Once a VC decides they’re seriously interested in investing in your company, the next major milestone is the term sheet. This short document lays out the key terms of the proposed investment deal. While it’s technically non-binding (except for things like confidentiality and exclusivity), it forms the basis of your legal agreement. So it’s incredibly important to understand what you’re agreeing to before signing anything, and make sure it’s aligned with your vision and core values.
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The term sheet is where the real negotiation begins, and sets the tone for your relationship with your investors. This can have long-lasting implications for your relationship with your investors, and can have long-lasting implications for your company’s future, your ownership and your ability to raise capital later on.
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Don’t go into a term sheet negotiation alone. Get support from experienced mentors, advisors and your legal team to make sure you fully understand the terms. |
SAFEs and convertible notes
For startups seeking to raise less than $2 million, it is very common to seek investments through convertible notes or Simple Agreements for Future Equity (SAFEs). These financing instruments provide capital under straightforward terms, converting to equity only upon the closure of a subsequent priced equity round. The most popular, modern version of a convertible note is the post-money SAFE, which caps the valuation that is used to calculate how much equity the SAFE investor will acquire upon conversion of the note at a pre-defined level. Such instruments are advantageous for startups, as they can be negotiated and executed quickly with minimal legal deliberation, and investors know what percentage ownership they will have ahead of the round. However, there are some drawbacks, especially if you receive multiple SAFEs. Each SAFE needs to be negotiated individually, creating the potential to clutter your capitalization table with several small investors (all with potentially different terms) that may receive equity at a lower or discounted valuation compared to what your company will be priced at during the equity raise.
We recommend taking the time to learn more about this type of financing, given how common it is for startups. There are several great resources across the web, including this video.
For startups seeking to raise less than $2 million, it is very common to seek investments through convertible notes or Simple Agreements for Future Equity (SAFEs). These financing instruments provide capital under straightforward terms, converting to equity only upon the closure of a subsequent priced equity round. The most popular, modern version of a convertible note is the post-money SAFE, which caps the valuation that is used to calculate how much equity the SAFE investor will acquire upon conversion of the note at a pre-defined level. Such instruments are advantageous for startups, as they can be negotiated and executed quickly with minimal legal deliberation, and investors know what percentage ownership they will have ahead of the round. However, there are some drawbacks, especially if you receive multiple SAFEs. Each SAFE needs to be negotiated individually, creating the potential to clutter your capitalization table with several small investors (all with potentially different terms) that may receive equity at a lower or discounted valuation compared to what your company will be priced at during the equity raise.
We recommend taking the time to learn more about this type of financing, given how common it is for startups. There are several great resources across the web, including this video.
What’s in a Term Sheet for a Priced Equity Round?
Term Sheet clauses fall into two main categories: Economics (who gets what) and control (who gets to decide what).
Economics
Valuation
Investment Amount
Equity and Ownership
Option Pool
Liquidation Preference
Investors in a priced round receive “preferred” shares of equity, rather than “common” stock. The liquidation preference term applies to these preferred shares, and defines who gets paid first in a sale or exit, and how much they receive. Note, from an investors point of view, a liquidation event is a good thing - the goal, in fact, assuming that the company has increased its value or the value of the asset. Also keep in mind that preferred stock can be converted to common stock (in a one-way, irreversible process) at any time. Depending on the amount of money the company or asset is sold for, it may be more advantageous for the investor to convert to common stock and receive their share of the sale simply according to the percentage of equity they hold in the company.
There are two components to this term, 1) the preference and 2) the participation. The liquidation preference simply states that upon a liquidation event the investor gets “x-fold” of their initial investment back before any other distributions. In early-stage rounds, this is almost always kept at 1x, and is largely meant to protect investors from losing money if the company sells quickly for a small amount.
Participation rights (often called "participating preferred" stock) build on liquidation preferences. Non-participating terms state that preferred stock holders take the liquidation preference and that’s it. Remember, preferred shares can convert to common at any time if that is a better outcome. Participating preferred stock holders would receive their liquidation preference followed by a share of what’s left - rated according to their percent equity ownership. Often this is capped at some multiple (e.g., 3x) of the investment, but can significantly squeeze founders if the company exit is not enormous.
→ Why it matters: A >2x and/or participating clause can significantly affect what is left for founders
Anti-Dilution Provisions
Vesting and Founder Stock
Term Sheet clauses fall into two main categories: Economics (who gets what) and control (who gets to decide what).
Economics
Valuation
- Pre-money valuation: The company's value before the new investment.
- Post-money valuation: Pre-money valuation plus the investment amount = total value after the deal
Investment Amount
- The size of the check your investor is writing, at what price per share of stock, sometimes in tranches tied to milestones
Equity and Ownership
- Details how much ownership (equity take) the investor gets, based on the fully diluted cap table (i.e., all outstanding and issued shares are included)
- Investors typically receive preferred shares, which carry special rights and protections
- Preferred stock may carry dividends (e.g., cumulative or non-cumulative). These may not get paid out but accrue to increase investor returns on exit.
- Conversion rights state that preferred stock can convert to common stock at the investor’s discretion, and there may be automatic triggers (e.g., IPO at a certain valuation)
Option Pool
- Equity reserved for future team members (10-15% is common in biotech)
- Usually created pre-investment, which means existing shareholders get diluted, not the new investors
Liquidation Preference
Investors in a priced round receive “preferred” shares of equity, rather than “common” stock. The liquidation preference term applies to these preferred shares, and defines who gets paid first in a sale or exit, and how much they receive. Note, from an investors point of view, a liquidation event is a good thing - the goal, in fact, assuming that the company has increased its value or the value of the asset. Also keep in mind that preferred stock can be converted to common stock (in a one-way, irreversible process) at any time. Depending on the amount of money the company or asset is sold for, it may be more advantageous for the investor to convert to common stock and receive their share of the sale simply according to the percentage of equity they hold in the company.
There are two components to this term, 1) the preference and 2) the participation. The liquidation preference simply states that upon a liquidation event the investor gets “x-fold” of their initial investment back before any other distributions. In early-stage rounds, this is almost always kept at 1x, and is largely meant to protect investors from losing money if the company sells quickly for a small amount.
Participation rights (often called "participating preferred" stock) build on liquidation preferences. Non-participating terms state that preferred stock holders take the liquidation preference and that’s it. Remember, preferred shares can convert to common at any time if that is a better outcome. Participating preferred stock holders would receive their liquidation preference followed by a share of what’s left - rated according to their percent equity ownership. Often this is capped at some multiple (e.g., 3x) of the investment, but can significantly squeeze founders if the company exit is not enormous.
→ Why it matters: A >2x and/or participating clause can significantly affect what is left for founders
Anti-Dilution Provisions
- Protects investors if the company raises a down round (a round at a lower valuation that the previous round)
- Types:
- Full ratchet: Converts shares that were allocated from the previous round to match the lower new price
- Weighted average: Adjusts share price proportionally
Vesting and Founder Stock
- Specifies vesting schedules for founder shares and the option pool (e.g., 4 years with a 1-year cliff) to ensure founders remain committed to the company
Control
Voting Rights
Board Composition
Drag-Along and Tag-Along Rights
Rights of First Refusal (ROFR) and Co-Sale
No-Shop Clause
Confidentiality and Exclusivity
Conditions Precedent
Governance and Reporting, Information Rights
Exit Rights
Why Term Sheets Matter
Term sheets may look like short documents, but they are not lightweight. They define your company’s ownership, power dynamics, and exit potential. Some terms are negotiable, and some may not be. It’s not just about getting a term sheet, it’s about getting the right one. If you receive a term sheet, review it carefully and talk to your advisors, mentors and legal team.
Voting Rights
- Outlines investor influence on major decisions (e.g., mergers, hiring key executives)
- May include protective provisions requiring investor approval for specific actions
Board Composition
- Defines the structure of the board of directors (e.g., number of seats, who appoints them)
- A typical early-stage board might include 1 founder, 1 investor and 1 independent
Drag-Along and Tag-Along Rights
- Drag-along: Forces minority shareholders to agree to a sale if majority approves
- Tag-along: Allows minority investors to join a sale on the same terms as majority
Rights of First Refusal (ROFR) and Co-Sale
- ROFR: Gives investors the right to buy shares before they’re sold to others
- Co-sale: Allows investors to sell their shares alongside founders or other shareholders
No-Shop Clause
- You agree not to talk to other investors for a set period after signing the term sheet.
- Ensures exclusivity during negotiations
Confidentiality and Exclusivity
- Requires both parties to keep terms confidential
Conditions Precedent
- Lists requirements to close the deal (e.g., due diligence, legal documentation)
- May include milestones or approvals needed before funding
Governance and Reporting, Information Rights
- Outlines investor expectations for financial reporting, audits, or operational updates
- Ensures transparency post-investment
Exit Rights
- May include clauses like redemption rights (investors can demand repayment after a period)
- Can outline IPO or acquisition preferences
Why Term Sheets Matter
- They define ownership and control (power in decision making) going forward
- They determine how returns are shared between investors and founders
- They can influence how attractive your company is to future investors
- They reveal how your potential VC partners behaves under pressure (which is important, since this relationship can last years, through many ups and downs)
Term sheets may look like short documents, but they are not lightweight. They define your company’s ownership, power dynamics, and exit potential. Some terms are negotiable, and some may not be. It’s not just about getting a term sheet, it’s about getting the right one. If you receive a term sheet, review it carefully and talk to your advisors, mentors and legal team.
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Compare it with other offers if possible. And assess not just the numbers, but be mindful around who you’re bringing onto your cap table, because these investors will be with you for the long haul. Does this relationship feel good to you? Can you see having a long-term relationship with them? Make sure that you are choosing the people that will help position you and your company for long-term growth and success.
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Founder Tip: Founders often focus on valuation, but the control terms can be just as, if not more important. Don’t ignore the details around governance, board control or liquidation preferences. According to Carta, pre-Seed through Series A rounds in the current market usually contain straightforward terms and founder-friendly, 1x, non-participating liquidation preferences. |