A term sheet is a non-binding agreement that outlines the key terms of a venture investment. Most founders focus on valuation and check size — the headline numbers. But term sheets contain dozens of provisions that collectively determine how much of your company you actually own, how much control you retain, and what happens in various exit scenarios. Understanding these terms is non-negotiable.
Valuation: Pre-Money vs Post-Money and Dilution
A $5M investment at a $20M pre-money valuation gives the investor a 20% stake ($5M ÷ $25M post-money). This seems straightforward, but the option pool — shares reserved for future employee equity grants — is typically included in the pre-money calculation, meaning founders dilute more than the headline percentage suggests. Always calculate founder dilution on a fully diluted basis including the option pool refresh.
Liquidation Preferences: The Provision That Matters Most
A 1x non-participating liquidation preference means investors receive their investment back before founders and employees share in the proceeds. This is standard and reasonable in a downside scenario. "Participating preferred" stock is more aggressive: investors first receive their preference, then participate pro-rata in the remaining proceeds. In a $100M exit on a $10M investment, this difference can amount to millions of dollars.
Multiple liquidation preferences (2x, 3x) were common in the late 2020s correction and represent significant founder-unfriendly terms. Push back hard on anything above 1x non-participating.
Pro-Rata Rights and Information Rights
Pro-rata rights give investors the right (but not obligation) to invest in future rounds to maintain their ownership percentage. For founders, this means fewer spots for new investors and potential complications in future rounds. Information rights — quarterly financials, board observer seats — seem benign but create obligations and can slow down your operations. Understand what you're committing to before you sign.
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