Term Sheets at Pre-Seed: The Terms That Matter

If you're in the middle of a funding round and you've never seen a term sheet before, it's hard to know what normal looks like. Investors deal with term sheets, and the legal documents that follow them, day in, day out. Founders usually don't, and they don't always understand what each term means for them. This guide walks through what a typical UK pre-seed term sheet contains, which terms are normal, which are red flags, and which start to matter more in later rounds.

What is a term sheet?

A term sheet sets out the key terms of an investment. The fund and the company both sign it to agree the headline terms, so the lawyers can draw up the full legal documents knowing the most material points are settled. In the UK you'll sometimes hear it called heads of terms.

It covers the deal structure, which is the most important part, along with exclusivity and costs. Most of it is non-binding, apart from confidentiality, exclusivity and costs: if one side backs out, the term sheet says who pays the costs already incurred.

Some funds give very light term sheets and let the detail be worked out while the legals are drafted. Others give very detailed ones and try to agree all the material points up front. With a light term sheet, expect more of the negotiation to happen later.

The economics.

Investment amount and tranching

The term sheet sets out how much is being invested, and whether it arrives in one go or in tranches. Tranching isn't typical at pre-seed.

If you need £500k to give you 18 months to two years of runway, and you need all of it to execute your plan, having it tranched is a red flag. It doesn't give you the capital to make the decisions you otherwise would, and it can stop you operating properly.

Tranching can be okay if the first tranche is enough on its own for you to go and execute. Be aware of the signal if an investor doesn't go ahead with a later tranche, as other investors will want to know why.

Valuation, price per share and the option pool

The term sheet gives a pre-money valuation and a price per share. The pre-money valuation is usually expressed as fully diluted, which means it includes the option pool the investor wants in place after the round.

The pool is created or topped up before the new money comes in, so the dilution from it falls on the existing shareholders, not the new investor. For example, an investor puts £500k into a £2m pre-money round and wants a 10% option pool afterwards. The investor gets 20%, the pool is 10%, and the existing shareholders end up with 70%. In effect, £250k of your £2m valuation is the new pool.

That's standard, and it's very uncommon for it to work the other way round. At pre-seed, a pool of between 5% and 15% is normal, with 10% the most common. Our guide to pre-money vs post-money valuation and the dilution calculator show how the numbers work.

Share class

This is one of the most important parts of a term sheet, and one founders don't always fully understand. In the UK, new investors often get a new class of share, such as A ordinary shares, and that class can carry different rights from the founders' shares.

At pre-seed, what's normal is either ordinary shares with the same rights as the founders, or ordinary shares with a 1x non-participating liquidation preference. Anything beyond that is unusual at this stage.

Liquidation preference

A liquidation preference decides who gets what when the company is sold or wound up. There are two types.

• Non-participating. The investor gets either their money back or their share of the exit proceeds, whichever is higher.
• Participating. The investor gets their money back first, then their share of whatever is left. In effect, they double dip.

Say an investor puts in £500k for 20% and the company sells for £2m. With a non-participating preference, they take £500k, because that's more than their 20% share of £400k. With a participating preference, they take £500k plus 20% of the remaining £1.5m, so £800k in total.

The industry norm is a 1x non-participating preference. Participating preferences are usually used when a punchy valuation has been agreed and the investor wants other terms to compensate for it. Anything beyond 1x non-participating, or a participating preference, is starting to become aggressive, particularly at an early stage.

Anti-dilution

Anti-dilution rights protect an investor if you later raise at a lower valuation (a down round). New shares are issued to them so that some or all of the dilution is offset. There are different ways of calculating it, and the most aggressive, a full ratchet, resets the investor's price entirely to the new lower price.

Anti-dilution isn't common at pre-seed. When you do see it, it's usually because a punchy valuation has been agreed and the investor wants protection if the next round comes in lower. Because the SEIS and EIS rules on preferential rights are strict, you'll rarely see it from SEIS and EIS funds.

Warrants

Warrants are very uncommon at pre-seed. A warrant gives the investor the right to buy more shares later, often at a nominal price (penny warrants), with conditions on how and when they can be used. Like participating preferences, they're often a way of compensating for a punchy valuation.

Founder terms.

Vesting and reverse vesting

Investors want founders tied into the company. To do that, they make founders' shares subject to being clawed back if a founder leaves within a certain period.

In the UK this is done through reverse vesting. The founders own all their shares from day one, and lose some of them if they leave early. Strictly, vesting means shares aren't issued until a time or milestone has been reached, which is how EMI options work. Because founders already own their shares, theirs reverse vest. This only applies to shareholders: employees' options are governed by their option agreements, not the investment documents.

What's normal varies. Arrangements I've seen at pre-seed include:

• nothing vested on day one, with everything vesting over four years
• 25% vested on day one, with the rest vesting over three to four years
• a portion vested on day one, up to 80% vested over a set number of years, and the remainder vesting only on an exit

Good and bad leavers

Leaver provisions define what happens to a founder's shares when they leave. A bad leaver is usually someone dismissed for gross misconduct or fraud, or who resigns in anticipation of that. A good leaver is often simply anyone who isn't a bad leaver. Some documents add a very good leaver, for someone who leaves because of death, incapacity or similar reasons.

Normally, a good leaver keeps their vested shares at fair value and gets nominal value for their unvested shares. A bad leaver gets nominal value for all of their shares. A very good leaver may keep all of their shares at fair value.

Treating voluntary resignation as a bad leaver is a red flag. Anything outside fraud, gross misconduct or resigning in anticipation of them is atypical.

Warranties and indemnities

This is an area most founders don't think about enough. An investor will do due diligence, but they'll also ask for warranties: promises that the information you've given them is accurate and complete. If it isn't, the investor can claim for their loss. Indemnities are usually for known issues that get raised during diligence: a promise to cover that specific loss in full if it comes back to bite.

Warranties can be given by the company, by the founders personally, or both. Since 2023, the BVCA's model documents (now published by UK Private Capital) have the company give the warranties, not the founders. If there's a problem, the investor claims against the company for their loss. Many early-stage deals still ask founders to give warranties too.

If you give personal warranties, you'll want a cap on how much you could be on the hook for. A cap of one to two times your salary is normal for founders. For the company, the cap is normally up to the amount invested.

Most term sheets just say "customary warranties". The detail gets agreed in the subscription agreement as you go through the legals.

Restrictive covenants and insurance

Restrictive covenants, such as a founder not competing with the business or poaching staff after leaving, aren't usually in the term sheet, but they work their way into the final documents. Twelve months is normal for founders. It can be longer, but less than 12 months is unusual.

The company may also commit to obligations such as directors' and officers' insurance and key person insurance.

Control.

Board seats

The term sheet will say which of the new investors have the right to a board seat. One investor director is normal at pre-seed. You want investors on your board who add value and have a reasonable amount of influence.

Too many investors on the board isn't wise, particularly if they have small shareholdings. Board rights also change over time, and some investors lose their seat as later rounds come in.

Investor consents

This is one of the areas that often gets difficult. Most investor consents start with an agreed business plan: anything in the plan, you can do. Outside it, there are spending thresholds by category or time period, and going over them needs investor consent.

The thresholds are relative to the round. If you raise £250k, you might be able to spend £10k to £20k a year outside the business plan without asking. In a £5m round, the numbers are very different.

Consents are usually split into two groups:

• Material matters that directly affect shareholder value, such as putting the company into liquidation, issuing or selling shares, or selling the IP. These usually need the consent of an investor majority.
• Operational matters, such as hiring someone above a certain salary or changing founders' pay. These are often handled by the lead investor or the investor director, who knows the business day to day.

At pre-seed you might only have a lead investor and a few angels, so it's not unusual for the lead alone to give consents. It's at the aggressive end when the lead alone controls the material matters too, rather than an investor majority.

Information rights

The term sheet will set out what you report and how often, and who signs off the accounts and budgets. Quarterly management accounts, an annual budget and the statutory accounts are normal.

Shares and exits.

Pre-emption

Pre-emption rights let existing shareholders buy new shares before anyone else, so they can keep their percentage. Often this is just standard statutory pre-emption. Sometimes investors try to limit other shareholders' pre-emption rights, which is worth checking.

Drag-along and tag-along

• Drag-along. If a set proportion of shareholders want to sell the company, the rest are dragged along on the same terms. A threshold of 50% to 75% is normal.
• Tag-along. If a set proportion of shareholders get an offer for their shares, everyone else has the right to sell on the same terms.

Between the drag-along threshold and the investor consents, these clauses decide whether an investor can block an exit, so read them together.

SEIS and EIS obligations.

If you're taking SEIS or EIS money, you'll sign up to some obligations to keep the investors' tax relief safe, and that limits the rights their shares can carry. Our guide to SEIS and EIS covers what the schemes need from you.

Fees and costs.

Legal fees

Normally the company pays all the legal fees for the transaction, including the investor's, usually up to a cap. At pre-seed, once legal fees go above about £10k in total, it's getting expensive. It can be done for less, and you should look at the fees in the context of how big the round is.

Arrangement and monitoring fees

Some funds charge fees to the companies they invest in. This is particularly common with SEIS and EIS funds, whose business model is based on charging fees to their investors, to their portfolio founders, or both. Funds that don't use the schemes more often charge only their own investors, so there are no fees for founders.

• Arrangement fees are charged upfront, as a percentage of the money being invested.
• Monitoring fees are ongoing, often around 2% of the amount invested. They rarely say when they stop.

Excluding legal fees, arrangement and monitoring fees adding up to 5% to 7% upfront isn't uncommon, particularly for SEIS and EIS money. If it's higher, it's usually because the monitoring fees have been charged in advance.

Exclusivity, expiry and backing out.

Exclusivity is normally one to two months. Once you sign the term sheet, you go into structured due diligence and the legals get drafted at the same time, and during that window you agree not to do a deal with anyone else.

The term sheet will also have an expiry date, after which the offer lapses, and it will list what's needed to complete: what diligence is left, the legal documents and any approvals.

Because most of the term sheet is non-binding, either side can walk away. If they pull out without a material enough reason, the side backing out often has to pick up the costs.

What happens after you sign.

The term sheet becomes the basis for the long-form documents: usually a subscription agreement, a shareholders' agreement and new articles of association. This can take a few weeks to a month or two. Having a legal data room ready makes it quicker, and our guide to how long it takes to raise pre-seed covers the whole timeline.

Which terms matter more in later rounds.

As you raise later rounds, preferences, anti-dilution rights, investor controls and warrants start to appear more often. It's also worth knowing that when you raise from new investors, you'll often enter into a completely new set of legal documents, so what you agree now isn't necessarily what you'll live with for good.

Normal terms and red flags at pre-seed.

If a term sheet has landed and you want to understand it properly, get a commercial lawyer who knows venture deals to read it before you sign. If you're raising pre-seed for a UK B2B tech business, you can apply to Solid Bond. Next, read our guide to the advance subscription agreement, which many founders use to raise part of a round before the full legals are done.