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Which terms in a term sheet actually matter?

FundraisingGovernanceEquity

Six terms in a priced-round term sheet decide what the founders own, what they receive when the company is sold, and who controls the company in between: the valuation and what is counted inside it, the liquidation preference, the makeup of the board, the investors' protective provisions, founder vesting, and the anti-dilution formula. Those are the ones to negotiate. Most of the rest are customary, appear in every deal, and are not worth spending goodwill on. Investors know which terms matter, expect founders to push on those, and read a founder who argues every line as inexperienced. Settle the six and close.

Valuation, and what is inside it

The pre-money valuation matters, and so does the sentence after it saying whether the option pool and any converting SAFEs and notes are inside it. A pre-money that is fully diluted for a 20 percent post-money pool and every converting SAFE is a much lower number for the founders than the headline. Compare term sheets on the founders' post-money percentage, and remember that a lower valuation from an investor you want can be the better deal.

Liquidation preference

This is the term most often mistaken for boilerplate. It decides how the proceeds of a sale are split. A 1x non-participating preference means the investors take back their money or convert and share pro rata, whichever is more, and that is the customary term. Participating preferred takes the money back and then shares in the rest, and a multiple above 1x takes more than the money back first. Model an exit at two or three values to see what each formula does to the founders' share, because the Series A terms tend to carry into every later round.

The board

A common Series A board is three seats: two for the common stock, usually founders, and one for the investors. Some add an independent seat. The board hires and fires the CEO, so its composition is control, and a rule of thumb is that the seats should reflect the cap table.

Protective provisions

The list of decisions the preferred stock can veto. Some are ordinary, such as changing the rights of the preferred or paying dividends. Others reach further than they look: a veto over amending the charter is a veto over every future financing, since each round amends it, and a veto over a sale is a veto over your exit. Read the list with a lawyer and keep it short.

Founder vesting and anti-dilution

Investors will ask founders whose stock is fully vested to put it back on a schedule, so know what vesting start date, cliff and acceleration you are agreeing to. On anti-dilution, broad-based weighted average is the customary form and needs no discussion. Full ratchet is not customary and is a conversation with counsel.

Terms that are usually fine as drafted: non-cumulative dividends, information rights, conversion rights, registration rights, rights of first refusal and co-sale, and standard closing conditions. The one binding term in most term sheets is the exclusivity period, which stops you talking to other investors while the documents are drafted; 30 to 45 days is enough.

Written by the lawyers who built Arabella. This is legal information, not legal advice for your situation, and reading it does not make us your lawyers. For a real dispute or a high-stakes decision, talk to a licensed attorney. More questions.