A term sheet is the document that arrives before the real paperwork does. It's a short, mostly non-binding summary of the key conditions under which an investor will put money into a company, or one party will acquire another. Founders and small-business owners often treat it as a formality. It isn't. The term sheet sets the framework that lawyers then lock into binding contracts, and the assumptions baked into it can shape how much of your company you actually own five years from now.
What a term sheet actually contains
Most term sheets cover a handful of core areas. Valuation comes first: specifically, the pre-money valuation (what the company is worth before the investment) and the post-money valuation (what it's worth after). If an investor offers $2 million at a $8 million pre-money valuation, the post-money figure is $10 million and the investor owns 20 per cent. Simple enough. But that arithmetic changes fast once other clauses enter the picture.
Liquidation preferences are the clause founders most often underestimate. A 1x non-participating preference means the investor gets their money back first in a sale before anyone else sees a dollar, but then stops there. A 2x participating preference means they get double their money back and then share in whatever's left. That distinction can mean the difference between founders walking away with something meaningful and walking away with close to nothing.
Anti-dilution provisions are next. These protect investors if the company raises a future round at a lower valuation, a "down round". Broad-based weighted-average anti-dilution is the more founder-friendly version. Full ratchet anti-dilution is the harsher one: it resets the investor's price to the new, lower price per share, often wiping out a significant chunk of founder equity in the process.
Other standard items include:
- Board composition: who gets a seat, and whether investors get veto rights over key decisions.
- Pro-rata rights: whether existing investors can participate in future rounds to maintain their ownership percentage.
- Vesting schedules: how founders earn their equity over time, and what happens if they leave early.
- Drag-along rights: whether a majority can force minority shareholders to vote in favour of a sale.
Binding versus non-binding: a critical distinction
Most of a term sheet is non-binding. The valuation, the equity split, the board structure: none of these create legal obligations until they're written into a shareholder agreement or a share subscription agreement. But two sections almost always are binding: the exclusivity clause and the confidentiality clause.
Exclusivity, sometimes called a "no-shop" provision, means you can't talk to other investors for a set period, typically 30 to 60 days, while due diligence is underway. That's a meaningful commitment. If the deal falls apart at week eight, you've lost two months of fundraising time and the momentum that came with it.
Confidentiality prevents you from disclosing the terms to outside parties. That's standard practice, but it also means you can't casually shop the term sheet around to create competitive tension without risking a breach.
Understanding what you're actually signing is not just a legal question; it's a strategic one. If you're raising venture capital for the first time, our earlier piece on what venture capital is and how it works covers the broader funding landscape and helps put a term sheet in context.
Common mistakes founders make with term sheets
The most common mistake is rushing. An investor who says "sign this by Friday or we move on" is creating artificial urgency. Serious investors don't evaporate because a founder took a week to get legal advice. Any pressure to skip that advice should itself be a signal.
Second mistake: focusing on valuation alone. A $12 million pre-money valuation with a 2x participating liquidation preference and full ratchet anti-dilution can deliver worse outcomes for a founder than a $9 million valuation with clean, standard terms. The headline number is not the deal. The deal is all the clauses underneath it.
Third mistake: ignoring governance. A term sheet that gives an investor board control, combined with veto rights over hiring and spending above a low threshold, can leave a founder unable to run their own business without sign-off. That's not hypothetical. It's a common outcome for first-time founders who didn't read the governance section carefully.
It's also worth understanding how a term sheet connects to your company's broader ownership structure. If you've already got co-founders or early employees holding equity, the dilution maths get complicated quickly. Knowing your obligations under any existing shareholders' agreement before you sign a term sheet can prevent some very awkward conversations later.
What to do when you receive one
Get a lawyer. Not your uncle who does conveyancing. A lawyer who works with startups and understands venture capital terms. The cost is real, but it's far smaller than the cost of signing away rights you didn't realise you were giving up.
Run the numbers on every scenario. Model out what you receive if the company sells for $5 million, $15 million, and $50 million. Look at each scenario with and without the liquidation preference kicking in. The investor's counsel did this already. You should too.
Ask questions. A reputable investor won't be offended when a founder asks why a particular clause is structured the way it is. If they are, that's useful information about what the relationship will look like after the money arrives.
Finally, compare terms across multiple offers if you have them. Term sheets aren't standardised. The National Venture Capital Association publishes model documents that set a useful baseline for what "standard" looks like, even if you're raising in Australia. The Australian Investment Council also provides guidance specific to the local market. Knowing the baseline makes it easier to spot when a clause is genuinely unusual.
A document worth taking seriously
A term sheet doesn't close a deal. It opens one. The clauses inside it will shape the legal documents, the board dynamics, the dilution outcomes, and ultimately how much of the business you own when it either succeeds or fails. Most founders only receive a handful of term sheets in their careers. Read every one as if it's the most important contract you'll sign. It often is.