What a Term Sheet Contains
A term sheet is a non-binding document that outlines the key terms of an investment. It covers two categories: economic terms (who gets how much money) and control terms (who makes decisions).
Economic terms: Valuation, investment amount, liquidation preference, anti-dilution, dividends, participation rights.
Control terms: Board composition, protective provisions, information rights, registration rights, drag-along, right of first refusal.
Most founders focus on valuation and ignore the rest. This is a mistake. Control terms and economic preferences can be more impactful than a 10-20% valuation difference.
Key Economic Terms Explained
Pre-money valuation: What the company is worth before the investment. Your ownership = pre-money / (pre-money + investment amount).
Option pool: Investors typically require a 10-15% option pool created pre-money. This dilutes founders, not investors. Negotiate the pool size based on your actual hiring plan.
Liquidation preference: Determines payout order in an exit. 1x non-participating is standard and fair. Participating preferred and 2x+ preferences are aggressive — push back.
Anti-dilution: Protects investors in down rounds. Broad-based weighted average is standard. Full ratchet is punitive — decline it.
Dividends: Rarely paid in startups, but some term sheets include cumulative dividend provisions that accrue over time. Understand the cash impact before accepting.
Key Control Terms Explained
Board composition: Determines who controls the company. Maintain founder majority or founder-plus-independent majority for as long as possible.
Protective provisions: Investor veto rights over major decisions — fundraising, M&A, changes to charter. Standard provisions are reasonable; expansive provisions give investors too much control.
Drag-along: Requires minority shareholders to support a sale approved by the majority. Standard and usually acceptable.
Right of first refusal (ROFR): Gives investors the right to purchase shares before they're sold to third parties. Standard, but negotiate reasonable time limits.
Information rights: Quarterly financial reports, annual audits, board observer rights. Standard and reasonable at most stages.
How to Evaluate a Term Sheet
When you receive a term sheet:
1. Don't sign immediately. Take 48-72 hours to review carefully with your attorney.
2. Model the economics: Run exit scenarios at $20M, $50M, $100M, and $200M. How much does the founder receive under each scenario, given the terms?
3. Compare to standards: Is each term at, above, or below market? Your attorney and advisor should benchmark every provision.
4. Prioritize: Identify the 2-3 terms that matter most to you. Negotiate those hard. Accept market-standard terms on everything else.
5. Don't negotiate everything: Pushing back on every line item signals distrust and can kill the deal. Pick your battles.
6. Use competition: If you have multiple term sheets, use them to improve terms — but be transparent about it. Fabricating competing offers destroys trust.
The preparation to evaluate term sheets should happen before you receive one. Understanding these mechanics in advance means you can respond with knowledge, not panic.
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