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If you are considering investing in a startup, a term sheet is a document that helps both parties focus on the key commercial terms of the investment. It is a confidential but otherwise non-binding agreement that sets out the most important aspects of the deal.

Who Provides the Term Sheet?

In family and friends or seed rounds, startup founders will usually issue you the term sheet. In later rounds, especially when it involves venture capital investment, the lead investors will often provide their term sheet for negotiation.

Where an equity round involves several investors, the startup founders usually negotiate the term sheet with the lead investor. Any other investors will then accept the same terms.

What are the Key Terms in a Term Sheet?

Investment and Valuation 

The investment and valuation clause sets out: 

  • the amount you are investing;
  • the minimum and maximum round size;
  • the company’s pre-money valuation (the value of the startup before the investment round takes place) and post-money valuation (the value after the investment round); and 
  • whether the Employee Share Option Plan is part of the pre-money or post-money valuation.

Preference Share Terms

A key term to negotiate is whether you will be receiving ordinary or preference shares. Holders of preference shares receive preferential treatment over ordinary shareholders. This may include the right to: 

  • receive priority in the division of sale proceeds during liquidation;
  • convert preference shares into a higher number of ordinary shares if the startup’s valuation decreases between rounds;
  • preferential dividend payments; and
  • additional voting rights.

Employee Share Option Plans (ESOPs)

An Employee Share Option Plan (ESOP) is a pool of equity set aside to be offered to new employees to attract and retain talent. 

Typically, 10-15% of the company’s equity is reserved for an ESOP. While this is a large portion of the startup’s available shares, a startup’s success hinges on the quality of its team. For this reason, many sophisticated investors require that at least 10% of the equity pool is reserved for an ESOP.

As an investor, you should consider requesting to include this share pool in the fully-diluted pre-money valuation. Fully diluted means that the valuation is calculated as if all options under the ESOP have already been issued. If the ESOP is calculated as part of the post-money valuation, your investment will be diluted by the value of the option pool. Dilution occurs because the addition of the shares in the ESOP pool to the share pool will reduce your percentage ownership in the company. If you shuffle the ESOP pool to be calculated as part of the pre-money valuation, the existing shareholders’ equity will be diluted, whereas your investment will not be. 


Sophisticated investors often require the founders’ shares to be subject to vesting. This means that the founders have to earn them over time. This incentivises the founders to remain with the startup in its crucial early years. 

The vesting period is usually four years with a one year cliff. For example, a one year cliff could be where 25% of the shares vest at the end of year one, and the remaining 75% vest incrementally over the next three years (four years total). 

Leaver Provisions 

Leaver provisions require the founders (and any employee shareholders) to sell their shares back if they leave. This protects the startup against situations such as having past employees remain as major shareholders even after their employment has ended on bad terms. 

Leaver provisions also help maintain a clean capitalisation table. A startup with many shareholders, some of whom are no longer contributing to the company, may deter some investors. 

Founder Sale Restriction

This provision states that a founder cannot sell a stipulated proportion of their vested shares without approval. This approval is either by the board or the board plus a major shareholder. 

The reason for this is that if a founder sells a substantial portion of their shares, they are unlikely to be as incentivised to grow the business and the company share price. Including this term in your term sheet will help you incentivise the founders to stay with and grow the business. 

Board and Control 

If you are becoming a major shareholder, you may negotiate for the right to appoint a director or board observer. 

A board observer does not have a right to vote or take part in decisions. However, being present in board meetings gives you an insight into the company’s affairs to better track the success of your investment.

If you have the right to appoint a director, you may want your appointed director to have the following rights:

  • a veto right on certain important business decisions (like an exit event or fundamental change in the nature of the business); and
  • that your appointed director must be present to meet the quorum at any directors’ meeting.

Conditions Precedent to Completion 

The term sheet will usually require that certain conditions are fulfilled before completion will take place, including that:

  • you have performed due diligence on the startup;
  • the company has raised a set minimum amount before a certain date (to ensure the startup can achieve what it is promising to do with your investment); and 
  • the company has obtained all required approvals and consents. 

Capitalisation Tables 

The term sheet will generally contain a pre and post-completion capitalisation table for full transparency. 

When looking at these tables, be wary of startups that have shareholders who are neither investors nor key current employees.

Make sure the tables are calculated on a fully diluted basis. This means that you should calculate any option pools, convertible notes and simple agreements for future equity (SAFEs) as if they were fully issued. This allows you to understand your true ownership stake. 

Subscription Agreement Provisions

This clause will highlight whether the company and founders are required to give any warranties (promises). It will also set out any other important terms that an investor may expect to find in the subscription agreement.

For example, you may want to include the assignment of IP owned by the founders to the company as a condition of your investment. 

You may also wish to stipulate that the founders must agree to not work on other ventures while the startup is in its early phase.

Shareholders Agreement Provisions 

This clause sets out key provisions that the Shareholders Agreement will contain for your protection. Common terms include:

  • pre-emptive rights on issue and transfer of shares. This entitles shareholders to purchase shares that the company issues or another shareholder sells before they are offered to third parties;
  • a shareholders’ right to appoint a director;
  • how decisions must be made;
  • drag along and tag along rights. A drag along right enables a majority shareholder (or majority group of shareholders, typically with at least 75% of the shares) to force (or ‘drag along’) minority shareholders to join in the sale of the startup. A tag along right is the reverse of a drag along right. It allows minority shareholders to join or ‘tag along’ in a major sale of the startup’s equity (typically 50- 75%);
  • founders’ vesting provisions;
  • the right to management’s updates and/or financial statements on a stipulated regular basis; and
  • shareholder restraints (applying to shareholders other than the investors).


The confidentiality clause is binding. Parties to the term sheet cannot discuss its terms with anyone else, other than with their legal teams.


The exclusivity clause is also binding. While negotiating the term sheet, the founders must not ‘shop around’ for other investors but must negotiate in good faith. If you do not come to an agreement on the term sheet by the expiry date, the founders can then approach other investors.

Next Steps

If you agree upon the term sheet, you will sign the Shareholders Agreement (or its Deed of Accession) and the Subscription Agreement. These documents should reflect the terms agreed through the term sheet negotiations. You will then purchase the shares on the terms set out in those documents.

Key Takeaways

The term sheet will set the key terms for your investment, so it is important to negotiate with a good understanding of the practical effect of its terms. Your ability to negotiate for terms that give you more power or protection will depend on the size of your investment, the type of capital raising round and your bargaining power. If you have any questions about your proposed startup investment, contact LegalVision’s startup lawyers on 1300 544 755 or fill out the form on this page.


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