Term sheets provide an important first step in the financing process, as they outline the basic terms and conditions of an investment. They are the main document used to negotiate between the company, or Issuer, and the investor. While there are no universal criteria for a term sheet and contents vary among agreements, term sheets typically include details on the financing partnership and equity split, investment amount and/or proposed valuation of the Issuer, voting rights and board seats of the investor, liquidation preferences, and other related capital structure pieces. In addition, they may also include other covenants and provisions such as anti-dilution protection and investor commitment.

The negotiation process of a term sheet is a critical step in raising capital and is often lengthy. Depending on the complexity of the deal, the negotiation process involves the Issuer and its legal advisor, the investor, and their legal advisor. When multiple investors are involved, a lead investor might also be included in the process.

Given the importance of capital raising, terms sheets also serve to protect the investors’ interests. For example, investors may require certain covenants planned for the company, such as monopolistic protection and mandatory dividend payout. This ensures that Issuers use the funds in a disciplined manner and the investors are able to realize a return.

Term sheets play a pivotal role in the financing decisions of entrepreneurs and venture capitalists and are the beginning of structured capital investment deals. They provide a legal framework to the terms that make up a deal, while being flexible enough to accommodate the differing designations that separate venture capital deals from more traditional business financing. As such, they are a fundamental tool in the venture capital game.