Term sheets

Comprehensive guide to term sheets for equity financing and convertible notes, including Series Seed and other standard forms

A term sheet is a non-binding document that outlines the principal terms of a proposed investment. It serves as the foundation for negotiation and the basis for drafting definitive legal agreements.

Except for specific binding provisions like exclusivity and confidentiality, term sheets are expressions of intent and do not create legally binding obligations until definitive agreements are executed.

Understanding term sheets

Term sheets bridge the gap between initial investor interest and final documentation. They allow both parties to align on key economic and control terms before investing time and legal fees in comprehensive agreements.

Why term sheets matter

Set expectations early

Term sheets establish clear expectations on valuation, investment amount, investor rights, and founder obligations before significant legal costs are incurred.

Framework for negotiation

They provide a structured format for negotiations, ensuring all critical terms are discussed and agreed upon.

Speed to closing

With terms agreed upfront, drafting definitive agreements becomes largely mechanical, accelerating the path to closing.

Reference for legal counsel

Term sheets give attorneys clear direction on deal structure, reducing back-and-forth and legal costs.

Types of term sheets

Different financing instruments require different term sheet structures.

Equity term sheets

Used for direct sales of preferred stock. These establish:

• Valuation: Pre-money or post-money valuation
• Securities: Type and amount of preferred stock
• Liquidation preference: Priority in exit scenarios
• Voting rights: How preferred stock votes
• Board composition: Number and selection of directors
• Protective provisions: Actions requiring investor approval
• Information rights: Financial reporting obligations
• Participation rights: Pro rata rights in future rounds

Example sources:

• Series Seed Term Sheet (Equity)
• Y Combinator Series AA Term Sheet
• NVCA Series A Term Sheet

Convertible note term sheets

Used for debt that converts to equity at a future qualified financing:

• Principal amount: Investment size
• Interest rate: Annual interest (typically 2-8%)
• Maturity date: When note must be repaid or converted
• Discount: Conversion discount (typically 15-25%)
• Valuation cap: Maximum conversion valuation
• Qualified financing threshold: Minimum raise to trigger conversion
• Change of control: Treatment on acquisition

Example sources:

• Series Seed Term Sheet (Convertible Note)
• Techstars Bridge Term Sheet

SAFE term sheets

SAFEs are so simple they typically don’t require separate term sheets - the SAFE itself serves as the complete agreement. However, some investors may want a summary term sheet covering:

• Investment amount
• Valuation cap (if applicable)
• Discount rate (if applicable)
• Pro rata side letter (optional)
• MFN provision (most favored nations)

See our SAFE agreements guide for more details.

Key term sheet provisions

Understanding each provision helps you negotiate effectively and protect your interests.

Economic terms

1. Valuation

   The pre-money valuation determines what percentage of the company investors receive. For example:

   • Pre-money valuation: $8M
   • Investment: $2M
   • Post-money valuation: $10M
   • Investor ownership: 20%

   Series Seed documents include an option pool calculation. Make sure you understand whether the option pool comes from pre-money or post-money shares.

2. Liquidation preference

   Defines the order and amount of payouts in a liquidation event (sale, merger, or dissolution).

   Standard Series Seed terms: 1x non-participating preference

   • Preferred gets 1x their investment back first
   • Remaining proceeds distributed to common stock
   • Preferred can convert to common if that yields more

   Avoid participating preferred with multiple liquidation preferences in early rounds - these can create misaligned incentives and complicate future financings.

3. Anti-dilution protection

   Protects investors if you raise future rounds at a lower valuation (a “down round”).

   Series Seed standard: Broad-based weighted average

   • More founder-friendly than full ratchet
   • Adjusts conversion price based on new round size and price
   • Optional in Series Seed (can be excluded)

Control and governance terms

Board composition

Defines the size and composition of your board of directors.

Typical seed stage structure:

• 1-2 common stock directors (founders)
• 0-1 preferred stock directors (lead investor)
• 0-1 mutual consent directors (independent)

Series Seed approach: Flexible based on round size and investor involvement

Board of Directors: 3 members
- 2 elected by Common Stock (founders)
- 1 elected by Series Seed Preferred (lead investor)

Protective provisions

Actions that require approval from preferred stockholders, protecting them from adverse changes.

Standard Series Seed protective provisions require preferred majority approval for:

• Changing rights of preferred stock
• Creating new senior or pari passu securities
• Paying dividends or repurchasing shares (with exceptions)
• Changing authorized share numbers
• Liquidating or selling the company
• Changing board size

These are reasonable protections that most investors expect.

Voting rights

How each class of stock votes on company matters.

Series Seed standard: Preferred votes with common on as-converted basis

• Each preferred share votes as if converted to common
• One vote per common share equivalent
• Separate class votes only for protective provisions

This is the most common and founder-friendly approach.

Investor rights

Information rights

Major Purchasers (typically $25K+ investors) receive:

• Annual unaudited financial statements
• Quarterly unaudited financial statements
• Inspection and visitation rights

Small investors typically don’t receive these rights to reduce administrative burden.

Participation rights

Pro rata rights allow Major Purchasers to maintain their ownership percentage by participating in future rounds.

Example: If you own 10% now, you can invest enough in the next round to maintain 10% after that round closes.

These rights typically include:

• Right to participate pro rata
• Overallotment rights if others don’t participate
• Standard exclusions (employee options, etc.)

Series Seed term sheet walkthrough

Let’s examine a Series Seed equity term sheet in detail, using the standardized form from Cooley LLP.

Offering terms

Series Seed Key Terms

Securities to Issue: Series Seed Preferred Stock
Aggregate Proceeds: $[Investment Amount]
Purchasers: Accredited investors approved by the Company
Price Per Share: Based on pre-money valuation of $[______]
  Including [X]% option pool post-money

Understanding the option pool

The option pool calculation significantly affects founder dilution.

Example:

• Pre-money valuation: $8M
• Investment: $2M
• Post-money option pool: 20%

Two calculation methods:

1. Post-money pool (founder-friendly):
   • Investor pays for 20% of their shares to fund the pool
   • Founder dilution: 20% from investment + portion of pool
2. Pre-money pool (investor-friendly):
   • Full 20% pool carved from founder shares before investment
   • Founder dilution: Higher

Series Seed documents default to post-money calculation.

Conversion terms

Voluntary conversion

Each share of Series Seed Preferred is convertible into Common Stock:

• Initial ratio: 1:1 (subject to adjustments)
• At holder’s option: Any time
• Adjustments: For stock splits, dividends, combinations
• Optional anti-dilution: Broad-based weighted average

Automatic conversion

Preferred automatically converts to common on:

• IPO: Qualified public offering
• Holder vote: Majority of preferred approves

This ensures preferred shareholders participate in liquidity events.

Additional terms

1. Financial information

   Major Purchasers investing ≥ $[threshold] receive:

   • Annual unaudited financial statements
   • Quarterly unaudited financial statements
   • Standard information and inspection rights
2. Participation right

   Major Purchasers have right to participate pro rata in subsequent equity issuances (with standard exceptions).

3. Expenses

   Company reimburses purchaser counsel for flat fee of $[5,000-15,000].

   This is standard for seed rounds. The flat fee caps your legal cost exposure for investor counsel.

4. Key holder matters

   Founders and key employees must:

   • Have 4-year vesting (with 1-year cliff typical)
   • Include “Double Trigger” acceleration on change of control
   • Assign all IP to the company before closing
5. Future rights

   Series Seed automatically receives rights given to later series (with appropriate economic adjustments).

   This protects early investors from being disadvantaged by later rounds.

Convertible note term sheets

Convertible notes are debt instruments that convert to equity at a qualified financing. They’re popular for early-stage rounds because they defer valuation negotiations.

Core provisions

Principal and interest

Principal Amount: Total investment

Interest Rate: Typically 2-8% annually

• Usually simple interest (not compounded)
• Accrues from issuance date
• Converts with principal at qualified financing

Investment: $100,000
Interest: 5% per annum (simple)
Time to conversion: 18 months
Total converting: $107,500

Maturity date

The date by which the note must be repaid or converted, typically 18-24 months from issuance.

What happens at maturity?

Three common approaches in Series Seed documents:

1. Automatic conversion to equity (most common)
   • Converts at pre-set valuation cap
   • Avoids forcing repayment or default
2. Holder option to convert
   • Noteholder chooses conversion or repayment
   • Company may prefer extension
3. Repayment with approval
   • Majority holders can demand repayment
   • Puts pressure on company to raise or exit

Make sure your maturity date gives you enough time to raise a qualified financing. 12 months is typically too short; 24 months is safer.

Qualified financing

The equity round that triggers automatic conversion.

Typical threshold: $500K -$1.5M in new investment

• Excludes notes converting in the round
• Must have “principal purpose of raising capital”
• Can’t be insider round to game the threshold

Conversion mechanics:

Qualified Financing: Series A at $1.00/share
Note discount: 20%
Note conversion price: $0.80/share

$100,000 note balance converts to:
$100,000 ÷ $0.80 = 125,000 shares

Conversion discount

Rewards note holders for early risk by giving them a discount to the qualified financing price.

Typical range: 15-25%

• 20% is most common for seed notes
• Higher discounts for earlier, riskier investments
• Lower discounts with a strong valuation cap

How it works:

• Qualified financing price: $1.00/share
• Note discount: 20%
• Note conversion price: $0.80/share
• Note holders get 25% more shares (1/0.8 = 1.25x)

Valuation cap

Sets a maximum effective valuation for conversion, protecting noteholders if your valuation increases significantly.

Example:

Note terms:

• Valuation cap: $6M
• Discount: 20%

Qualified financing:

• Price: $2.00/share
• Valuation: $12M pre-money
• Outstanding shares: 6M

Conversion price calculation:

Option 1 - Using discount: $2.00 × 80$1.60/share

Option 2 - Using cap: $6M cap ÷ 6M shares =$1.00/share ✓ (better for investor)

Note converts at $1.00/share (the cap price)

Notes typically convert at the lower price between the discount and the cap, giving noteholders the better deal.

Change of control

Defines what happens if the company is acquired before a qualified financing.

Common approaches:

1. Automatic repayment (most common)
   • Company repays principal + interest
   • Optional: +20-50% premium on principal
2. Holder choice
   • Noteholder elects: (a) repayment or (b) convert to common at cap
   • Gives noteholder optionality
3. Automatic conversion
   • Converts to common at valuation cap
   • Noteholder participates in acquisition proceeds

Most Favored Nations (MFN) provision

MFN provisions ensure that if you issue notes with better terms while existing notes are outstanding, prior noteholders automatically get those better terms.

How MFN works:

1. You issue Note A: 5% interest, 20% discount, $5M cap
2. Three months later, you issue Note B: 5% interest, 25% discount, $4M cap
3. Note A’s MFN triggers: Note A automatically adopts 25% discount and $4M cap

Why investors want MFN:

• Protects against being disadvantaged by later notes
• Prevents company from offering better terms to later investors
• Creates parity among all noteholders

Founder consideration:

• Limits flexibility in later negotiations
• May need to offer same terms to all or not improve terms at all
• Can complicate your cap table

Negotiating term sheets

Effective negotiation balances founder interests with investor requirements while maintaining a collaborative relationship.

What to negotiate

Always negotiate

Critical terms that significantly impact your company:

• Valuation: Core economic term
• Liquidation preference multiple: Keep at 1x
• Participation: Avoid participating preferred
• Board composition: Maintain founder control when possible
• Protective provisions: Keep list reasonable
• Vesting acceleration: Double trigger on change of control
• Option pool size: Affects founder dilution

Focus on the terms that matter most for your stage and situation. Don’t fight every battle.

Usually standard

Terms that are typically market standard:

• 1x liquidation preference: Standard for seed
• Pro rata participation rights: Expected for Major Purchasers
• Information rights: Reasonable for investors
• Standard protective provisions: Normal investor protections
• Market stand-off (lock-up): Standard 180 days

Pushing back on standard terms may signal inexperience or unreasonableness.

Red flags

Terms to push back on or avoid:

• Multiple liquidation preferences (2x, 3x): Too investor-favorable
• Participating preferred at seed stage: Creates misalignment
• Full ratchet anti-dilution: Punitive to founders
• Investor control of board at seed: Too early for this
• “No-shop” periods > 45 days: Limits your options too long
• Pay-to-play provisions: Penalizes investors who don’t follow on

If an investor insists on multiple red flag terms, they may not be the right partner for you.

Negotiation best practices

1. Understand market terms

   Research standard terms for your stage, geography, and investor type. The documents in the Startup Starter Pack represent market-standard terms.

   Resources:

   • CooleyGO for Silicon Valley norms
   • NVCA resources for standard forms
   • Your lawyer’s recent deal experience
2. Prioritize your issues

   Identify your top 3-5 most important points. You won’t win every negotiation point.

   Example priorities:

   1. Keep option pool at 15% (not 20%)
   2. Four-year vesting with one-year cliff (not monthly from day one)
   3. Broad-based weighted average anti-dilution (not full ratchet)
   4. Founder maintains board control until Series A
   5. Standard protective provisions only
3. Explain your reasoning

   When pushing back, explain why:

   • “We need a 15% option pool because we only have 2 of our 8 key hires made”
   • “One-year cliff is important because the first year is when we’ll know if this works”
   • “We’d prefer to add an investor board seat at Series A when we’ll have more resources to support board meetings”

   Reasoning is more persuasive than simple rejection.

4. Use your lawyer effectively

   Your lawyer can:

   • Provide market context for each term
   • Play “bad cop” when needed
   • Negotiate technical language
   • Spot issues you might miss

   Have your lawyer review the term sheet before you sign it, not after. Term sheet provisions largely dictate the final documents.

5. Document everything in the term sheet

   If you negotiate a point, make sure it’s reflected in the term sheet. Oral agreements don’t bind lawyers drafting documents later.

   Get amendments to the term sheet in writing before proceeding to definitive documents.

Binding provisions

While most term sheet provisions are non-binding expressions of intent, two sections typically are binding:

Exclusivity / No-shop

During the exclusivity period, you agree not to:

• Solicit other financing offers
• Negotiate with other potential investors
• Disclose the terms to other investors

Typical period: 30-45 days

What happens if you violate:

• Investor can walk away
• Potential lawsuit for breach
• Reputation damage

Don’t sign a no-shop unless you’re serious about closing with this investor. You’re taking other options off the table.

Confidentiality

You agree not to disclose term sheet terms except to:

• Officers and directors
• Professional advisors (lawyers, accountants)
• Other investors in the same round

Duration: Typically survives indefinitely

Purpose:

• Protects investor negotiating strategy
• Prevents information shopping
• Maintains negotiation integrity

From term sheet to closing

Once you sign a term sheet, you’ll move through these phases:

1. Due diligence

   Investors will review:

   • Corporate documents and cap table
   • Financial statements and projections
   • Material contracts and IP
   • Employment agreements
   • Compliance with laws and regulations

   Your job: Respond promptly and completely to all requests

   Timeline: 2-4 weeks for seed rounds

2. Definitive document drafting

   Lawyers will draft:

   • Stock Purchase Agreement or Note Purchase Agreement
   • Restated Certificate of Incorporation (for equity)
   • Board Consent
   • Stockholder Consent
   • Investor Rights Agreement (if applicable)

   Timeline: 1-3 weeks depending on complexity

3. Document review and negotiation

   Review definitive documents carefully:

   • Compare to term sheet - they should match
   • Flag any new provisions not in term sheet
   • Negotiate any problematic language

   If you used Series Seed or other standard forms in your term sheet, definitive documents should be largely mechanical. Major surprises indicate a problem.

4. Board and stockholder approval

   Obtain necessary corporate approvals:

   • Board of Directors approval (always required)
   • Stockholder approval (required for equity rounds)
   • Written consents or meeting minutes

   See our guides on Board Consent and Stockholder Consent.

5. Closing

   Execute final documents and exchange:

   • Investors wire funds
   • Company delivers stock certificates or updates cap table
   • File restated certificate of incorporation (for equity)
   • Update corporate records

   Celebration time! 🎉

Resources and templates

Series Seed documents

Complete Series Seed package including term sheets, stock purchase agreement, and consents

Y Combinator resources

SAFE agreements and Series AA term sheet templates

CooleyGO

Document generators and extensive guides on startup financing

NVCA resources

Model documents for Series A and later rounds

Next steps

SAFE agreements

Learn about Y Combinator’s simple alternative to convertible notes

Convertible notes

Deep dive into convertible promissory note terms and mechanics

Stock purchase agreements

Understand the definitive agreements for equity financing