Term Sheet Basics

Warm-up: Your first term sheet

2 warm-up questions

• Have you ever signed a contract you didn't fully understand — a job offer, a lease, a loan? What made you sign anyway?
• First try: an investor offers you $2M for 20% of your company. In 30 seconds, tell me what your company is worth before and after the deal — and whether you'd take it.

Reading: Term Sheet Basics

Read a 260-word text about Term Sheet Basics

Term Sheet Basics A term sheet is a non-binding agreement outlining the basic terms and conditions of an investment. Understanding term sheets is critical—accepting unfavorable terms early can cost you millions in dilution or control over time. While your lawyers will review details, you need to understand the fundamentals yourself. Term sheets typically run 5-15 pages and cover several key areas. The economic terms include investment amount, valuation, price per share, and liquidation preferences. These determine how much of your company you're selling and how proceeds get distributed if the company is sold or goes public. Control terms specify board composition, voting rights, and protective provisions that give investors veto power over certain decisions. Two terms often cause confusion: pre-money valuation versus post-money valuation. Pre-money valuation is what your company is worth before the investment. Post-money valuation includes the new investment. Example: $8M pre-money valuation + $2M investment = $10M post-money valuation. The investor owns 20% ($2M/$10M). Other important sections cover pro rata rights (investor's right to participate in future rounds to maintain ownership percentage), anti-dilution protections (adjustments if you raise money later at a lower valuation), and vesting schedules for founder stock (to ensure founders stay committed). Many terms interact with each other, so changing one can significantly affect others. Standard versus aggressive terms vary by stage and market conditions. In a strong fundraising market, founders can negotiate more favorable terms. During downturns, investors demand more protection. Understanding what's market-standard for your stage helps you identify unusually investor-friendly or founder-friendly terms. Always consult an experienced startup lawyer before signing.

Vocabulary: Term Sheet Basics Vocabulary

8 items

Framework: The Term Sheet Anatomy

The Term Sheet Anatomy, 7 steps

The Term Sheet Anatomy: A breakdown of the 7 key components in every term sheet. Understanding these sections helps you negotiate confidently and avoid common founder mistakes.

Reading: Two model walkthroughs

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Two model walkthroughs The fastest way to sound credible around a term sheet is to walk it aloud, top to bottom, in plain English. Here are two complete performances — first a founder briefing their co-founder, then the same founder querying the investor. The structural moves are in bold. Briefing your co-founder (two minutes, plain English) "OK, here's the deal on one page. The valuation: $8M pre-money, they invest $2M, so $10M post-money — they get 20%, and we keep the rest between us and the option pool. The shares: they get Series A preferred with a 1x non-participating liquidation preference — in plain English, if we sell, they take their $2M back first OR convert to their 20%, whichever is worth more. They can't take both. The board: five seats — you, me, two investors, one independent. We don't control it alone any more, but neither do they. Anti-dilution: broad-based weighted average, which is the founder-friendly version — if we ever raise a down round, it adjusts their price gently, not brutally. Vesting: our own shares re-vest over four years with a one-year cliff. I don't love it, but it's market-standard, and it protects each of us if the other walks away. The one thing I want to push back on is the protective provisions — right now they'd need investor approval for any debt over $100K, and that threshold is too low." Querying the investor (smart questions, not objections) "Thanks for sending this over — the structure is mostly clear, and I want to make sure I understand three things before our lawyers dig in. First, the liquidation preference: it reads as 1x non-participating — can you confirm there's no participation above the 1x? Second, the option pool: the 15% pool is created pre-money, which means the dilution lands on the founders — is that your standard structure, or can we size the pool to the actual hiring plan? And third, the protective provisions: the debt threshold is $100K, which would catch even a standard line of credit. Could we raise that to $500K? None of these are deal-breakers — I just don't want either of us surprised at closing."

Practice: Practice: Term Sheet Terminology

Gap-fill exercise, 5 items

• ____ valuation is calculated before the new investment is added.
• ____ determine who gets paid first if the company is sold.
• ____ rights allow investors to participate in future rounds to maintain their ownership percentage.
• Each funding round causes ____ as new shares are issued to investors.
• ____ give investors veto power over major company decisions.

Practice: Practice: the language of the deal

Gap-fill exercise, 6 items

• A term sheet is ____ — it creates no legal obligations until you sign definitive agreements.
• An $8M pre-money valuation plus a $2M investment equals a $10M ____ valuation.
• Founder shares typically ____ over four years with a one-year cliff.
• Term sheets cover economic terms and ____ terms — board composition, voting rights, vetoes.
• Full ratchet ____ protection is very investor-friendly; weighted average is more balanced.
• Economic terms determine how proceeds get ____ if the company is sold.

Practice: Match the term to its plain English

Matching exercise, 6 items

• Liquidation preference
• Pre-money valuation
• Pro rata rights
• Vesting with a one-year cliff
• Protective provisions
• Anti-dilution protection

Dialogue: Role Play: Reviewing Your First Term Sheet

Role-play: You just received a term sheet from a seed-stage VC fund. You're meeting with your startup lawyer to go over the key terms before responding. (4 lines)

• lawyer: I've had a chance to review the term sheet from Vertex Ventures. Before we go through it section by section, can you tell me what your initial understanding of the key terms is?
• lawyer: That's a good start. The liquidation preference is set at 1x non-participating, which is fairly standard. Do you understand how that would work in an exit scenario?
• lawyer: Exactly right. Now, there's also a pro-rata rights clause and an information rights section. How do you feel about giving investors quarterly financial reports and the right to participate in future rounds?
• lawyer: Pro-rata rights are generally founder-friendly, yes. One area I'd flag is the board composition clause. They're requesting two board seats out of five. What are your thoughts on board control at this stage?

Discussion: Your mission: walk the term sheet

3 discussion questions

• Mission: walk your tutor through a term sheet for YOUR startup (real or imagined). Cover valuation (pre-money, investment, post-money and the investor's percentage — with correct arithmetic), share class and liquidation preference, board composition, and vesting — all in plain English. Success = the maths is right and every term is explained so a non-lawyer could repeat it back. (Tutor: play the co-founder and interrupt twice with 'wait — what does that actually mean?')
• Second take: your tutor's term sheet hides one aggressive term — full ratchet anti-dilution, a 2x participating preference, or a $100K debt veto. Find it, explain why it worries you, and say what market-standard would look like.
• Look back at your 30-second answer about the $2M-for-20% offer from the start of the lesson. What would you say now — and which term would you check before celebrating?