Term Sheets 101: The Five Terms That Actually Matter
Beyond valuation, the term sheet terms that matter most are the liquidation preference, board composition, anti-dilution protection and founder vesting. A high valuation with a participating preference or full-ratchet anti-dilution can leave founders with far less than a lower valuation on clean, standard terms.
A term sheet can run several pages, and most founders reading their first one lock onto the valuation and skim the rest. I get it. The valuation is the number your friends will ask about.
But I've sat on both sides of term sheet negotiations, and the valuation is rarely what decides what you walk away with. Four other terms usually decide more about what happens to you and your company over the next several years.
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SEND ME THE CHECKLIST →What Is A Term Sheet?
A term sheet is a short, mostly non-binding document that lays out the key terms of an investment before the lawyers draft the full agreements. It's where the deal gets shaped. By the time you're in the definitive documents, changing the big terms is much harder.
Term sheets show up in priced equity rounds, which, by the way, is what many newer angels and high-net-worth investors quietly prefer. They want a price and a clear picture of what they own. That makes understanding these terms even more important, because you'll be negotiating them.
What Are The Most Important Terms In A Term Sheet?
Five terms carry most of the weight:
| Term | What it controls | Founder-friendly version | Watch out for |
|---|---|---|---|
| Valuation | Price per share and how much you sell | A fair price you can grow into | A high number paired with harsh terms |
| Liquidation preference | Who gets paid first in an exit | 1x non-participating | 2x or more, or participating |
| Board composition | Who controls major decisions | Founders keep control early | Investor majority at seed |
| Anti-dilution | Investor protection in a down round | Broad-based weighted average | Full ratchet |
| Founder vesting | Whether you re-earn your own shares | Credit for time already served | Full re-vesting from zero |
One valuation detail first: know whether the number is pre-money or post-money. Raise $2M at an $8M pre-money valuation and the post-money is $10M, so the investor owns $2M / $10M = 20%. Raise $2M at a $10M pre-money and the post is $12M, so they own about 16.7%. Same "ten million" in conversation, different ownership. Also check whether the option pool gets created or expanded before the round, because that dilution usually lands on founders alone.
How Does A Liquidation Preference Work?
A liquidation preference decides what an investor gets back before common shareholders, including founders, see anything in a sale.
- 1x non-participating (standard): the investor takes their money back first or converts to their ownership share, whichever is worth more. Not both.
- 2x participating (aggressive): the investor takes double their money back first, then also takes their ownership share of what's left.
Here's what that does with real numbers. Consider two hypothetical companies. Both raise $2M at a $10M post-money valuation, so the investor owns 20%. Both sell a few years later for $15M.
| Company A: 1x non-participating | Company B: 2x participating | |
|---|---|---|
| Investor's choice or preference | Converts: 20% of $15M = $3M (beats $2M back) | Takes 2 x $2M = $4M off the top |
| Investor's share of the rest | None, already converted | 20% of the remaining $11M = $2.2M |
| Investor total | $3M | $6.2M |
| Left for founders and common | $12M | $8.8M |
Same headline valuation. Same exit. Company B's founders and team walk away with $3.2M less, purely because of a term behind the number.
Board Composition: Who Really Runs The Company
Board seats decide who controls hiring and firing the CEO, future raises and a sale. A board that tips toward investors early can constrain your ability to run the company on your own judgment. A common early-stage setup keeps founders in control, with one investor seat. Know exactly what you're giving up before you agree, and read what a board seat actually costs you before you hand one out.
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GET THE FREE CHECKLIST →Anti-Dilution: Broad-Based vs Full Ratchet
Anti-dilution protects investors if a future round prices lower than this one. The version matters a lot.
Say an investor bought 2,000,000 shares at $1.00, and you have 10,000,000 shares outstanding. Later you raise $1M at $0.50 a share, issuing 2,000,000 new shares.
- Full ratchet: the investor's price resets to $0.50, as if they'd paid the new price all along. Their 2,000,000 shares now convert into 4,000,000. That extra ownership comes largely out of founders.
- Broad-based weighted average: the new price is $1.00 x (10M + 1M) / (10M + 2M), about $0.917. Their shares convert into roughly 2,181,818. A modest adjustment.
Broad-based weighted average is standard and reasonable. Full ratchet can crush founders in a down round, and down rounds do happen. They're not the end, as I explain in why down rounds aren't a death sentence, but a ratchet makes them far worse.
Founder Vesting: Earning Back What You Already Built
Some investors require founders to re-vest existing shares on a new schedule. That's a real ask. It can mean a founder who spent years building the company has to earn part of their own ownership back. Negotiate credit for time served, and understand what happens to unvested shares if you leave or are pushed out. More on that in how founder vesting works.
The Objection: "Isn't This What My Lawyer Is For?"
Why should I learn the mechanics if I'm paying an attorney to catch problems?
Your attorney will flag technical issues and negotiate language. What they can't do is decide, strategically, which terms are worth fighting for and which you can concede given your goals. That call requires you to understand what each term does to your outcome in a downside and an upside scenario, not just trust that "market standard" means fine for you.
Questions to bring your startup attorney: Is the preference participating? What's the anti-dilution formula? Who controls the board after the next round? Is there any founder re-vesting? Real dollars ride on the specifics, so confirm your reading with them before you sign.
What To Do This Week
Take any term sheet you have, or a sample one, and run these five terms through two scenarios for your company: a modest exit and a big one. Write down what you'd actually take home in each. This is exactly the kind of modeling we drill in The Raise Academy, because the number on the front page is the term everyone fights over, and the terms behind it decide what you keep.
Key takeaways
- Valuation is one of five terms; the other four often matter more.
- A 2x participating preference can take millions from founders at the same exit.
- Model every term in a downside and upside scenario before you sign.
Frequently asked questions
What is a standard liquidation preference?
The most common early-stage standard is a 1x non-participating preference. The investor gets either their money back first or their ownership share of the sale, whichever is greater, but not both. Multiples above 1x or participation features are more investor-friendly and worth pushing back on.
What is the difference between full ratchet and weighted average anti-dilution?
Full ratchet resets the investor's price all the way down to a lower future round price, which can heavily dilute founders. Broad-based weighted average adjusts the price only partly, based on how much new stock is issued. Weighted average is standard and far more founder-friendly.
Should I negotiate a term sheet myself or let my lawyer do it?
Do both. Your startup attorney handles the language and flags technical issues, but you decide which terms matter most for your goals. Understand what each term does to your outcome in a few exit scenarios so you can make those calls yourself.
Mike Nathan
Founder & CEO, Impero Ventures · Founding Partner, Exit 156 Capital
20+ companies. $170M revenue. $55M raised. 3 exits. 2 VC funds. 1M+ YouTube subscribers.
He doesn't just pitch investors. He founded two venture capital funds.
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