# What Are Term Sheets?

![Term Sheet: A nonbinding agreement outlining the basic terms and conditions of an investment.](https://www.investopedia.com/thmb/P4cIR1msVvdhlXhDLKp1orf88xc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/termsheet.asp-final-213468cdb00e4554b8340c7d92e39938.png)

*— Investopedia / Sydney Saporito*

> **Definition**
>
> A term sheet allows parties to negotiate and ask for clarification on details before a contract is signed.

A term sheet is a nonbinding form outlining an investment's basic terms and conditions. It is a template for more detailed, legally binding documents. A contract is created when all parties agree on the details in the term sheet.

### Key Takeaways

*   A term sheet outlines the basic terms and conditions under which an investment will be made.
*   Startup entrepreneurs use a term sheet to attract investors, such as venture capitalists (VC).
*   A term sheet may include a company's valuation, investment amount, percentage stake, or voting rights.
*   Term sheets are used for mergers, acquisitions, and commercial real estate development.

## Creating and Using Term Sheets

Term sheets are often associated with startups. Entrepreneurs find this document crucial for investors like [venture capitalists](https://www.investopedia.com/terms/v/venturecapitalist.asp), who may offer funding. A term sheet may be part of a [merger](https://www.investopedia.com/terms/m/merger.asp) or attempted acquisition. Lenders and potential debt agreements may begin with a term sheet.

The term sheet covers the significant aspects of a deal without detailing every minor contingency covered by a binding contract. All term sheets contain information on the assets, price, and any contingencies that may affect the cost. Term sheets vary with the parties, conditions, and agreements. Term sheets commonly:

*   **Summarize Conditions**: Identify the agreement's overall purpose and the intended outcome. This includes explicitly addressing the project and identifying each legal party involved.
*   **List Terms**: While the term sheet should not include the complete list of details in the agreement, it should provide enough information to entice the other party without overwhelming them.
*   **Define a Timeframe**: Even if the term sheet is nonbinding, it should include an expiration date that requires the opposing party to take action by a specific time.
*   **Encourage Feedback**: Consider distributing a digital version of the term sheet that tracks changes. Ideally, the first draft would be a complete meeting of the minds with no further changes needed.

> **Tip**
>
> Buyers and sellers should understand all financial items listed and up for negotiation in the term sheet before a formal contract is drafted.

## Investment Term Sheets

Term sheets for investments outline nonbinding terms assuring the relevant parties that they are not legally obligated to abide by whatever is outlined on the term sheet. Because this type of term sheet may address shareholders and funding sources like [angel investors](https://www.investopedia.com/terms/a/angelinvestor.asp), it may include the following details:

*   **Valuations:** Company valuations, investment amounts, the percentage of stakes, and [anti-dilutive provisions](https://www.investopedia.com/terms/a/anti-dilutionprovision.asp) should be detailed clearly.
*   **Voting rights**: Investors may be interested in what they say they have over the company's operations.
*   **Liquidation preference**: Investors may want to know the order in which owners are paid if the company is sold.
*   **Investor commitment**: The term sheet should state how long the investor is required to remain vested.
*   **Dividends**: Investors may want clarity on the net income distributions they will be entitled to.
*   **Drag-along clause**: A [drag-along clause](https://www.investopedia.com/terms/d/dragalongrights.asp) guarantees that minority stakeholders will follow the guidance of majority stakeholders.
*   **No-shop agreement**: This outlines the terms that restrict the company from taking investment money from other people for a specific period.
*   **Pro-rata rights:** Investors understand their rights for future investing rounds with [pro-rata rights](https://www.investopedia.com/terms/p/pro-rata.asp). They may be entitled to the right of first offer for a future investment offering.
*   **Valuation**: Investors might want the [pre-money](https://www.investopedia.com/terms/p/premoneyvaluation.asp) and post-money valuations done before an official investment agreement.
*   **Valuation cap**: This is the value at which convertible notes can be converted into equity. Often a crucial point in negotiations, this figure should be discussed early to ensure a fair starting point for a startup's valuation.

## Debt Agreement Term Sheets

A debt agreement's term sheet outlines the loan size, interest rate, and repayment terms. The lender will often specify their conditions to reduce risk, including any loan extension rights attributed to the borrower and what is required at [closing](https://www.investopedia.com/terms/c/closing.asp). Additionally, this type of term sheet may include the details for:

*   **Collateral**: Borrowers may have to post [collateral](https://www.investopedia.com/terms/c/collateral.asp) to substantiate value in case of default.
*   **Financial covenants**: Borrowers may need to prove financial health to the lender.
*   **Guarantee**: Borrowers may need to identify a legal entity with established credit to vouch for the debt and be liable if the company defaults.
*   **Interest rate:** Depending on the loan, terms may vary widely. The [interest rate](https://www.investopedia.com/terms/i/interestrate.asp) may include a fixed spread rate plus a variable rate for long-term loans.
*   **Loan amount:** Borrowers need a specific amount of funds to borrow. This term may be a fixed dollar amount, subject to [loan-to-value](https://www.investopedia.com/terms/l/loantovalue.asp) metrics, a debt service coverage ratio, and net operating income calculations.
*   **Loan costs:** A lender may require an annual administration fee or a one-time closing fee.
*   **Term:** Borrowers must know when the loan is fully payable. For open lines of credit or development loans, this is the period during which interest is assessed, but principal payments may not be due.

## Example

In 2024, the New York City Department of Housing Preservation & Development released a term sheet for its HomeFirst Down Payment Assistance Program. The program helps low-income people buy owner-occupied homes by offering forgivable loans toward a down payment.

The term sheet outlines who is eligible for the program, what home types qualify, the loan amount, terms, and construction requirements. At the end of the term sheet, the department's contact information is shown, so interested parties who agree to these terms can communicate with the NYC Office of Development.

## Who Prepares a Term Sheet?

Depending on the financial instrument, different parties may prepare the term sheet. For seed investments, investors often provide a term sheet when offering their private investment. A lending institution will provide a term sheet to prospective borrowers.

## Is a Term Sheet the Same As an MOU or LOI?

A term sheet, a Letter of Intent, and a Memorandum of Understanding are similar. An [LOI](https://www.investopedia.com/terms/l/letterofintent.asp) is a document that declares a preliminary commitment by one party to work with another. These are common when one company announces its intention to do business with a second company. A term sheet is like an LOI when the action is one-sided, as in acquisitions, to serve as a jumping-off point for negotiations. Memoranda of understanding ([MOUs](https://www.investopedia.com/terms/m/mou.asp)) outline agreements between two or more people or organizations in a formal document. They often serve as the starting point for contract negotiations or mergers.

## What Are the Common Pitfalls to Avoid When Drafting a Term Sheet?

Common pitfalls include being too vague or overly detailed, failing to distinguish between binding and nonbinding terms, not setting realistic time frames, and neglecting to outline key financial terms and conditions.

## The Bottom Line

A term sheet is a document that evidences serious intent between two parties that often signals the beginning of a transaction. It's the first step for the two parties working on structuring a deal. Though term sheets are usually not binding, they allow parties to view the terms and open up negotiations.

> **Article Sources**
>
> 1.  Association of Corporate Counsel. "[Term Sheets, Letters of Intent and Other 'Non-Binding' Pre-Deal Documents](https://www.acc.com/sites/default/files/2020-07/7.7.20%20Term%20Sheets.pdf)."
>     
> 2.  Embarc Advisors. "[Understanding Term Sheet Negotiation](https://embarcadvisors.com/understanding-term-sheet-negotiation/)."
>     
> 3.  Silicon Valley Bank. "[Understanding Venture Capital Term Sheets](https://www.svb.com/startup-insights/vc-relations/venture-capital-term-sheets/)."
>     
> 4.  First National Realty Partners. "[What Is the Difference Between a Term Sheet and Commitment Letter?](https://fnrpusa.com/blog/what-is-the-difference-between-a-term-sheet-and-commitment-letter/?utm_term=blog%2Bwhat-is-the-difference-between-a-term-sheet-and-commitment-letter)"
>     
> 5.  New York City Department of Housing Preservation & Development. "[Home First Term Sheet](https://www.nyc.gov/assets/hpd/downloads/pdfs/services/homefirst-term-sheet.pdf)."