Understanding term sheets: a founder's guide

A term sheet outlines the key terms of an investment. Here's what each clause means and what to watch out for.

What Is a Term Sheet?

A term sheet is a non-binding document that outlines the key terms of an investment offer. It's not a contract — the actual legal agreements come later — but it sets the framework for everything that follows. Once you sign a term sheet, you're implicitly committing to the deal (even if not legally bound), so understanding what you're agreeing to is critical.

Key Economic Terms

Valuation The pre-money valuation is what investors think your company is worth before their investment. If you raise $500K at a $2M pre-money valuation, your post-money valuation is $2.5M, and investors own 20%.

Option Pool Many term sheets include a "pre-money option pool shuffle" — the option pool is created before the investment, which dilutes the founders more than investors. Watch for this. A 15% option pool carved out pre-money significantly reduces your effective valuation.

Pro-Rata Rights The right for investors to participate in future rounds to maintain their ownership percentage. Reasonable and standard.

Anti-Dilution Protects investors if you raise a future round at a lower valuation (a "down round"). Full ratchet is investor-friendly and harsh on founders; broad-based weighted average is the standard and more balanced.

Key Control Terms

Board Composition Who sits on the board? A typical seed board is 2 founders + 1 investor. Be wary of giving investors board control before you have significant scale.

Protective Provisions Rights that give investors veto power over certain decisions (selling the company, issuing new shares, taking on significant debt). Standard provisions are reasonable; extensive lists of vetoes are founder-unfriendly.

Information Rights Investors' rights to receive financial updates. Quarterly or annual reporting is standard.

Liquidation Preference

In the event of a sale or wind-down, investors typically get their money back first before founders get anything. A 1x non-participating preference is standard and fair. Participating preferred (where investors get their preference AND a proportional share of remaining proceeds) is much more investor-friendly.

SAFE vs. Priced Rounds

At the earliest stages, many investments happen via SAFEs (Simple Agreement for Future Equity) — they convert to equity at a future priced round. SAFEs avoid the complexity of setting a valuation immediately. If you're getting your first term sheet, clarify whether it's a SAFE with a cap or a priced round.

What to Negotiate

Focus on: 1. Valuation (directly affects dilution) 2. Option pool size (affects effective valuation) 3. Board composition (affects control) 4. Liquidation preference (affects exit economics)

Don't die on every hill. Prioritize the terms that matter most for your situation.