Breaking Down Your First Term Sheet: What Founders Need to Know
Understand key terms, common pitfalls, and how to negotiate your first term sheet.
DEAR STAGE 2: I just got our first term sheet, but don’t know what terms are expected or standard. What should I be looking for as I review it? ~FIRST-TIME FOUNDER
DEAR FIRST-TIME FOUNDER: Congrats! Receiving your first term sheet is a huge milestone. But let’s be real— term sheets are dense, filled with legal jargon, and can have lasting implications for your company. Let’s break it down.
First, hire a lawyer. Find a lawyer who specializes in venture deals. Seriously. I’m hearing more stories of founders using AI to evaluate term sheets, and while I’m all for expediency, the right legal counsel will spot red flags and negotiate on your behalf.
Looking for a starting point? YC’s SAFE guide and the NVCA model term sheet provide great frameworks for understanding industry standards.
From my seat, these are the most common sections/terms you’ll see—and what they actually mean.
Round Size & Make-Up: How much money is being invested, and who’s participating? Pay attention to whether the round is structured as equity (preferred shares) or convertible securities (like SAFEs or convertible notes).
Valuation: These can be written as pre-money or post-money. The pre-money valuation is what your company is worth before this investment, and the post-money valuation is the pre-money valuation + new capital. Investors will own a percentage of your company based on the post-money valuation.
Option Pool Refresh: Investors often require an increase in your employee option pool (ESOP)—before their investment. This effectively lowers your valuation, so negotiate carefully.
Board Construction: Who gets a board seat? How are they appointed? We try to keep board rooms as small as possible. Generally this looks like a 3 person board (2 common + 1 investor) and grows to a 5-person board by the B (2 common + 2 investors + 1 independent). We like to see an odd number, but the makeup can vary.
Revesting of Founder Equity: it’s fairly standard for investors to ask founders to “re-earn” a portion of their shares over time to ensure everyone is aligned in outcomes and committed to the future of the business. Potential red flag if it’s >50%.
Liquidation Preferences: Determines how preferred investors get paid in an exit. 1x non-participating is standard (investors get their money back first, then share in remaining proceeds). Avoid participating preferred (investors double dip—getting their money back and a share of the exit).
Investor Rights: Voting rights, veto rights, and approval on key company decisions. Check out NVCA docs for the current “standard”
Right of First Refusal (ROFR): Gives investors the first shot at buying shares before they’re sold to outsiders. Standard, but beware of overly broad ROFRs that limit flexibility in future fundraising.
Legal Fees: Most term sheets will ask the company to cover investor legal fees. Negotiate a cap ($25K-$50K is reasonable depending on stage/round).
No-shop/Confidentiality: you can expect to see a 30-45 day period of exclusivity once a term sheet is signed.
And then there are the terms to watch out for…the gotchas. While most term sheets follow a fairly standard structure, some terms should raise a red flag.
Dividends: Early-stage startups rarely pay dividends. If included, it’s usually a way to extract more value for investors.
Liquidation Preferences >1x: Some investors push for 2x or 3x liquidation preferences, meaning they get paid multiple times their investment before founders see anything. Standard is 1x non-participating.
Named Rights: Certain investors may try to secure special privileges beyond standard protections. Be cautious of terms that limit your flexibility in future funding rounds.
Negotiating a fair term sheet is critical, but remember—you’re also choosing a long-term partner. The best investors bring more than just capital and everything here is negotiable. This sets the tone for the rest of the relationship and the hope is that you can work through this quickly and get back to building.
Take your time, ask questions, and don’t be afraid to push back on terms that don’t align with your vision.
Until next week!