Term Sheet
A term sheet is a non-binding document that outlines the key terms and conditions of a proposed venture capital investment. It is the first formal step after a verbal agreement — not the final contract, but a mutual statement of intent that governs negotiation of the binding legal documents (typically a Stock Purchase Agreement and Investor Rights Agreement) that follow.13
Most of a term sheet's provisions are legally non-binding — a VC firm can walk away if due diligence surfaces problems. Two clauses typically are binding: exclusivity (the founder agrees not to negotiate with other investors for a set period, usually 30–60 days) and confidentiality.1
Economics
Valuation
The term sheet states either a pre-money valuation (the company's value before the investment) or a post-money valuation (after). The distinction matters because it directly determines how much equity the investor receives:4
- Pre-money: $10M valuation + $2M investment = $12M post-money, investor gets 16.7%
- Post-money: $10M post-money valuation means investor gets exactly 20% for a $2M check
SAFEs issued since 2018 are stated on a post-money basis, giving founders and investors clarity on ownership at the moment of signing.
Liquidation preference
Liquidation preference determines who gets paid first — and how much — when the company is sold or wound down. Most modern term sheets specify a 1x non-participating liquidation preference: the investor gets back their original investment first, and if the remaining proceeds are worth more per share than that, they convert to common stock and share pro-rata.13
The more investor-friendly variant is participating preferred: the investor gets their 1x back and participates pro-rata in the remaining proceeds alongside common shareholders. This "double dips" and can significantly reduce founder and employee payouts in modest exits. Participating preferred has become less common as founder leverage has increased.5
| Type | What investor gets at exit |
|---|---|
| Non-participating 1x | Higher of: (1) 1x investment back, or (2) pro-rata conversion to common |
| Participating 1x | 1x investment back plus pro-rata share of remaining proceeds |
| 2x participating | 2x investment back plus pro-rata share of remaining proceeds |
Anti-dilution
Anti-dilution provisions protect investors if the company raises a future round at a lower valuation (a "down round"). There are two main types:4
- Broad-based weighted average — the investor's conversion price is adjusted downward based on a formula that accounts for all outstanding shares. This is founder-friendly and the market standard.
- Full ratchet — the investor's conversion price drops to the lower round price, regardless of size. Extremely investor-friendly and rare in competitive deals.
Governance
Board composition
Term sheets specify how board seats are allocated. A typical Series A board might have two founders, one lead investor, and one independent director agreed on by both parties. Board control is one of the most consequential provisions — the board can hire and fire the CEO.3
Pro-rata rights
Pro-rata rights (also called "follow-on rights") give investors the right — but not the obligation — to invest in future rounds at the same percentage ownership. This allows early investors to maintain their ownership as the company grows. Super pro-rata rights grant the right to invest more than their ownership percentage.1
Information rights
Investors typically receive the right to quarterly financial statements, annual audited accounts, and an annual budget. Larger investors may negotiate more detailed rights.3
Protective provisions
A set of shareholder actions that require investor approval, regardless of ownership percentage. Typical examples: selling the company, taking on significant debt, issuing new shares senior to the investor's class, or changing the company's business materially.1
Vesting
Term sheets often specify or reference founder vesting schedules — typically four years with a one-year cliff. If a founder leaves before the cliff (usually 12 months), they receive no vested shares. After the cliff, shares vest monthly. This protects investors from a co-founder departing with a large equity stake shortly after funding.3
Negotiating a term sheet
The most important clauses to negotiate are liquidation preference, anti-dilution, and board composition — in that order. Valuation gets most attention but matters less than these structural terms in downside scenarios. A $10M valuation with a 2x participating liquidation preference may be worth less to founders than an $8M valuation with a 1x non-participating preference.2
The Y Combinator model deliberately avoids most of this complexity at the seed stage — its SAFE instrument has no liquidation preference, no board seats, and no protective provisions, deferring all of that negotiation to the Series A.