A term sheet, clause by clause — and which half of it is about control.

What a term sheet is for

A priced venture round is documented by a stack of agreements: a certificate of incorporation creating the new preferred series, a stock purchase agreement, an investors' rights agreement, a voting agreement and a right of first refusal and co-sale agreement. Those documents run to a hundred pages or more. The National Venture Capital Association publishes free model versions of all of them, and most US venture financings are marked-up copies of those models.

The term sheet is the two-to-eight-page summary that says which choices will be made inside that stack. It is negotiated first, because negotiating the whole stack before agreeing the economics wastes everyone's legal budget. Once it is signed, the lawyers draft to it, and re-opening a term the term sheet settled is possible but socially expensive.

Economic terms versus control terms

Read the term sheet twice. The first pass answers "how is money split?" The second answers "who decides?" Almost every clause lands in one bucket or the other, and founders reliably over-index on the first while investors are often quietly buying the second.

Valuation, and the option pool trick underneath it

The pre-money valuation is the number everyone quotes, but it is not the price. The price per share is the pre-money valuation divided by the pre-money share count, and the term sheet also specifies what goes into that share count. If it requires an unallocated option pool to exist before the round — "the pre-money valuation assumes a 10% post-closing unallocated option pool" is the standard phrasing — then that pool is added to the pre-money denominator and the price per share falls.

The effect is not small. A round of $1,000,000 at a $4,000,000 pre-money leaves the founders with 80% if there is no pool, and 70% if a 10% post-closing pool is created pre-money. The full arithmetic, with both cap tables, is in /equity/pre-money-vs-post-money. The short version: subtract the pool percentage times the post-money valuation from the stated pre-money, and you have the effective pre-money you are actually being offered.

Liquidation preference and participation

The liquidation preference says what the preferred holders are paid first when the company is sold, liquidated or hits any of the deemed liquidation events the documents define — which in the NVCA model includes a merger and a sale of substantially all the assets. A 1× non-participating preference means the investor takes back their money or converts to common and takes their percentage, whichever is larger, but not both.

Participation changes that "or" into an "and". A participating preferred takes the preference off the top and then shares in the remainder as though it had converted. A capped participation does the same but stops once the holder has received a stated multiple of the original price. On a large exit these structures converge, because at some point converting to common beats any capped preference. On a modest exit they are the difference between the common stock being worth something and being worth nothing. The full payout tables are in /equity/liquidation-preference.

Anti-dilution, worked

Anti-dilution protection adjusts the price at which preferred converts into common if the company later issues shares below that price. It does nothing in a flat or up round. In a down round it silently increases the investor's share count at the expense of everyone without the protection — which is the founders and the employees.

The market-standard form is broad-based weighted average. The new conversion price is the old price multiplied by (shares outstanding before the down round, plus the number of shares the new money would have bought at the old price) divided by (shares outstanding before, plus the shares actually issued). Narrow-based weighted average uses only the affected preferred series in the denominators instead of the whole fully diluted count, which produces a much larger adjustment. Full ratchet simply resets the conversion price to the new lower price.

Concretely: an investor holds 2,000,000 Series A shares bought at $2.00. The company has 10,000,000 shares fully diluted. It then issues 5,000,000 new shares at $1.00, raising $5,000,000.

Notice that full ratchet does not care how small the down round is. That is why it is unusual outside distressed financings, and why founders should read carefully for it. All three flavours normally come with carve-outs — option grants under the plan, shares issued on conversion of existing securities, shares issued in acquisitions approved by the board — and the width of those carve-outs matters almost as much as the flavour.

Board composition and protective provisions

Control is the half of the term sheet that founders most often skim. A typical early structure is a board of three: one seat for the founders, one for the lead investor, one independent director agreed by both. That structure means neither side can act alone, and the independent seat becomes the swing vote on every contested decision, including whether to sell the company and whether to replace the chief executive.

Protective provisions sit alongside the board and operate differently. They are a list of actions the company may not take without the consent of a stated percentage of the preferred, voting as a separate class — typically amending the charter, creating a senior series, redeeming shares, paying dividends, selling the company, or increasing the option pool. A holder with a protective provision can block those actions even if they hold a small minority and even if the whole board disagrees.

• Ask how many directors each side appoints, who appoints the independent seat, and what happens to those rights if the investor's stake falls below a threshold.
• Ask whether the protective provisions are voted by all preferred together or by each series separately. Series-by-series voting hands a veto to every past round, and later financings get harder with each one.
• Ask what the drag-along thresholds are, and whether the common stock has to vote with the preferred or can be dragged by the preferred alone.
• Ask whether board approval or preferred approval is required to increase the option pool, because that determines who controls employee equity for the next two years.

The terms that are easy to miss

• Cumulative dividends. A dividend that accrues and is added to the liquidation preference quietly grows the preference every year, even though no cash ever moves.
• Redemption rights. A right for the preferred to demand their money back after a period. Rarely exercised, occasionally decisive.
• Founder re-vesting. New vesting imposed on stock the founders already own, sometimes with credit for time served and sometimes not.
• Exclusivity length. A 60-day no-shop and a 30-day no-shop are very different negotiating positions.
• The definition of a qualified financing, which governs whether outstanding SAFEs and notes convert into this round. See /equity/safe-note and /equity/convertible-note.
• Expense reimbursement caps. Uncapped investor legal fees paid by the company are a real cost that comes straight out of the round.