How a term sheet actually works, clause by clause
Valuation is the number everyone quotes, but the terms are where deals are won and lost. A practical tour of liquidation preferences, pro rata rights, anti-dilution, and the clauses founders actually negotiate.
Every founder remembers the number: the valuation on their first real term sheet. Far fewer remember the clauses that came with it — and those clauses, not the number, decide who gets what when things go very right or very wrong.
#Liquidation preference
The liquidation preference determines who gets paid first when the company is sold or wound down. The market standard is a 1x non-participating preference: the investor gets their money back, or converts to common and takes their ownership percentage — whichever is worth more. Participating preferred, multiple preferences (2x, 3x), and seniority stacks all shift risk from investors to founders and employees.
#Anti-dilution
If the company later raises at a lower valuation, anti-dilution provisions adjust the earlier investors’ conversion price. Broad-based weighted average is standard and relatively founder-friendly. Full ratchet — repricing the entire earlier round at the new, lower price — is rare and punishing.
#Pro rata and information rights
Pro rata rights let an investor maintain their ownership percentage in future rounds. For seed funds, pro rata is often the entire business model: the ability to double down on winners is where the power law actually compounds.
#Control terms
Board composition, protective provisions, and drag-along rights determine who controls the company between financings. A standard Series A board is two founders, one investor, and sometimes an independent seat. Protective provisions give preferred shareholders veto rights over major events: a sale, a new round, changes to the option pool.
The terms are the price. The valuation is just the headline.
None of this is exotic. Standard documents — YC’s SAFE, NVCA model docs — exist precisely so that founders and investors argue only about the handful of terms that genuinely differ deal to deal. Know which handful they are before you sign.
