B) of financing, these investors will have the right to also invest in that round if they want. 

• Key Holder Matters: Each Key Holder will have four years vesting beginning December 2, 2023. Full acceleration upon “Double Trigger.” Each Key Holder shall have assigned all relevant IP to the Company before closing. You are your co-founders are “Key holders”. If you wrote the software code (IP) personally you will need to assign it to the company (so that it’s clear that it’s owned by the company and investors, not you). Also, your founders’ stock will need to put on a vesting schedule, so that you don’t leave the company in less than four years. If the company is sold and you are fired (“double trigger”), then the vesting is accelerated and you get all your stock back. Founders scream (“I already own my founders’ stock, you can’t put it on a vesting schedule!”, and venture capitalists just smile and explain they need protection to make sure you don’t leave). 

• Expenses: Company to reimburse counsel to Purchasers for a flat fee of $25,000. That’s right! You get to pay your lawyer and the investors’ lawyer for handling the financing transaction! This may seem bizarre, but it is considered standard because VC’s want the transaction expenses to be paid by the fund. 

• Diversity Rider: In order to advance diversity efforts in the venture capital industry, the Company and the lead investor, Delicious Ventures, LLC, will make commercial best efforts to offer and make every attempt to include as a co-investor in the financing at least one Black or other underrepresented group including, but not limited to LatinX, women, LGBTQ+ check writer (DCWs), and to allocate a minimum of 10% or $100,000 of the total round for such co-investor. A rider that can be added into a term sheet, in an attempt in get more diversity within investment syndicates. 

• Binding Terms: For a period of 30 days, the Company will not solicit offers from other parties for any financing.  Without the consent of Purchasers, the Company will not disclose these terms to anyone other than officers, directors, key service providers, and other potential Purchasers in this financing. Once the term sheet is signed, the parties agree to work to close the deal within 30 days. During that time, you cannot go out and try to find an investor who will beat these terms, nor will you tell anyone else about these terms. 

These are the typical items you will find on a standard term sheet for a Series A venture capital financing, but they will vary depending on the investor, the company, and advice of counsel. I’m providing this simply in the hope that it will be helpful to you to be familiar with some of these terms as you pursue your own startup venture. But I ain’t no lawyer, and I don’t intend any of this to be legal advice.