Understanding Term Sheets: A Founder's Guide

A term sheet outlines the key terms of an investment before drafting full legal documents. It typically comes after initial meetings and due diligence, signaling serious investor interest.

• Term sheets are typically 5-10 pages long
• Most terms are non-binding, except exclusivity and confidentiality
• Expect 4-8 weeks from term sheet to closing
• You can negotiate—nothing is set in stone
• Have an experienced startup lawyer review every term

Valuation determines how much of your company investors will own. Understanding pre-money vs. post-money valuation is essential.

• Pre-money valuation: Company value before the investment
• Post-money valuation: Pre-money + investment amount
• Example: $8M pre-money + $2M investment = $10M post-money = 20% ownership
• Option pool is typically included in pre-money, increasing effective dilution
• Focus on the percentage owned, not just the valuation number

Liquidation preferences determine who gets paid first and how much when the company is sold or goes public. This is one of the most important terms to understand.

• 1x non-participating: Investors get their money back OR convert to common (standard and founder-friendly)
• 1x participating: Investors get money back AND their pro-rata share (double-dipping)
• 2x or higher: Investors get 2x+ their investment before anyone else
• Participating preferred can dramatically reduce founder returns in moderate exits
• Always push for non-participating preferred with 1x preference

Anti-dilution provisions protect investors if you raise a future round at a lower valuation (a 'down round').

• Weighted average: Adjusts based on how much money raised at lower price (more founder-friendly)
• Full ratchet: Adjusts as if all previous shares were bought at lower price (harsh for founders)
• Broad-based weighted average is the standard and fair approach
• Full ratchet can be devastating—avoid if possible
• These only apply in down rounds—if you're growing, they don't matter

The board of directors makes major company decisions. Board composition affects control and governance.

• Early stage: Often 3-person board (2 founders, 1 investor)
• Later stages: Boards expand to 5-7 members
• Independent directors can help balance founder/investor dynamics
• Protective provisions may require board or investor approval for major decisions
• Consider future rounds—each investor may want a board seat

These give investors veto rights over certain major decisions, even if they're minority shareholders.

• Common provisions: Selling the company, raising new rounds, changing charter
• Less common but important: Hiring/firing executives, large contracts, debt
• Try to limit protective provisions to truly major decisions
• Threshold requirements can help (e.g., majority of preferred, not just one investor)
• Too many provisions can slow down decision-making

Pro-rata rights allow investors to maintain their ownership percentage in future rounds by investing additional capital.

• Standard for institutional investors
• Can crowd out new investors if all existing investors exercise
• Super pro-rata means investors can increase their percentage
• Consider caps or limitations on pro-rata rights
• Pro-rata from angels is less common and negotiable

Even as founders, you may have vesting requirements as part of the investment terms.

• Standard: 4-year vesting with 1-year cliff
• Credit for time already worked is common
• Acceleration on change of control (single or double trigger)
• Single trigger: Full acceleration if company is sold
• Double trigger: Acceleration only if sold AND you're terminated

Investors typically require regular updates and access to company information.

• Monthly or quarterly financial statements
• Annual budgets and business plans
• Cap table and investor updates
• Right to visit offices and speak with management
• Balance transparency with administrative burden