What Is a Term Sheet (And What It's NOT)

A term sheet is a non-binding preliminary agreement outlining the key terms of an investment. It's not a legal binding contract (yet).

What it does: Sets the framework for future negotiations. Once both sides agree to the term sheet, lawyers draft the actual legal documents (stock purchase agreement, preferred stock certificate, etc.).

What it doesn't do: It doesn't close the deal. Until you sign the final legal documents AND money clears, the investment isn't final. Term sheets can fall apart.

Why it matters: Because the final legal documents almost always follow the term sheet roadmap exactly. So if you negotiate a bad term sheet, you're stuck with it^[1].

The Term Sheet Structure (What to Expect)

Most term sheets follow this structure:

1. Investment Amount & Valuation
2. Type of Security (common vs. preferred stock)
3. Economic Rights (how you make money)
4. Control Rights (who has power)
5. Other Terms (vesting, anti-dilution, etc.)
6. Conditions to Close (what needs to happen first)

The Critical Clauses (Explained Simply)

1. Investment Amount & Valuation

What it says: "We're investing ₹2Cr at a ₹12Cr post-money valuation."

What it means:

• Investor writes a cheque for ₹2Cr.
• Your company's total value after investment = ₹12Cr.
• Pre-money valuation = ₹12Cr - ₹2Cr = ₹10Cr.
• Investor owns ₹2Cr / ₹12Cr = 16.7% of your company.
• You're diluted from 100% to 83.3%.

What's negotiable: Everything. The valuation, the amount, sometimes even the terms.
What's not negotiable: Math. Once you agree on valuation and amount, ownership % is fixed by formula.

2. Type of Security (Preferred vs. Common Stock)

What it says: "Investor receives Series A Preferred Stock. Founders retain Common Stock."

What it means: Preferred stock gets special rights (see below). Common stock gets basic ownership (no special perks).

Why it matters: Preferred stock holders get paid first in an exit (liquidation preference). Common stock holders (you) get paid last.

3. Liquidation Preference (The Most Important Clause)

What it says: "Preferred shareholders have a 1x non-participating liquidation preference."

What it means: In an exit (acquisition, bankruptcy, etc.), preferred stock holders get their money back first, at 1x their investment amount.

Example:

• Investor put in ₹2Cr at Series A.
• Company gets acquired for ₹5Cr.
• With 1x liquidation preference: Investor gets their ₹2Cr first. Remaining ₹3Cr goes to founders and other investors.

Red flag: Participating Preferred Stock

If it says "1x participating," that means investor gets ₹2Cr PLUS their pro-rata share of remaining proceeds.

• Investor gets ₹2Cr (preference).
• Then gets their 16.7% of remaining ₹3Cr = ₹50L.
• Total: ₹2.5Cr (instead of ₹2Cr). That's extra $$ coming out of your pocket.

Key insight: 1x non-participating is standard. 1x participating is aggressive (bad for founders). Avoid 2x+ at all costs.

4. Anti-Dilution Protection

What it says: "Anti-dilution clause protects preferred shareholders if future rounds are at lower valuation."

What it means: If you raise a down round (lower valuation), preferred shareholders get extra shares for free to protect their ownership %.

Example:

• Series A: Investor owns 16.7% (got it at ₹12Cr valuation).
• Series B: You raise at ₹6Cr (oops, down round).
• Without anti-dilution: Investor still owns 16.7%, but their stake is worth half as much.
• With "full ratchet" anti-dilution: Investor gets extra shares so their average cost = new Series B price. They might own 25% now (you got diluted more).

Types of anti-dilution:

• Full ratchet (bad for founders): Investor's cost resets to new lowest price. Super punishing.
• Weighted average (standard): Investor gets some protection, but not full. More reasonable.
• None (good for founders): Down round doesn't trigger extra shares for investor. Rare.

Negotiation tip: Push for weighted average. Fight hard against full ratchet.

5. Pro-Rata Rights (Right of First Refusal)

What it says: "Investor has the right to participate in future funding rounds to maintain their ownership percentage."

What it means: In your next round, investor gets to buy shares first (before new investors) to keep their %. If they don't want to participate, they lose the right.

Impact on you: Usually neutral. It just means existing investors can keep their ownership if they want to. Not that painful.

6. Board Seats & Voting Rights

What it says: "Investor gets one board seat. Investor has voting rights on major decisions."

What it means: Investor can attend board meetings and veto certain decisions (hiring CEO, raising more debt, major pivots, etc.).

Red flag: Veto rights on small things

• Bad: "Investor must approve any hire over ₹50L salary" (too intrusive).
• OK: "Investor must approve any debt over ₹1Cr" (reasonable threshold).

7. Drag-Along & Tag-Along Rights

Drag-along: If majority shareholders want to sell the company, they can force minority shareholders (including you) to sell too.

Example: Investors own 60% combined. They get an acquisition offer. They can drag you along, force a sale even if you don't want to.

Tag-along: If majority shareholders sell their stake to someone, minority shareholders can "tag along" and sell at the same price.

Impact on you: Drag-along is standard and reasonable. Tag-along is pro-founder. Push for it.

8. Founder Vesting

What it says: "Founder shares vest over 4 years with a 1-year cliff."

What it means: You don't own your shares all at once. You earn them over time. If you leave in year 1, you lose most shares.

Standard terms: 4-year vesting, 1-year cliff. This is market standard. Don't fight it.

Double-sided cliff (bad for founders): Some term sheets have a "co-founder clause" where if one founder leaves, all founders' vesting accelerates (you lose protection). Avoid this.

9. Participation Rights & Information Rights

What it says: "Investor gets quarterly financial reports and the right to inspect books."

What it means: Investor can see your financials and ask questions. Standard and reasonable.

10. Right of First Refusal (ROFR) & Co-Sale Rights

Right of First Refusal: If you (founder) want to sell your shares, investor gets first dibs to buy them at that price.

Co-sale: If you sell your shares to a third party, investor can sell their shares too (at same price/terms).

Impact: Usually not a big deal. You're probably not selling shares anyway. But it does limit your flexibility down the line.

What's Negotiable vs. What's Standard

Red Flags: Terms That Should Scare You

🚩 1x Participating Liquidation Preference

The clause: "Investor has 1x participating preferred shares."

Why it's bad: Investor gets their money back + pro-rata share of proceeds. In a ₹100Cr exit, this can cost founders ₹10-20Cr.

What to do: Push for 1x non-participating. If they won't budge, consider walking.

🚩 Full Ratchet Anti-Dilution

The clause: "Full ratchet anti-dilution protection."

Why it's bad: In a down round, investor gets massive dilution to you. You get wiped out.

What to do: Insist on weighted average. Full ratchet is deal-killer level bad.

🚩 Investor Controls Board Majority

The clause: "Investor gets 2 board seats. Founders get 1."

Why it's bad: You've lost control of your company. Investor can make major decisions without you.

What to do: Standard is investor gets 1 seat, founders get 1+ seats. Push back.

🚩 Veto Rights on Minor Decisions

The clause: "Investor must approve any employee hire over ₹25L salary."

Why it's bad: Micromanagement. Slows down hiring.

What to do: Push for high thresholds (₹1Cr+) or remove small-item vetoes entirely.

🚩 Double-Sided Founder Vesting Cliff

The clause: "If any founder leaves, all remaining founders' vesting accelerates to current cliff rate."

Why it's bad: If co-founder leaves, you lose equity protection. This is punishing.

What to do: Push for single-sided cliff (only leaving founder loses acceleration).

🚩 Multiple Liquidation Preferences

The clause: "Series A has 2x preference. Series B has 3x preference. Series C has 4x."

Why it's bad: In a modest exit (₹50Cr), all investor preferences get paid first. You get almost nothing.

What to do: This is common in late-stage, but worth pushing back on at early stage.

Negotiation Tactics (How to Get Better Terms)

1. Come Prepared with Data

"We looked at 5 comparable Series A rounds in our space. The average valuation is 8-10x ARR. We have ₹2Cr ARR. We should be valued at ₹16-20Cr, not ₹12Cr."

2. Use Investor Competition

"We have 2 other term sheets pending. One has weighted average anti-dilution. Can you match that?"

3. Pick Your Battles

Don't fight on vesting (standard). Fight on valuation, liquidation preference, anti-dilution. That's where the money is.

4. Make It a Conversation, Not an Argument

"We love your firm and think we're aligned. But we're concerned about 1x participating. It could cost us $5M in upside. Can we explore 1x non-participating?"

5. Know When to Walk

If an investor is asking for full ratchet + 2x liquidation preference + control of board, they don't respect your company. Walk.

The Process (After You Get the Term Sheet)

1. Understand every clause. Don't let "standard" terminology pass without understanding it.
2. Get legal review. Hire a startup lawyer (₹1-2L for a good lawyer is worth it). They spot risks you miss.
3. Negotiate. Use the tactics above. Push on big items. Give ground on small items.
4. Get to mutual agreement on term sheet. Once both sides sign, it's mostly locked in.
5. Full legal documentation. Lawyers now draft the final stock purchase agreement and other docs.
6. Due diligence. Investor investigates your company deeply (financials, customers, tech, legal risks).
7. Final signatures & wire. Once due diligence is clear, both sides sign final docs and money clears.

Conclusion

A term sheet is not just a formality. Every clause matters. Some clauses (liquidation preference, anti-dilution) can cost you millions in upside.

Read it carefully. Understand it. Negotiate on the big items. Get a lawyer. And don't sign until you're confident you're getting a fair deal.