A term sheet is a nonbinding agreement that shows the basic terms and conditions of an investment. It is a template and basis for more detailed, legally binding documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a contract that conforms to the term sheet details is drawn up.

Uses of a Term Sheet

The term sheet should cover the significant aspects of a deal without detailing every minor contingency covered by a binding contract. This helps ensure the parties in a business transaction agree on most major aspects while reducing the likelihood of a misunderstanding. This, in turn, could avoid costly legal challenges later on.

All term sheets contain information on the assets, the initial purchase price, any contingencies that may affect the cost, a time frame for a response, and other important information.

Term sheets are most often associated with startups. Entrepreneurs find this document crucial for investors, often VCs, who may offer capital to fund startups.

A term sheet used as part of a merger or attempted acquisition typically contains information about the initial purchase price, the preferred payment method, and the assets included. It might also have information about what, if anything, is excluded from or must be part of the deal for one or both parties.

What's Included in a Term Sheet?

The details in a term sheet depend on what's being agreed to. For an angel investment, the early funding investment term sheet will be substantially different from what's included in one for a commercial real estate development.

Generally, though, there are standard details included:

• Nonbinding terms: Neither party is legally obligated to abide by whatever is outlined on the term sheet.
• Valuations: Company valuations, investment amounts, the percentage of stakes, and anti-dilutive provisions should be detailed clearly.
• Voting rights: Startups seeking funding are usually at the mercy of VCs who want to maximize their investment return. This can result in the investor asking for and obtaining a disproportionate influence on the company's direction.
• Liquidation preference: The term sheet should state how the sale proceeds will be distributed between the entrepreneur and the investors.
• Investor commitment: The term sheet should state how long the investor is required to remain vested.

     For debt agreements, here is what's commonly included:

1. Financial details: This consists of the term, loan size, interest rate, and other financial matters common to debt.
2. Risk mitigation preferences: The lender will often require specific conditions to be met or particular information to be provided in a recurring manner.
3. Extension rights: The borrower is often allowed to extend a loan, but the term sheet identifies the conditions and cost of the extension.
4. Due diligence at closing: As part of the term sheet, the lender may stipulate what they require when the loan agreement is drafted.