Unlocking Key Terms in a Term Sheet

Shradhanjali Sarma

Fundraising is one of the most defining moments in a startup’s journey. It is when the late nights, pitch decks, and relentless execution finally lead to investor interest. And then comes the term sheet, a document which looks like a mere formality, but has the potential to decide the impact of the fundraise on the startup.

In this article, I break down the key terms in a term sheet, and what you need to know. Before you put the term sheet on ChatGPT to understand what are the advantageous and disadvantageous clauses for you, here is a breakdown of each clause for you to structure your negotiations confidently with your investors.

Every founder knows what a term sheet is, but here are a few basics. A term sheet is a non-binding agreement that outlines the key terms and conditions under which an investor intends to invest in your startup. It serves as a blueprint for the legally binding documents that follow such as the Shareholder’s Agreement and the Share Subscription Agreement.

Most of the clauses that you discuss during the term sheet stage get incorporated in the binding agreements. It is the stage where founders can negotiate and align on the commercial terms and formalize the transaction.

First Understand the Term Sheet

It is important for the founder and investor to focus on the term sheet, as it is directed to the major business and structural issues involved in the proposed investment. The material terms included in the term sheet focuses on these three legs: a) terms that impact valuation and economic division of profits and proceeds; b) terms that impact control over decision-making; and c) reasonable terms for protection of the parties.¹

While the term sheet is considered as a non-binding agreement, there are certain clauses which are considered binding such as confidentiality, no-shop clauses and the clause on expenses. Term sheets frequently provide that, although the main provisions are non-binding, certain expenses of the investor are to be borne by the startup, irrespective of whether the transaction has been consummated or not. Additionally, the confidentiality provisions should be binding on both the parties, as it safeguards both the startup founder and the investor.

When you sit down to negotiate with the investor, check which are the binding clauses and which are the non-binding clauses.

Terms That Impact Economics

1. Valuation

Ask any startup founder, and valuation is one of the most discussed terms. It determines how much of your company you are willing to give away in exchange for investment. And every founder is familiar with the two terms - pre-money valuation and post-money valuation.

Pre-Money Valuation is the value of your company before the new money comes in, while Post-Money Valuation is simply the pre-money value plus the amount being invested. For example, if an investor is putting INR 2 Cr into your startup at a pre-money valuation of INR 8 Cr, your post-money valuation becomes INR 10 Cr. The investor will own 20%, which is 2 Cr of INR 10 Cr. This simple math directly determines your dilution, which in turn impacts your ownership, control, and eventual upside.

Many founders get excited about a high valuation, but the real economic impact comes from other terms in the term sheet. Things like liquidation preferences, anti-dilution rights, ESOP pool adjustments can quietly shift the economics away from you, even with a great valuation. So yes, valuation is important, but it’s just one piece of the puzzle when evaluating whether a deal is truly founder-friendly.

2. Liquidation Preference

Liquidation preference defines how the proceeds will be distributed in a situation where the company is liquidated or sold. The clause defines who gets paid first, and how much. The most common form is 1x non-participating liquidation preference, which means the investor gets back their initial investment before any remaining amount is distributed among shareholders. For example, if the investor invested 2Cr, under 1x non-participating liquidation preference, the investor will get back the 2Cr.

However, not all preferences are equal. Some investors may ask for participating preferences. This basically means that they get their investment back first and still participate in the remaining upside like a shareholder. Others may even ask for multiple liquidation preferences like 2x or 3x, where they receive two or three times their original investment before anyone else gets paid.

This is the time when as a founder you need to negotiate. Try to negotiate for a 1x non-participating preference. It’s the most founder-friendly and widely accepted.

Terms That Impacts Control

1. Anti-Dilution Protection

Anti-dilution clauses protect investors if your startup raises funds in the future at a lower valuation. There are two primary types:

First, is the full ratchet, where the original investor’s share price is adjusted to match the new lower price. This heavily dilutes founders. Second is the weighted average, where the price is based on the number of new shares.

If you are sitting on the negotiation table, always push for weighted average anti-dilution over full ratchet. It strikes a balance between investor protection and founder equity.

2. Board Composition

This clause outlines the structure of the company’s Board of Directors post-investment. It may also define who has the right to appoint board members and what decisions require board or investor approval. A term sheet might propose a 3-member board, which will include one nominee from the investors, one from the founders, and one independent director.

I have always heard founders stating that they do not want to give away substantial rights to the investors. While the fear is understandable, it is best to sit down and wisely negotiate. It is best to retain some control over board decisions, especially for early-stage startups. Avoid giving away majority control unless absolutely necessary.

3. ESOP Pool

Investors often ask startups to increase the ESOP pool before investment, as part of the pre-money valuation. This means dilution from the ESOP pool affects only the founders, not the new investors. It is best to clarify whether the ESOP top-up is calculated on a pre-money or post-money basis. On the negotiation table, negotiate wisely to protect your equity.

Terms for Protection of the Parties

1. Exit Rights: Drag-Along and Tag-Along

Drag-Along and Tag-Along Rights are protective clauses commonly found in investor term sheets, designed to govern what happens when shares are being sold. Drag-along rights are triggered when a majority of shareholders decide to sell the company or a significant portion of shares.

Once triggered, they can compel minority shareholders, including founders or early employees to also sell their shares on the same terms. This ensures a clean, 100% transfer of ownership to the buyer, without holdouts. While useful for closing deals, founders should negotiate for fair thresholds and safeguards, as it could force them into an exit they didn’t initiate.

Tag-along rights, on the other hand, are triggered when a majority or significant shareholder chooses to sell their shares to a third party. These rights give minority shareholders the option, not the obligation to "tag along" and sell their proportionate shares under the same terms and conditions. Together, drag and tag provisions balance control and protection, ensuring smooth exits for majority stakeholders while also safeguarding minority interests.

2. Right of First Refusal (ROFR) and Pro Rata Rights

Right of First Refusal (ROFR) and Pro Rata Rights are common investor protections in startup financing, and as a founder, it is important to understand how they might impact you long-term. ROFR gives existing investors the option to match any third-party offer you receive if you decide to sell your shares. This means you cannot just sell your equity to an outside party without first offering it to your current investors on the same terms.

It is designed to protect investors from losing influence or ownership to unknown buyers. As a founder, you need to check how long this right applies and whether it extends beyond your initial financing rounds.

Pro Rata Rights, on the other hand, let investors maintain their percentage ownership by participating in future fundraising rounds. So if they owned 10% in your seed round, they can buy enough in your Series A to keep that same 10%. This can be helpful for your cap table stability and maintaining committed backers, but it also means you might have less room to bring in new investors unless you expand the round size

Understand these terms well to plan out your strategies for the company's growth.

3. Confidentiality

Confidentiality clauses in a term sheet are there to ensure that the details of your fundraising discussions remain private. As a founder, this means you are agreeing not to share the terms of the deal, like valuation, investor names, or key conditions with outside parties, unless required by law or agreed upon by both sides. Investors typically want this to prevent sensitive information from influencing other potential deals or leaking to competitors or the press. It also protects you by keeping negotiation details contained while things are still in flux.

Additionally, confidentiality is important for protection of your business as well.

As a founder, it is important to check how broad or restrictive the clause is. Some confidentiality terms apply just to the term sheet itself, while others might extend to any discussions or documents related to the deal. Also, take note of how long the confidentiality obligation lasts and whether there are any exceptions.

4. Information Rights

Information rights give investors access to certain updates and financial details about your company after they have invested. This usually includes things like quarterly or annual financial statements, budgets, and sometimes even board meeting notes. While it might feel like a burden at times, it is completely reasonable for investors to request this information. After all, they have put money into the company and naturally want visibility into its financial health and overall performance.

The scope of these rights can vary depending on the investor and the stage of the company. Some investors, especially in early rounds, may only ask for basic financials once or twice a year, while later-stage or larger investors might want more frequent and detailed updates.

It is worth negotiating what’s reasonable for your team to provide without it becoming a burden, especially in the early days when resources are tight.

In conclusion, knowledge is negotiating power.

A term sheet is not just paperwork. It is a statement of how your company will be run, who holds power, and what happens when things go right or wrong. As a founder, legal literacy is your strength and not a burden. Understanding the fine print empowers you to lead with clarity and confidence, especially when it comes to negotiating critical documents like term sheets.

1. Morgan Lewis, Preparing a Venture Capital Term Sheet.