Binding versus Non-Binding Clauses in a Term Sheet: What Founders Should Know

This article was written by Shreyaah Srinivasan, Associate, and Karthik Jayakumar, Partner.

When first-time founders receive a term sheet from an investor, we have found that, more often than not, the immediate instinct is to treat it as the final “deal document” based on which the money would hit the company’s account.

Typically, a term sheet details the terms of valuation, board seats, liquidation preferences, and exit rights among other things. However, here’s the critical  truth: a term sheet is usually not binding in nature, and this note will help the reader in understanding the nuances of a term sheet.

A term sheet can be likened to a handshake that is captured in writing. While it reflects intent, it would not serve as an enforceable contract. Yet, some clauses contained in a term sheet are specifically binding and can come back later to haunt a founder if they are ignored. It is crucial to understand  this distinction before you sign.

The Nature of a Term Sheet - Binding or Non-Binding?

A term sheet is an agreement to agree upon detailed specifics of a particular investment deal. It is meant to set out the key commercial and legal terms of a proposed investment before the parties invest time and cost into detailed documentation (such as the Shareholders’ Agreement and Share Subscription Agreement).

For this reason, most substantive provisions in a term sheet are non-binding: they are promises to negotiate in good faith but are not enforceable commitments.

That said, investors often insert a few binding clauses to protect themselves during the negotiation period. This note will also touch on a few such clauses, for the benefit of a founder.

Non-Binding Clauses

The heart of the term sheet, which contains basic terms such as valuation, rights, obligations, and deal structure - falls into the non-binding bucket. This means that, until definitive agreements are signed, either party can walk away without legal liability (apart from certain specific binding clauses that the founders and investors agree to).

Non-Binding Clauses in a Term Sheet

Typical non-binding clauses include the following clauses, each of which we will break down in separate notes:

• Valuation & Price Per Share          

  Numbers in a term sheet reflect current understanding but can change after due diligence or renegotiation.

• Investment Amount & Instruments           

  Whether the investor is subscribing to equity, CCPS, CCDs, or another instrument is usually non-binding until definitive agreements are executed.

• Governance Rights  

  Board seats, voting rights, veto rights, and information rights are generally proposals until the shareholders’ agreement is signed.

• Liquidation Preference, Anti-Dilution, Exit Rights         

  These economic and control provisions only come into effect once the investment is completed.

• ESOP Pool    

  The requirement to carve out or expand an ESOP pool is agreed later in the binding agreements.

• Founder Vesting & Leaver Clauses           

  Proposals around reverse vesting or restrictions on founders are not enforceable until formally documented.

In short, all the exciting and critical parts of the term sheet that founders obsess over are at this stage, only indicative.

Binding Clauses

Now, let’s examine the clauses that are binding. These are not about the economics of the deal, rather about process and basic protection accordingly.

Binding Clauses in a Term Sheet

Typical binding clauses include the following, each of which we will break down in separate notes:

• Exclusivity / No-Shop Clause          

  Prevents the company from talking to other investors for a defined period (say 30–90 days). This ensures the investor who issued the term sheet has a clear runway to complete due diligence without competition from another potential investor.

• Confidentiality

  Binds both sides to keep the deal discussions and the contents of the term sheet private. This protects sensitive financial and strategic information.

• Costs

  Sometimes, term sheets specify who bears legal and due diligence expenses. If the company agrees to pay for the cost of advisors (including those of the investor), this obligation is binding, regardless of whether the deal closes.

• Governing Law & Jurisdiction       

  Even at the term sheet stage, parties may agree on which laws will govern disputes and where they’ll be resolved.

These binding clauses are narrow in scope, but they can have real consequences, if breached. For instance, violating exclusivity could lead to reputational damage or even claims for reimbursement of expenses.

Why This Distinction Exists

Why not make the whole term sheet binding? The answer simply lies in practicality – and the fundamental rule of ‘trust, but verify’.

• For Investors: They don’t want to be forced into an investment until due diligence is complete, and all risks are assessed.

• For Founders: They don’t want to be locked into a structure until they’ve seen the fine print.

  
  

Commitments on deal terms are left flexible, while commitments on process and conduct are typically locked down, to safeguard both sides in some form.

Essential Term Sheet Lessons for Founders

We accordingly take the opportunity to also pen down a few practical lessons for founders as follows:

• Don’t panic over the terms yet. Since valuation, governance, and rights are non-binding, don’t treat the term sheet as the final word. You are allowed to negotiate on terms, in a term sheet, however this can be situational.

• Watch the exclusivity period. Long exclusivity windows can tie your hands if the investor is slow or unsure. Negotiate a shorter period or include outer time frames to keep it tight.

• Be careful with costs. If you agree to cover investor diligence or legal expenses, those become payable even if the deal falls through. Try and keep this capped, so that you know your outflow.

• Confidentiality cuts both ways. Ensure confidentiality is mutual so the investor can’t share your sensitive details with competitors. While one would assume this is a fundamental way of being, protection is still key.

• Remember reputation. Even though most clauses are non-binding legally, backing out after signing can hurt credibility. Investors talk, and ecosystems are small. Sometimes, backing out for no-reason can have their own implications, including a back-out fee.

• Sign carefully, negotiate timelines and costs, and keep your eyes open. Remember - the term sheet sets the tone for the investor relationship, and clarity at this stage can save you many headaches later.