Term Sheet vs Shareholders Agreement - What’s The Difference?

Raising capital or formalising co-founder arrangements is exciting, but it also introduces a stack of new documents and legal decisions. Two terms you’ll hear a lot in Australia are “term sheet” and “shareholders agreement”. They sound similar, but they serve very different purposes at different stages of the journey.

If you’re wondering which one you actually need, when to use it, and how they fit with the rest of your company documents, you’re in the right place. In this guide, we’ll break it down in plain English so you can negotiate confidently and set your business up for long-term success.

What Is A Term Sheet (And When Do You Use One)?

A term sheet is usually the first written step when you’re negotiating an investment or a co-founder equity split. Think of it as a roadmap for the deal: it records the commercial headline terms you’ve agreed in principle so everyone can see the big picture before lawyers draft the detailed contracts.

Typical Purpose

The purpose of a term sheet is to align expectations early. It covers the who, what and how of a proposed investment or equity arrangement without getting lost in the fine print. This helps you test whether you’re truly on the same page before spending time and money on the final documents.

Common Contents

• Valuation and price per share
• Amount being invested and by whom
• Pre- and post-money cap table outline
• Type of shares (ordinary vs preference) and key rights
• Board composition and appointment rights
• Founder vesting and leaver provisions (high level)
• Information rights and reporting cadence
• Conditions precedent (e.g. due diligence, agreements to be signed)
• Any exclusivity (“no shop”) and confidentiality terms

At this stage, you’re agreeing the commercial spine. The detailed legal rights, definitions and mechanisms will live in the definitive agreements that follow (more on those below).

Is A Term Sheet Binding?

Usually, most of a term sheet is expressed to be non-binding. That means you’re not legally locked into completing the deal just because you signed it. However, some clauses in a term sheet are commonly stated as binding for a short period (for example, confidentiality, exclusivity and governing law). Read those carefully.

If you’re ready to put your heads of terms in writing, you can use a concise, investor-friendly Term Sheet to guide the process and keep momentum without committing prematurely.

What Is A Shareholders Agreement?

A shareholders agreement (often called an “SHA”) is a legally binding contract between the shareholders of a company. It governs how the company is run, how decisions get made, what happens if someone leaves, and how shares can be issued or transferred. If a term sheet sets out the handshake, an SHA is the rulebook you’ll live by.

Why You Need One

Even if you don’t have external investors, an SHA between founders is crucial. It reduces the risk of disputes, sets expectations and provides a clear process for big events (raising more funds, selling the company, or handling a co-founder exit).

How It Works Alongside Other Documents

Your SHA sits alongside the company’s constitution and, where relevant, investment documents like a share subscription agreement. The constitution is the company’s internal rulebook registered with ASIC, while the SHA is a private contract that can go deeper or allocate rights among specific shareholders. If you’re establishing a company or tightening your governance, consider how your Company Constitution and your Shareholders Agreement interact.

Key Clauses In A Shareholders Agreement

• Decision-making and reserved matters (what requires board vs shareholder approval)
• Board composition and appointment/removal mechanics
• Share transfers, pre-emptive rights and tag/drag provisions
• Founder vesting and treatment of good/bad leavers
• Dividend policy and working capital expectations
• Dispute resolution processes
• Confidentiality and intellectual property ownership
• Exit pathways and what happens on a sale or IPO

Term Sheet vs Shareholders Agreement: The Practical Differences

In practice, you’ll often use both. Here’s the difference in how and when they’re used, and why each matters.

Timing And Purpose

• Term Sheet: Used early, to agree headline commercial terms before drafting the final documents. It’s about speed and alignment.
• Shareholders Agreement: Signed at completion or when investors come on board. It’s about enforceable governance and long-term clarity.

Level Of Detail

• Term Sheet: High level. It outlines the direction and key numbers/rights without all the mechanisms and definitions.
• Shareholders Agreement: Detailed and comprehensive. It sets out processes, notice periods, formulas and the legal machinery behind each right.

Binding Effect

• Term Sheet: Largely non-binding, with specific binding clauses (confidentiality, exclusivity) if stated.
• Shareholders Agreement: Fully binding on the shareholders who sign it.

Who Signs

• Term Sheet: Typically signed by the proposed investor(s) and the company (or founders) to record intent.
• Shareholders Agreement: Signed by all shareholders who will be bound by it (including founders and new investors) - and often the company as a party.

What They Don’t Do

• Term Sheet: Doesn’t issue shares, change the cap table or govern day-to-day operations.
• Shareholders Agreement: Doesn’t itself issue new shares - you’ll usually pair it with a Share Subscription Agreement or other investment documents to complete the raise.

How These Documents Fit Into An Australian Capital Raise

Here’s a common flow if you’re raising funds in Australia as a private company.

1) Align Commercial Terms

Meet investors, negotiate, and capture the key points in a Term Sheet. If confidentiality matters before you reveal numbers or IP, use an Non-Disclosure Agreement early in discussions.

2) Draft The Definitive Agreements

Your lawyers will translate the agreed terms into formal documents - commonly an SHA, a subscription agreement, updated or new constitution (if needed) and any ancillary deeds. This is where important mechanisms (vesting, leaver provisions, transfer restrictions and reserved matters) are properly engineered.

3) Completion

On completion, investors pay the subscription price and the company issues the agreed shares. Your cap table updates, ASIC lodgements are made, and the corporate records are updated to reflect the new ownership and governance settings.

4) Ongoing Governance

After the raise, you’ll operate under the SHA and your constitution. Founders and investors follow the agreed processes for future raises, director appointments, information rights and exits.

What Should A Good Term Sheet Cover To Avoid Re-Negotiation?

While a term sheet is short by design, a few carefully drafted bullet points can avoid headaches later. Consider including:

• Valuation and instrument: Price per share and class of shares (e.g. ordinary or preference) plus any liquidation preference headline.
• Board and voting: Number of directors, any investor appointment rights, and key matters requiring special approval.
• Founder vesting: High-level vesting period and cliffs, and treatment of good vs bad leavers. Details can be finalised in the SHA.
• Information rights: Frequency and scope of financial reports and access.
• Conditions precedent: What must occur before completion - for example, due diligence, IP assignments to the company, or an updated constitution.
• Exclusivity and confidentiality: Limited binding provisions that protect the deal while you negotiate.

If you plan to offer employee equity post-raise, it can help to note in the term sheet that an option pool will be created, with the mechanics to be finalised in the SHA or an Employee Share Option Plan.

What Does A Shareholders Agreement Typically Include (In More Detail)?

Every company is different, but most Australian SHAs include the following categories.

Governance And Decision-Making

Who sits on the board, how meetings are called, quorum requirements, and what needs shareholder approval versus board approval. Many deals list “reserved matters” that require a supermajority or the investor director’s consent.

Share Issuances And Transfers

Rules about issuing new shares, pre-emptive rights for existing holders, and limits on transfers to third parties. Tag-along and drag-along provisions ensure minority and majority holders are treated fairly in a sale scenario.

Founder Vesting And Leaver Provisions

Time-based or milestone vesting for founder shares, and how unvested/vested shares are treated if a founder leaves. This protects the company if someone exits early while also being fair to long-term contributors.

Dividends, Funding And Budgeting

How dividends are considered, expectations about reinvesting profits, and the process for approving annual budgets or capital expenditure.

Dispute Resolution

A staged process to resolve disagreements (negotiation, mediation, and as a last resort, arbitration or court). Clear pathways here can save significant time and cost later.

Confidentiality, IP And Restraints

Confirming the company owns all relevant intellectual property and setting reasonable confidentiality obligations. Some agreements include non-solicitation or other restraints to protect the business.

Exit Paths

Rules for a sale of the company, an IPO or buy-backs, and how proceeds are distributed. A well-drafted SHA makes exits smoother and less contentious.

How Do These Documents Interact With Your Constitution And Founder Docs?

In Australia, your company’s constitution sets the baseline rules under the Corporations Act 2001 (Cth). An SHA adds a private layer of agreed rules between shareholders. If there’s a conflict, the SHA typically says which document prevails (often the SHA for matters between signatories). It’s important to check alignment so you don’t have inconsistent processes or rights.

Where co-founders are at an earlier stage (pre-company or before raising), a Founders Agreement is a helpful stepping stone. Later, you can fold those arrangements into a formal Shareholders Agreement once the company is set up and shareholdings are settled.

Common Pitfalls (And How To Avoid Them)

1) Treating A Term Sheet Like A Full Contract

Don’t assume a term sheet covers every scenario. It’s a summary, not a substitute for the definitive documents. Make sure it clearly says what is and isn’t binding, and push the detail (like vesting mechanics) into the SHA where it belongs.

2) Forgetting The Downstream Documents

If you’re agreeing high-level terms in a term sheet, sanity-check that the outcomes are implementable in the SHA, subscription agreement and constitution. For example, if you agree to issue a new class of shares with special rights, ensure your constitution can accommodate those rights or plan to adopt a new one at completion.

3) Not Defining Decision Rights Early

Ambiguity around who can approve what leads to friction. Get clear on reserved matters, voting thresholds and board composition at the term sheet stage to reduce surprises.

4) Ignoring Founder Vesting And Leavers

It can be uncomfortable, but investors expect vesting and leaver provisions to be discussed early. A clear, fair approach reassures investors and protects the company’s future if circumstances change.

5) No Plan For Employee Equity

If you intend to offer options or performance rights, reference an option pool in your term sheet and implement it through an Employee Share Option Plan and any needed Option Deed. This avoids dilutive surprises later.

Which One Do You Need Right Now?

If you’re still negotiating commercial points or testing mutual interest, start with a concise Term Sheet. It keeps everyone aligned and avoids scope creep.

If you’ve agreed the deal or you’re formalising co-founder dynamics, prioritise a Shareholders Agreement. Pair it with the right investment documents (like a Share Subscription Agreement) and check it works smoothly with your Company Constitution.

Not sure which path you’re on? That’s normal. A short scoping chat with a lawyer can help you map the right sequence for your raise or founder arrangement.

FAQs

Is A Term Sheet Necessary If We Already Agree On Everything?

It’s still useful. A term sheet gives structure to the deal and reduces the risk of misunderstandings. It also speeds up drafting because the lawyers have a clear, agreed brief.

Can We Skip A Shareholders Agreement And Just Use A Constitution?

We wouldn’t recommend it. A constitution is generic by design. An SHA captures the specific bargain between your shareholders, including vesting, leavers and reserved matters that a standard constitution won’t cover in sufficient detail.

Will Investors Sign An NDA Before Seeing Our Numbers?

Some will, some won’t. It depends on norms at the stage and the investor’s policy. If you need confidentiality early, propose a simple Non-Disclosure Agreement, or keep sensitive details high-level until you have exclusivity in a term sheet.

Do We Need Separate Contracts For The Investment?

Yes. The SHA governs ongoing shareholder relationships, whereas the investment itself is usually implemented under a Share Subscription Agreement (or similar). These documents work together.

Key Takeaways

• A term sheet captures headline commercial terms early, is mostly non-binding, and keeps negotiations on track without committing too soon.
• A shareholders agreement is a binding rulebook for shareholders that governs decision-making, share transfers, vesting, exits and more.
• Use a term sheet to align on valuation, board seats, vesting, information and key rights; then implement those terms through the SHA and investment documents.
• Your SHA should work hand-in-hand with your Company Constitution and any subscription or option plan documents.
• Clarity on reserved matters, founder vesting and leaver treatment reduces disputes and reassures investors.
• Getting the sequence right (term sheet → definitive docs → completion) saves time, cost and headaches, especially under Australian company law.

If you’d like a consultation on choosing and drafting the right mix of a Term Sheet and Shareholders Agreement for your raise, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.