Term Sheet

A term sheet is the short document that turns an investor's interest into a concrete offer. It sits between the last pitch meeting and the long legal contracts, and it names the valuation, the amount to be invested, the resulting shareholding, the rights attached to the new shares and the timetable to closing. Very little of it is legally enforceable. Almost all of it is economically final.

What is legally binding?

Most of a term sheet is a statement of intent. Valuation and investment amount depend on the due diligence coming back clean and on the definitive agreements being signed. In Germany that last step is stricter than in the United States or the United Kingdom. Share subscriptions and share transfers in a GmbH have to be notarised, so no term sheet, however detailed, moves money on its own.

The binding part is usually short: exclusivity, confidentiality, who bears which costs, and governing law. Exclusivity is the one that matters. It removes competition between investors for several weeks, and that competition is the strongest lever a founding team has. A fixed end date belongs in the first draft, not the second.

The non-binding part still binds in practice. A clause accepted at term sheet stage is reopened later only with a genuinely new argument, and every reopening costs time and goodwill. The negotiation happens here, not in the contract phase.

The three clauses that cost the most later

Valuation is the number everybody talks about. Three other clauses decide how much of a sale price actually reaches the founders and who holds the pen day to day.

Liquidation preference

The liquidation preference sets the order of payment when the company is sold. A non-participating 1x preference gives the investor either the money invested back or the pro rata share of the proceeds, whichever is higher, and the remainder goes to the other shareholders. That is the usual structure in European venture deals. A multiple above 1x, or a participating preference that pays the investor again on top of the pro rata share, changes the founders' outcome at every sale price short of a very large one.

Anti-dilution protection

Anti-dilution applies when a later round prices the company below this one. The earlier investor receives additional shares so that the effective entry price falls. Broad-based weighted average adjusts in proportion to the size of the new round and is the common compromise. Full ratchet resets the price entirely and loads the whole loss onto the founders and anyone not putting in fresh money. In a GmbH the adjustment is normally implemented as a capital increase at nominal value reserved for that investor. The mechanism is agreed in the investment and shareholders' agreement, and each adjustment still requires a shareholder resolution and a notary.

Veto rights

Veto rights, usually drafted as consent matters or reserved matters, list the decisions that cannot be taken without the investor. Spending above a threshold, new financing, the sale of the company, senior hires, changes to the employee share programme. A short list is ordinary governance. A long one shifts control of the business without moving a single percentage point on the cap table, which is why that list deserves the same attention as the valuation.

Worked example and common traps

An investor puts in EUR 4m for 20 per cent and holds a participating 1x preference. The company is later sold for EUR 10m. The investor takes EUR 4m first, then 20 per cent of the remaining EUR 6m, so EUR 5.2m in total on a 20 per cent holding. With a non-participating preference the same investor takes EUR 4m and the founders keep EUR 6m instead of EUR 4.8m. One clause, EUR 1.2m of difference, and the headline valuation is identical in both cases.

Traps that show up again and again:

• Exclusivity with no end date, or a period that rolls on silently.
• Pre-money and post-money left unstated, so the option pool is created out of the founders' shares after the fact.
• An ESOP assumed to work as it does in Delaware. German companies mostly grant virtual shares, a contractual cash claim payable on an exit, because issuing real shares in a GmbH requires a notary every time.
• Tranches tied to milestones that are only sketched in the term sheet and sharpened in the contract.
• Signing when runway is nearly gone. A team with no months left does not negotiate, it accepts.

This entry explains the document. It is not legal advice on any particular term sheet.

Related terms

• Liquidation preference
• Vesting
• Convertible loan
• Due diligence