A term sheet is a short document, mostly non-binding, setting out the principal terms of an investment. It's also where the actual deal gets decided, because whatever's in it will be reflected in the definitive documents.
Founders reliably focus on valuation. The provisions that determine what happens in most realistic outcomes sit elsewhere.
Valuation, and why it's less important than it seems
Pre-money valuation determines what percentage the investor receives. It's the headline number and the one that gets reported.
The reason it matters less than it appears is that it only determines outcomes in a clean scenario where everybody's shares are worth the same per share. Several standard provisions ensure that isn't what happens.
A high valuation with aggressive preference terms can be worth less to founders than a lower valuation with clean terms, in a wide range of outcomes. That trade is made constantly and frequently without the founder understanding it.
Liquidation preference
The single most consequential economic term.
A liquidation preference gives the investor the right to receive their money back — or a multiple of it — before other shareholders receive anything, in an exit.
A one-times non-participating preference is the market standard in most healthy conditions. The investor takes the greater of their money back or their pro-rata share, not both.
A participating preference means they take their money back and then share in what's left. That's substantially more expensive to founders and can dominate the outcome in a modest exit.
Multiples above one — two or three times — appear in harder funding environments and are extremely expensive.
The practical consequence: in a mediocre exit, preference terms determine who gets paid, and founders can receive nothing from a sale that returns capital to investors. That outcome is much more common than the scenarios anybody discusses when signing.
Anti-dilution
Protects the investor if a subsequent round is priced lower than theirs.
Broad-based weighted average is the standard and reasonable form — it adjusts the investor's conversion price partially, based on the size of the down round.
Full ratchet adjusts their price all the way down to the new price regardless of size. That can be enormously dilutive to founders and employees, and it's a term worth resisting firmly.
Board composition
Control rather than economics, and frequently more important.
The board makes the decisions that matter: hiring and firing executives, approving budgets, approving a sale.
Typical early-stage structure is a small board with founder representation, investor representation, and possibly an independent director. Who appoints the independent, and under what conditions, is worth negotiating carefully because that seat frequently decides contested questions.
Board control can pass to investors before they hold a majority of shares, through composition provisions. That's a distinction founders regularly miss.
Protective provisions
A list of actions requiring investor consent regardless of board or shareholder votes. Typically includes selling the company, raising further capital, changing the share structure, incurring debt above a threshold, and changing the business materially.
Some of these are entirely reasonable. The list can be extended to cover operational matters — hiring above a salary level, entering contracts above a value — at which point it becomes a functional veto over running the business.
Read the list carefully and negotiate the scope. Consent rights that seem harmless become constraining when you need to move quickly and a signature is on holiday.
The option pool
A quiet mechanism worth understanding. Term sheets frequently require an option pool for future employees, and specify that it comes out of the pre-money valuation.
That means existing shareholders — the founders — bear the entire dilution. The investor's percentage is calculated after the pool is created.
The effect on the real price paid is significant, and a larger pool at pre-money is functionally a lower valuation. It's a standard negotiation point and it's frequently accepted without discussion because it appears in a schedule rather than in the headline terms.
Founder terms
Vesting on founder shares is standard and generally sensible — it protects the remaining founders if somebody leaves early.
Points to examine: whether time already served is credited; what happens on termination without cause; and whether there's acceleration on a change of control. Single-trigger acceleration vests on a sale; double-trigger requires a sale plus termination. Double-trigger is the more common standard.
Practical advice
Use a lawyer who does this regularly. Not a general commercial solicitor — someone who sees these documents weekly and knows what's market.
Ask the investor to explain any term you don't understand, and be suspicious of anything described as standard without explanation. Some things genuinely are; the word is also used to close conversations.
Model the outcomes. Build a simple waterfall showing who receives what at various exit values, with the proposed terms. It takes an afternoon and it's the only way to see what you've actually agreed to.
And remember the reference class. Most companies don't have spectacular exits. Terms should be evaluated primarily against the modest and middling outcomes, because that's where most of the probability sits.