Understanding term sheets: a founder’s guide to navigating investor agreements

One of the most crucial moments in a startup’s fundraising journey is signing a term sheet: a document that outlines the key terms of an investment. While not legally binding, a term sheet sets the foundation for your funding round and dictates how much control, equity, and decision-making power you’ll retain.

So, how do you evaluate a term sheet like an experienced founder? Let’s break it down.

1. What is a term sheet & why does it matter?

A term sheet is a non-binding agreement that defines the high-level terms of an investment before a formal contract is signed. It helps both founders and investors align on valuation, ownership, governance, and exit terms before getting into legal paperwork.

While not legally binding, certain clauses (like exclusivity and confidentiality) can be enforceable, making it critical for founders to understand what they’re agreeing to.

Key reasons term sheets matter for founders:

• Equity & Ownership: Defines how much of your startup you’ll own after the round.
• Investor Control: Determines how much say investors will have in company decisions.
• Fundraising Terms: Sets expectations for future financing rounds and exits.
• Risk Protection: Poorly structured term sheets can lead to unnecessary dilution or loss of control.

For more on the fundraising process, check out Capwave AI’s Guide to Raising Capital.

2. Breaking down the term sheet: key sections you can’t ignore

Not all term sheets are equal. Some terms favor investors, while others protect founders. Here’s what to watch for:

Valuation & investment amount

• Pre-Money Valuation: Your startup’s value before investment.
• Post-Money Valuation: Your value after adding new investment.
• Investment Size: How much the investor is putting in and what % equity they receive in return.

💡 Example: If your pre-money valuation is $10M and you raise $2M, your post-money valuation is $12M. If an investor contributes $2M, they own 16.7% ($2M/$12M).

Equity & dilution

• Investors will take a percentage of your company in exchange for their investment.
• Future fundraising rounds will further dilute founder ownership.
• A well-structured cap table prepares you for future rounds without over-diluting.

👉 Learn more about dilution here: How much equity should startup founders give away?

Liquidation preferences: what happens in an exit?

Liquidation preference determines who gets paid first when your startup is sold.

• 1x liquidation preference (standard): Investors get back what they put in before common shareholders (you, employees) get paid.
• Participating preferred (less founder-friendly): Investors get their money back AND take a share of the remaining proceeds.
• Non-participating (founder-friendly): Investors must choose between taking their money back or converting to common shares.

💡 Example:

• Your company sells for $20M.
• Investor A invested $5M for 25% equity.
• Under 1x liquidation preference, they get their $5M back, and the remaining $15M is split among common shareholders.
• Under participating preferred, they get $5M back + 25% of the remaining $15M—totaling $8.75M (leaving founders with only $11.25M).

Board seats & investor control

• Investors often request board seats to oversee company decisions.
• Some investors push for a majority board, which can take control away from founders.
• Push for a balanced board where founders retain majority control early on.

💡 Tip: If giving up a board seat, ensure it’s to a value-add investor, not just anyone writing a check.

👉 See How Startup Boards Work for best practices.

Anti-dilution protection

Investors use anti-dilution clauses to prevent their stake from shrinking if you raise a down round (lower valuation).

• Weighted Average (Standard): Investors get slight protection against dilution.
• Full Ratchet (Aggressive): Investors keep their % stake, forcing founders to absorb dilution.

💡 Best Practice: Push for weighted average and avoid full ratchet, as it can hurt you in future rounds.

3. Common mistakes founders make with term sheets

🚩 Focusing only on valuation. A high valuation with bad terms (like participating liquidation or board control) can backfire.

🚩 Ignoring liquidation preferences. Even with 30% ownership, you could walk away with $0 if preferences aren’t structured well.

🚩 Overlooking future dilution. Retaining control matters not just today but through Series A, B, and beyond.

🚩 Not negotiating. Many founders assume term sheets are final. They’re not. Investors expect some negotiation.

4. Negotiating like a pro: key tips for founders

✅ Get multiple term sheets. Competitive tension gives you leverage.

✅ Negotiate non-economic terms. Valuation is important, but board control, liquidation prefs, and voting rights matter more.

✅ Hire a startup lawyer. A good lawyer can save you millions in the long run.

✅ Understand the market. See what’s standard for your industry and funding stage.

👉 Check out Carta’s Startup Funding Benchmarks here.

Final thoughts: play the long game

A well-negotiated term sheet protects your ownership, company vision, and long-term success. While raising capital is exciting, the wrong terms can hurt you more than a low valuation.

Be strategic, get legal advice, and remember: a great investor isn’t just about money. They’re a partner in your success.

💡 Need help modeling your equity distribution? Capwave AI offers tools and insights to help founders navigate fundraising and dilution effectively.

FAQs

1. Are term sheets legally binding?
Mostly non-binding, except for clauses like exclusivity and confidentiality.

2. Can I negotiate a term sheet?
Absolutely. Most investors expect some negotiation.

3. What’s the most important term to watch?
Liquidation preference and board control impact founders the most.

4. What happens after signing a term sheet?
Due diligence starts, and lawyers draft final agreements before the deal closes.

🚀 Stay ahead in your fundraising journey and get the latest startup insights from Capwave AI!