Sherman, Texas was named after the General Sidney Sherman (July 23, 1805 – August 1, 1873), who was a hero of the Texas Revolution. The community was designated as the county seat by the act of the Texas legislature which created Grayson County on March 17, 1846. In 1847, a post office began operation. Sherman was originally located at the center of the county, but in 1848 it was moved about three miles (5 km) east to its current location.

By 1850, Sherman had become an incorporated town under Texas law. It had also become a stop on the Butterfield Overland Mail route through Texas. By 1852, Sherman had a population of 300. It consisted of a public square with a log court house, and several business, a district clerk's office, and a church along the east side of the square.

During the 1850s and 1860s, Sherman continued to develop and it participated in the regional politics. The first flour mill was built in 1861. In 1862 the publisher of Sherman's anti-secessionist Whig newspaper, the Patriot, was murdered. During and after the Civil War, north Texas outlaw bands led by Jesse James and William Quantrill were seen in Sherman. Years later, James spent at least part of his honeymoon in Sherman, where he was photographed on horseback.

While there was general depression and lawlessness during Reconstruction, Sherman remained commercially active. During the 1870s Sherman's population reached 6000. In 1875, two fires destroyed many buildings east of the square. They were rebuilt with superior materials. This included a new Grayson County Courthouse built in 1876. In 1879, Old Settlers' Association of North Texas formed and met near Sherman. The Old Settlers' Association of Grayson County incorporated in 1898 and completed purchase of Old Settlers' Park in 1909.

In 1901 the first electric "Interurban" railway in Texas, the Denison and Sherman Railway, was completed between Sherman and Denison, Texas. The Texas Traction Company completed a 65-mile (105 km) interurban between Sherman and Dallas, Texas in 1908 and it purchased the Denison and Sherman Railway in 1911. Through the connections in Dallas and Denison, it was possible to travel to Terrell, Texas; Corsicana, Texas; Waco, Texas; Fort Worth, Texas; Cleburne, Texas; Denton, Texas; and to Durant, Oklahoma by interurban railways. One popular destination on the Interurban between Sherman and Denison was Loy Lake Park, a private amusement park at the time. By 1948, all interurban rail service in Texas had been discontinued.