The term sheet arrives in your inbox. It’s your first institutional funding. The valuation looks good. The check size is exactly what you need. You’re excited. Your co-founder is ready to sign immediately.
But hidden within that document are clauses that could slowly strip away your control, dilute your ownership beyond recognition, or leave you working in your own company as a glorified employee rather than a founder-owner.
This isn’t fiction. It happens every day to founders who don’t understand what they’re signing.
A term sheet is not just about valuation and investment amount. Those are the headlines. The real terms—the ones that determine whether you build lasting value or hand over your company piece by piece—are buried in clauses that most first-time founders don’t fully understand.
Understanding Term Sheets
A term sheet is a non-binding document (except for certain clauses like exclusivity and confidentiality) that outlines the key terms of an investment deal. It serves as the blueprint for the definitive legal agreements that follow.
Why Term Sheets Matter
Once you sign a term sheet, you’ve set the parameters for your relationship with that investor. Trying to renegotiate later makes you look difficult or inexperienced. The term sheet stage is your opportunity to negotiate favorable terms.
What founders often focus on:
- Valuation (pre-money and post-money)
- Investment amount
- Percentage dilution
What founders should also focus on:
- Control and decision-making rights
- Liquidation preferences
- Anti-dilution provisions
- Board composition
- Drag-along rights
- Protective provisions
The second list often matters more than the first in determining your long-term success and control over your company.
Red Flag Clauses: What Founders Should Never Accept
Let’s examine the terms that should trigger immediate concern and pushback:
1. Multiple Liquidation Preference (2x or Higher)
What it means: In an exit scenario (acquisition or liquidation), investors get a multiple of their investment back before founders and employees see anything.
Example: Investor puts in ₹10 crores with 2x liquidation preference. Your company sells for ₹25 crores. The investor gets ₹20 crores first. Only ₹5 crores remains for founders and employees who built the company.
Why it’s problematic:
- Destroys founder and employee incentives
- Makes outcomes that look successful actually mediocre for founders
- Creates misaligned interests between investors and founders
What’s acceptable: 1x non-participating liquidation preference is standard. Anything higher is investor-favored and should be strongly negotiated.
2. Participating Liquidation Preference (Double Dipping)
What it means: Investors get their money back first (1x or more), AND then participate in the remaining proceeds based on their ownership percentage.
Example: Investor puts in ₹10 crores for 20% stake with participating preference. Company sells for ₹100 crores.
- Investor gets ₹10 crores first (liquidation preference)
- Then gets 20% of remaining ₹90 crores = ₹18 crores
- Total: ₹28 crores on ₹10 crore investment (while founders split ₹72 crores despite owning 80%)
Why it’s problematic: Investors earn disproportionate returns while founders bear all the risk of building the company.
What’s acceptable: Non-participating preference. Investor chooses either to take their liquidation preference OR convert to equity and take their ownership percentage—not both.
Exception: A participation cap (e.g., “participating up to 3x return, then non-participating”) is more reasonable than uncapped participation.
3. Full Ratchet Anti-Dilution Protection
What it means: If the company raises money at a lower valuation (down round), the investor’s price automatically adjusts to the new lower price, as if they invested at that lower valuation originally.
Example: Investor buys shares at ₹1,000 per share. Next round prices shares at ₹500. With full ratchet, investor’s shares retroactively re-price to ₹500, doubling their share count at founders’ and employees’ expense.
Why it’s problematic:
- Massively dilutes founders and employees in down rounds
- Punishes founders for market conditions often beyond their control
- Destroys option pool value for employees
What’s acceptable: Weighted average anti-dilution (either broad-based or narrow-based). This adjusts the price proportionally based on how much new money comes in at lower prices, rather than full re-pricing.
Note: Broad-based weighted average is most founder-friendly as it includes all outstanding securities in the calculation.
4. Excessive Board Control by Investors
What it means: Board composition that gives investors control or veto power over company decisions.
Problematic structures:
- Investors control majority of board seats
- Investor representatives outnumber founder representatives
- Investor consent required for routine operational decisions
Why it’s problematic:
- You lose control of your own company
- Investors may prioritize quick exits over long-term value
- Board meetings become adversarial rather than collaborative
What’s acceptable:
- Early stage (Seed/Series A): 2 founders, 1 investor, 2 independent directors (balanced board)
- Later stages: Board size grows but founders retain meaningful representation
- Reserved matters require investor consent, but day-to-day operations remain founder-controlled
Key principle: Investors should have protective rights, not operational control.
5. Founder Vesting Without Credit for Past Work
What it means: Founders’ existing shares go into a vesting schedule, often without credit for years already spent building the company.
Example: You’ve worked on the company for 2 years before institutional funding. Investor requires 4-year vesting with 1-year cliff starting from investment date. If you leave after 6 months, you lose everything despite 2.5 years of building.
Why it’s problematic:
- Ignores value already created
- Treats founders like new employees
- Creates retention through fear rather than alignment
What’s acceptable:
- Vesting only on new shares issued in the round
- Vesting with substantial credit for past service (e.g., “2 years already vested”)
- Accelerated vesting upon acquisition (single or double trigger)
- Longer vesting periods (5-6 years) if no credit given, to acknowledge past contribution
Negotiation tip: If investor insists on vesting all shares, negotiate for 50-75% already vested based on time already invested.
6. Unreasonable Lock-Up and Transfer Restrictions
What it means: Founders cannot sell any shares even in secondary sales or after IPO for extended periods.
Problematic terms:
- 7-10 year absolute lock-ups
- No secondary sale opportunities even as company matures
- Restrictions that apply even after founder leaves the company
Why it’s problematic:
- Founders have no liquidity for years despite creating significant value
- Risk-reward becomes severely imbalanced
- Forces founders to stay even in unhealthy situations
What’s acceptable:
- 3-5 year lock-ups with reasonable exceptions
- Secondary sale opportunities in later rounds (e.g., founders can sell 10-20% of holdings)
- Lock-ups that end upon IPO or acquisition
- Pro-rata participation in any secondary sales that do occur
7. Overly Broad Drag-Along Rights
What it means: Investors (sometimes even minority investors) can force founders to sell the company even if founders disagree.
Problematic versions:
- Investors holding <75% can force a sale
- Drag-along applicable even to unfavorable terms
- No minimum price or terms required to trigger drag-along
Why it’s problematic:
- Founders can be forced to sell the company they built against their will
- May happen at valuations or terms founders consider inadequate
- Removes founder optionality
What’s acceptable:
- Drag-along requires super-majority (75-80%+) approval
- Minimum price threshold (e.g., at least 3x valuation of current round)
- Founders receive same per-share consideration as investors
- Good faith negotiation required before drag-along invoked
8. Pay-to-Play Provisions That Penalize Non-Participating Investors
What it means: Investors who don’t participate in future rounds lose rights or preferences.
Why it can be problematic:
- While protecting against non-supportive investors is reasonable, overly harsh pay-to-play terms can backfire
- May prevent helpful investors from continuing if they face liquidity constraints
- Can be used as pressure tactic
What’s acceptable: Balanced pay-to-play where non-participating investors:
- Convert to common stock (losing liquidation preference)
- But don’t lose all protective rights or board seats immediately
- Have exceptions for small funds that are fully deployed
9. Excessive Protective Provisions (Investor Veto Rights)
What it means: Long lists of actions requiring investor consent, effectively giving investors veto power over operations.
Overly broad protective provisions requiring investor approval:
- Hiring or firing any employee
- Any contract over a minimal threshold (e.g., ₹5 lakhs)
- Any marketing or product decisions
- Budget variations above trivial amounts
- Relocating office or changing vendors
Why it’s problematic:
- Company cannot operate efficiently
- Every decision becomes a negotiation
- Slows down execution in fast-moving markets
What’s acceptable: Protective provisions limited to truly major decisions:
- Raising debt above certain threshold
- Selling significant company assets
- Changing business direction fundamentally
- Amending charter documents
- Related party transactions
- Liquidation or merger
Threshold matters: If protective provisions include spending limits, they should be reasonable (e.g., contracts over ₹50 lakhs, not ₹5 lakhs).
10. Unfavorable Redemption Rights
What it means: Investors can force the company to buy back their shares after a certain period.
Why it’s problematic:
- If company hasn’t exited in 5-7 years, investor can demand their money back
- Company may not have cash to redeem shares
- Puts pressure on founders to exit prematurely
- Can trigger downward spiral if company must sell assets to fund redemption
What’s acceptable:
- No redemption rights at all (most founder-friendly)
- If included, should only kick in after 8-10 years and at cost basis (not with returns)
- Subject to legally available funds (company not required to go into debt)
- Redemption as last resort, not preferred exit mechanism
Red Flags About the Investor Themselves
Sometimes the terms are fine on paper, but the investor presents warning signs:
🚩 Rushing you to sign: “This offer expires in 48 hours”—good investors give you time to review with counsel
🚩 Refusing founder-friendly standard terms: If standard market terms are deal-breakers for them, that’s revealing
🚩 Bad reputation in founder community: Do reference checks with other founders they’ve invested in
🚩 No value-add beyond money: If they can’t articulate how they’ll help beyond the check, that’s a pure financial investor
🚩 Adversarial negotiation style: If they’re difficult before giving money, imagine after
🚩 Excessive diligence into personal matters: Financial diligence is normal; invasive personal questions aren’t
How to Negotiate Term Sheets Effectively
1. Get Legal Counsel Early
Hire a lawyer experienced in startup financing before the term sheet arrives. Legal fees are investments, not expenses. A good lawyer can:
- Explain implications of each clause
- Benchmark against market standards
- Suggest counterproposals
- Negotiate on your behalf
Cost consideration: Legal fees for term sheet review and negotiation typically range from ₹50,000 to ₹2 lakhs—minimal compared to the value at stake.
2. Understand Your Leverage
Your negotiating leverage depends on:
- How badly you need the money (runway remaining)
- Other investor interest (competing term sheets)
- Company traction and growth
- Investor’s enthusiasm about your business
Be realistic: If you have 2 months of runway and one term sheet, you have limited leverage. If you have multiple investors competing and 12 months of runway, negotiate hard.
3. Prioritize What Matters Most
You won’t win every point. Focus on:
- Control (board composition, protective provisions)
- Economics in realistic exit scenarios (liquidation preference structure)
- Flexibility (transfer restrictions, redemption rights)
You might accept a lower valuation to get better control terms—that’s often the right trade-off.
4. Ask “What If” Questions
For each clause, consider:
- What happens if we raise at lower valuation next round?
- What happens if we sell for 2x this valuation?
- What happens if I want to leave in 3 years?
- What happens if we don’t exit in 7 years?
Run scenarios to understand the real implications.
5. Seek Founder-Friendly Investors
The best negotiation strategy is choosing the right investor from the start. Seek investors known for:
- Fair, standard terms
- Long-term thinking
- Active value addition
- Positive founder references
Sometimes a lower valuation from a great investor beats a higher valuation from a difficult one.
6. Don’t Be Afraid to Walk Away
If terms are truly unfavorable and won’t budge, walking away might be the right choice. Better to bootstrap longer or find different investors than to lock in terms that destroy your upside or control.
Remember: A bad investor at the wrong terms can be worse than no investor at all.
Standard vs. Founder-Favorable vs. Investor-Favorable Terms
Understanding what’s market standard helps you negotiate:
| Term | Investor-Favorable | Market Standard | Founder-Favorable |
|---|---|---|---|
| Liquidation Preference | 2x+ participating | 1x non-participating | No preference |
| Anti-Dilution | Full ratchet | Broad-based weighted average | None |
| Board Composition | Investor majority | Balanced (2-2-1 structure) | Founder majority |
| Founder Vesting | 4 years, no credit | 4 years with credit for past service | No vesting on existing shares |
| Drag-Along | >50% can trigger | 75%+ super-majority | No drag-along or 90%+ |
| Protective Provisions | Broad operational veto | Limited to major decisions | Minimal or none |
Aim for market standard on most terms. Founder-favorable terms are rare unless you have exceptional leverage.
Getting Help: When to Involve My Legal Pal
Term sheet negotiation is not the time to go it alone. My Legal Pal provides specialized support for founders navigating investment terms.
Protect Your Future While Securing Your Present
Raising funding is exciting. It validates your vision and provides resources to scale. But in the excitement, don’t sign away the value you’re working so hard to create.
Remember: Valuation is just one variable. Control, economics in realistic scenarios, and flexibility matter just as much—often more.
The founders who build lasting valuable companies understand term sheets deeply, negotiate thoughtfully, and choose investors who offer fair terms and genuine partnership.
Before you sign that term sheet:
- Read every clause carefully
- Understand implications in multiple scenarios
- Get experienced legal counsel
- Negotiate terms that matter
- Choose investors based on more than check size
Your future self—five years from now when your company exits or faces a critical decision—will thank you for the careful attention you paid to these terms today.
Frequently Asked Questions (FAQs)
1. Are term sheets legally binding?
Term sheets are generally non-binding except for specific clauses like exclusivity (no-shop period), confidentiality, and sometimes expense reimbursement. However, they set the framework for binding definitive agreements. Once you sign, renegotiating is difficult and makes you look unprofessional.
2. What’s a reasonable valuation vs. favorable terms trade-off?
Many experienced founders prefer a 20-30% lower valuation with standard investor-friendly terms over a high valuation with onerous terms. Your ownership percentage matters less than the value of that ownership. Better to own 20% of something valuable than 30% of something with terms that destroy founder economics.
3. How long should I have to review a term sheet?
Take at least 1-2 weeks to review with legal counsel. Be wary of investors who pressure you to sign within 24-48 hours. Legitimate investors understand that important decisions require proper due diligence and legal review.
4. What is a 1x liquidation preference and why is it standard?
1x liquidation preference means in an exit, investors get their investment amount back before proceeds are distributed to other shareholders. It’s considered standard because it provides downside protection while keeping incentives aligned. The investor gets their money back first, then everyone shares remaining proceeds based on ownership percentage.
5. Should I accept founder vesting on existing shares?
This is negotiable. Many investors want founder vesting to ensure commitment, but you should get credit for time already invested. For example, if you’ve worked 2 years pre-funding, negotiate to have 50% already vested with the remainder vesting over 2-3 years. Complete re-vesting with no credit is unfavorable.
6. What’s the difference between participating and non-participating liquidation preference?
Non-participating (standard): Investor chooses either (a) their liquidation preference, or (b) converting to common stock and taking their ownership percentage—whichever is higher.
Participating (investor-favorable): Investor gets their liquidation preference AND participates in remaining proceeds based on ownership percentage—double-dipping that reduces founder returns.
7. How do I know if an investor is offering market-standard terms?
Consult with experienced startup lawyers who review many term sheets. They can benchmark your terms against recent deals. Also talk to other founders who’ve raised from the same investors. If the investor resists standard terms without good reason, that’s a red flag.
8. What are protective provisions and which ones are reasonable?
Protective provisions give investors veto rights over certain major decisions. Reasonable provisions cover: liquidation/dissolution, changing the charter, creating new share classes, declaring dividends, material acquisitions/sales, and related party transactions. Unreasonable provisions require approval for routine operational decisions like hiring employees or signing normal business contracts.
9. Can I negotiate after signing a term sheet?
Technically yes, since term sheets are mostly non-binding, but it’s very difficult and damages relationships. Investors will view you as inexperienced or untrustworthy. That’s why proper review before signing is critical. The term sheet stage is your negotiation window.
10. What if the investor says “these terms are non-negotiable”?
Everything is negotiable if you have leverage. If an investor claims terms are completely non-negotiable, either (a) they’re bluffing, (b) you lack leverage because of weak alternatives or desperate need for capital, or (c) they’re difficult investors you should reconsider. Good investors negotiate within reason on important terms.
11. Should I hire a lawyer even for a small seed round?
Absolutely yes. Even small seed rounds establish precedents for future rounds and can include problematic terms. Legal fees of ₹50,000-₹1,50,000 are minimal insurance against terms that could cost you crores later. Think of legal review as essential, not optional.
12. What is a no-shop or exclusivity period and is it reasonable?
No-shop means you cannot talk to other investors for a specified period (typically 30-60 days) while the investor completes due diligence. This is standard and reasonable—investors deserve focus after making an offer. However, 90+ days is excessive, and you should ensure you have adequate time to complete your own due diligence on them.
13. How do drag-along rights work and when are they fair?
Drag-along allows majority shareholders (typically requiring 75%+ approval) to force minority shareholders to join in selling the company. This prevents small shareholders from blocking favorable acquisitions. It’s fair when: super-majority is required (not simple majority), all shareholders receive same per-share price, and minimum valuation thresholds exist.
14. What happens if I reject a term sheet—will the investor walk away?
Possibly, but if the investor is genuinely interested in your company, they’ll negotiate. Respectful pushback on unfavorable terms is expected and respected by good investors. They’d rather negotiate now than deal with an unhappy founder later. However, ensure you have alternatives before rejecting terms entirely.
15. Where can I find sample term sheets to compare against?
Several organizations publish standard term sheet templates: National Venture Capital Association (NVCA), Y Combinator, and various law firms. However, comparing your specific term sheet to generic templates has limits—context matters. Working with experienced startup legal counsel provides better benchmarking against actual recent deals in your stage and geography.
Need expert help reviewing your term sheet? My Legal Pal’s startup legal specialists can analyze your terms, explain implications, and help you negotiate better outcomes. Don’t sign away your company’s future—get professional guidance today.
