term-sheet-analysis
Term sheet analysis — economic and control terms for VC deals.
When to Activate
- Reviewing a VC term sheet on behalf of founders or investors
- Negotiating economic terms (valuation, liquidation preference, anti-dilution)
- Evaluating control provisions (board composition, protective provisions, drag-along)
- Comparing multiple term sheets from different investors
- Advising on founder vesting and key employee equity terms
- Assessing the impact of terms on future fundraising flexibility
- Preparing for investor negotiations with data on market-standard terms
Core Concepts
Valuation Terms
The headline valuation determines ownership, but the details matter as much as the number:
- Pre-money valuation: Agreed value of the company before the investment. Determines existing shareholder dilution
- Post-money valuation: Pre-money + investment amount. Investor ownership = investment / post-money
- Fully diluted basis: Valuation per share is calculated on a fully diluted share count — includes all outstanding shares, options, warrants, and convertibles
- Option pool: Size and whether created pre-money or post-money is critical. A 20% pool on a pre-money basis at $20M pre-money means the operating company is effectively valued at $16M for existing shareholders
- Price per share: Post-money / fully diluted shares. Determines conversion ratios and sets the bar for future rounds
Liquidation Preference
The most important economic term after valuation. Determines how proceeds are distributed before common shareholders receive anything:
- 1x non-participating: Standard and founder-friendly. Investor gets 1x their investment back OR converts to common — whichever is higher. Aligns interests at higher exit values
- 1x participating: Investor gets 1x back AND shares in remaining proceeds pro rata. Significantly more investor-favorable. Less common in top-tier VC deals
- Participating with cap: Participating up to a total return cap (e.g., 3x or 5x). Compromise position
- Multiple preferences (2x, 3x): Investor gets 2x or 3x their money before common. Used in distressed or bridge rounds. Severely dilutes common shareholder returns at lower exit values
- Stacking: Later series typically have priority over earlier series (standard seniority) or may be pari passu
Anti-Dilution Protection
Protects investors from future down rounds by adjusting the conversion price:
Broad-Based Weighted Average (BBWA):
New Conversion Price = Old CP * (A + B) / (A + C)
A = Shares outstanding pre-round (fully diluted)
B = Shares that would have been issued at Old CP for new round proceeds
C = Shares actually issued in new round
- Standard market term. Adjusts proportionally based on the size and severity of the down round
- "Broad-based" means the denominator includes options and convertibles — more founder-friendly than narrow-based
Narrow-Based Weighted Average:
- Same formula but A includes only outstanding preferred shares (or outstanding preferred + common). More investor-favorable because the smaller denominator produces a larger adjustment
Full Ratchet:
- Conversion price drops to the lowest price at which new shares are issued in any subsequent round. No weighting for the number of shares issued
- Extremely punitive for founders and early investors. Rare outside distressed situations
- Even a small bridge at a lower price converts all protected shares at the new price
Pay-to-play interaction: Investors who do not participate in the down round may lose their anti-dilution protection
Board Composition
The board of directors controls major corporate decisions. Composition is a critical control term:
- Common structure at Series A: 2 founders + 1 investor + 0 or 1 independent = 3-4 seats
- Series B and beyond: Boards grow; investor seats accumulate. Risk: founders lose board control even while holding majority economic ownership
- Independent directors: Mutually agreed by common and preferred. Serve as tiebreakers and governance anchors
- Board observer rights: Non-voting seat, typically for smaller investors or co-investors
- Founder control principle: Many top VCs support founder-controlled boards through Series B. Control flips to investors typically at later stages or upon underperformance
Protective Provisions
Veto rights given to preferred shareholders over specific corporate actions, regardless of board composition:
Drag-Along / Tag-Along
- Drag-along: If a specified majority (typically holders of majority of preferred and common, voting together) approve a sale, all shareholders must sell on the same terms. Prevents minority holdouts from blocking an exit
- Tag-along (co-sale): If a founder or major shareholder sells shares, other shareholders have the right to sell a proportional amount on the same terms. Prevents founders from privately liquidating while investors remain locked in
- Carve-outs from drag: Typically, drag requires a minimum price or return threshold to protect against being dragged into a fire sale
Redemption Rights
Right for preferred shareholders to require the company to repurchase their shares after a specified period (typically 5-7 years):
- Purpose: Provides a liquidity backstop if the company has not achieved an exit
- Practical impact: Most startups cannot fund redemption from cash flow. Creates leverage for investors to force a sale or recapitalization
- Market practice: Less common in early-stage VC. More common in growth equity and late-stage rounds
- Accounting treatment: Redeemable preferred may be classified as mezzanine equity or debt under GAAP — affects financial statements
No-Shop / Exclusivity
- No-shop clause: Company agrees not to solicit or engage with other potential investors for a specified period (typically 30-60 days) after signing the term sheet
- Break-up fee: Rare in VC but occasionally included — company pays a fee if it accepts a competing offer
- Fiduciary out: Board retains the fiduciary duty to consider superior offers — no-shop cannot override this, but creates a practical barrier
Founder Vesting
- Reverse vesting: Founders' existing shares become subject to vesting. If a founder leaves, unvested shares are repurchased at cost
- Standard schedule: 4 years with a 1-year cliff. Some deals credit time already served (e.g., 1 year of credit for founders who have been building for 12+ months pre-funding)
- Acceleration: Single trigger (100% vesting upon change of control) or double trigger (change of control + termination). Double trigger is market standard; single trigger is founder-favorable
- Rationale: Protects the company and investors if a founder departs early. Without vesting, a departing founder retains their full stake with no ongoing contribution
Methodology
- Term extraction: Read the term sheet line by line. Extract every economic and control term into a structured summary
- Market comparison: Compare each term to market standards (NVCA model documents, recent benchmark data). Flag terms that are more aggressive or more favorable than standard
- Economic modeling: Build a cap table and waterfall model reflecting the proposed terms. Compute founder and investor ownership, dilution, and proceeds at various exit values
- Scenario analysis: Model downside (down round, fire sale), base case, and upside exits to understand how terms affect each stakeholder
- Anti-dilution impact: Simulate a future down round — quantify the additional dilution to founders under BBWA vs. full ratchet
- Control analysis: Map board composition and protective provisions. Identify which decisions the founders can make unilaterally vs. those requiring investor consent
- Negotiation priorities: Rank terms by economic and strategic impact. Identify the 3-5 terms most worth negotiating and propose specific counter-offers
Templates
Term Sheet Comparison Matrix
Term | Investor A (Lead) | Investor B | Market Standard
------------------------|----------------------|----------------------|-------------------
Pre-money valuation | $30M | $35M | N/A (deal-specific)
Investment amount | $8M | $8M | N/A
Post-money | $38M | $43M | N/A
Option pool (pre-money) | 15% | 20% | 10-15%
Liquidation pref | 1x non-participating | 1x participating | 1x non-participating
Anti-dilution | BBWA | BBWA | BBWA
Board seats | 2 founder, 1 inv, 1 ind | 2 founder, 2 inv | 2F + 1I + 1 ind
Protective provisions | Standard NVCA | Standard + budget | Standard NVCA
Founder vesting | 4yr, 1yr cliff, 1yr credit | 4yr, 1yr cliff, no credit | 4yr, 1yr cliff
Pro rata rights | Major investors | All investors | Major investors
No-shop | 45 days | 60 days | 30-45 days
Drag-along | Majority preferred + common | Majority preferred | Common + preferred
Anti-Dilution Simulation
Current Round: Series A at $5.00/share, 2M shares
Down Round: Series B at $3.00/share, 1.5M shares
Broad-Based Weighted Average:
Pre-round fully diluted shares: 10,000,000
Shares at old price ($5): 1,500,000 * $3 / $5 = 900,000
Shares actually issued: 1,500,000
New CP = $5.00 * (10M + 900K) / (10M + 1.5M) = $5.00 * 0.948 = $4.74
Additional shares to Series A: (2M * $5 / $4.74) - 2M = 109,705 shares
Dilution to common: ~1.0% additional
Full Ratchet:
New CP = $3.00 (drops to new round price)
Additional shares to Series A: (2M * $5 / $3) - 2M = 1,333,333 shares
Dilution to common: ~11.5% additional
Impact: Full ratchet creates 12x more dilution than BBWA in this scenario.
Founder Proceeds at Various Exit Values
Assumptions: $8M Series A, 1x NP preferred, 21% investor ownership, 2 founders at 30% each
Exit ($M) | Series A | Founder 1 | Founder 2 | Others/Pool
-----------|-------------|-------------|-------------|------------
$10M | $8.0M (pref)| $0.6M | $0.6M | $0.8M
$25M | $5.3M (conv)| $7.5M | $7.5M | $4.8M
$50M | $10.5M(conv)| $15.0M | $15.0M | $9.5M
$100M | $21.0M(conv)| $30.0M | $30.0M | $19.0M
$250M | $52.5M(conv)| $75.0M | $75.0M | $47.5M
Conversion threshold: $38.1M ($8M / 21%)
Below $38.1M: Series A takes preference, founders get residual
Above $38.1M: Series A converts, everyone shares pro rata
Quality Gate