The first time an investor sends you a term sheet, it feels like winning.
Someone believes in you. Someone wants to put real money into your idea. The number at the top looks big. You want to sign it before they change their mind.
Slow down.
My first business teacher, William Skelley, learned this the hard way, and today he sums it up in one line: “If you sign it, you own it — every word.” The founders I admire most aren’t the ones who raised the most money. They’re the ones who understood exactly what they were signing.
This is a plain-language guide to the words that matter most in a term sheet. It’s not legal advice — for that, you need a good startup lawyer — but it should help you walk into that conversation knowing what to ask.
What a term sheet actually is
A term sheet is a short document, usually a few pages, that lists the main terms of an investment: how much money, at what price, and with what rights for the investor.
Most of it is not legally binding on its own. The binding part comes later, in the long legal documents your lawyers draft from it. But don’t let that fool you. Once you agree to a term sheet, changing the terms later is very hard. In practice, the term sheet is where the deal is decided.
A few small parts usually are binding right away, such as confidentiality and a “no-shop” clause (more on that below).
1. Valuation: pre-money and post-money
The big number at the top is the valuation, and there are two versions of it.
- Pre-money valuation: what your company is worth before the new money comes in.
- Post-money valuation: pre-money plus the new investment.
A simple example:
| Amount | |
|---|---|
| Pre-money valuation | $4,000,000 |
| New investment | $1,000,000 |
| Post-money valuation | $5,000,000 |
| Investor’s ownership | $1M ÷ $5M = 20% |
The mistake many first-timers make: they hear “$5 million valuation” and don’t ask whether that’s pre- or post-money. That one word changes how much of your company you’re giving away.
Ask: “Is this valuation pre-money or post-money?”
2. Dilution: your slice gets smaller
Every time new shares are created — for investors or for employees — everyone else’s percentage goes down. That’s dilution.
In the example above, if you owned 100% before, you own 80% after. That’s normal and often worth it: 80% of a funded company can be worth much more than 100% of an unfunded one.
The danger is not dilution itself. The danger is not noticing how much you’re being diluted, round after round, until you own surprisingly little of the company you started.
The option pool trick
Investors usually ask the company to set aside shares for future employees — an option pool, often 10–20%. The important question is whose slice it comes from.
If the term sheet says the option pool is included in the pre-money valuation, the pool is created before the investor comes in. That means it dilutes only the existing owners — you — and not the new investor. Your “real” pre-money valuation is lower than the headline number.
Ask: “Is the option pool included in the pre-money or post-money, and how big does it really need to be?”
3. Liquidation preference: who gets paid first
This is the term that surprises founders most, and it matters most when things don’t go perfectly.
A liquidation preference decides who gets paid first, and how much, when the company is sold or shut down.
The common, founder-friendly version is a 1x non-participating preference. It means the investor can choose either:
- get their money back (1x what they invested), or
- take their ownership percentage of the sale price —
whichever is higher. Not both.
Let’s use our example (investor put in $1M for 20%) and imagine the company sells for $3M:
| Type of preference | Investor gets | Founders and others get |
|---|---|---|
| 1x non-participating | Higher of $1M or 20% × $3M ($600K) = $1M | $2M |
| 1x participating | $1M back plus 20% of the remaining $2M = $1.4M | $1.6M |
“Participating” means the investor gets their money back and then also shares in what’s left — sometimes called “double dipping.” Multiples above 1x (2x, 3x) make it even heavier.
In a huge exit, these differences fade. In a modest exit — which is how many real companies end — they can decide whether the founders walk away with something or nothing.
Ask: “Is the preference 1x? Is it participating or non-participating?”
4. Board seats: who can fire you
This is where the lessons from WeWork and Uber come in.
The board of directors makes the biggest decisions in a company, including hiring and firing the CEO. When investors put money in, they often ask for one or more board seats.
Count the seats carefully. If the board has five seats and investors control three, the founder can be outvoted on anything — including whether the founder keeps their job. Adam Neumann at WeWork and Travis Kalanick at Uber both built enormous companies and were still pushed out by the people who funded them.
That doesn’t mean investors on your board are bad. Good board members are incredibly valuable. It means you should know, on the day you sign, who has control.
Ask: “After this round, how many board seats are there, and who controls the majority?”
5. Protective provisions: the investor’s veto
Even without a board majority, investors often get protective provisions: a list of decisions the company can’t make without their approval.
Typical examples: selling the company, raising more money, changing the investor’s rights, taking on large debt, or changing the number of board seats.
Some of this is reasonable — investors want to protect their money from big surprises. But a long list can mean you need permission for almost everything. Read it slowly.
Ask: “Which decisions need investor approval, and is this list standard for a round our size?”
6. Founder vesting: your own shares can be taken back
Many founders are surprised to learn that a term sheet can affect their own shares.
Investors often ask that founder shares vest over time — commonly four years, with a one-year cliff. That means:
- If you leave before one year, you may keep none of the vesting shares.
- After one year, a chunk vests at once, and the rest vests month by month.
Why? Investors are betting on the team. If a co-founder walks away after three months with 30% of the company, that’s a disaster for everyone who stays.
This is actually fair, and it protects founders from each other too. But understand the details: what happens if you’re fired? What if the company is sold before you’re fully vested? (Look for “acceleration” clauses.)
Ask: “How does my vesting work, does my past work count, and what happens if I’m removed or the company is sold?”
7. Anti-dilution: if the next round is cheaper
If your company later raises money at a lower price than this round (a “down round”), anti-dilution protection gives the earlier investors extra shares to make up for it. Those extra shares come out of everyone else’s slice.
There are two common versions:
- Broad-based weighted average — the usual, more balanced version. It adjusts the investor’s price partway.
- Full ratchet — much harsher. It resets the investor’s price all the way down to the new, lower price, which can heavily dilute founders.
Ask: “Is anti-dilution broad-based weighted average?” If it’s full ratchet, ask why.
8. A few more words to watch
- Pro-rata rights: the investor’s right to keep their percentage by investing in future rounds. Common and usually fine.
- Drag-along: if a majority agrees to sell the company, everyone else can be required to sell too. Check whose majority it is.
- No-shop: for a period of time (often 30–60 days), you can’t talk to other investors. This one is usually binding. Keep the period short.
- Information rights: what reports you must send investors, and how often. Make sure it’s realistic for a small team.
The founder’s checklist
Before you sign any term sheet, make sure you can answer these in one sentence each:
- Is the valuation pre-money or post-money?
- How much of the company will I own after this round, including the option pool?
- If we sell for a modest amount, who gets paid what?
- Who controls the board?
- What decisions do I need investor permission for?
- How do my own shares vest?
- What happens to my ownership if the next round is cheaper?
- How long am I forbidden from talking to other investors?
If you can’t answer one of them, don’t sign yet. Ask your lawyer. Ask the investor. A good investor will happily explain — and how they react to your questions tells you a lot about what working with them will be like.
The real lesson
A term sheet isn’t just paperwork. It’s the rulebook for your relationship with the people funding your company: who decides, who gets paid, and who can replace whom.
As I wrote about my first business teacher, once you take someone’s money, you work for them. The term sheet is where you decide exactly what that means.
So read every word. Ask about every word you don’t understand. And only sign when you’d be comfortable explaining every line to your co-founder, your team, and your future self.
Because if you sign it, you own it.
Not legal or financial advice. Every deal is different — always have a lawyer who works for you, not for the investor, review your documents.
Related: My First Business Teacher: William Christopher Skelley, on why every founder ends up working for the investors.
