Term Sheet Knowledge

⚠️ Disclaimer: This skill explains term sheet terminology for educational purposes. It does not provide legal advice. All investment agreements must be reviewed by a startup-focused lawyer.

Term sheet key conditions, SAFE/convertible note structures, cap table dilution calculations, negotiation strategy, and red flags.

How It Works

┌─────────────────────────────────────────────────────────────────┐
│                  TERM SHEET KNOWLEDGE                            │
├─────────────────────────────────────────────────────────────────┤
│  Information Provided                                           │
│  ✓ Term sheet key terms explained (15 critical items)          │
│  ✓ SAFE vs convertible note vs Equity comparison               │
│  ✓ Cap table dilution calculations (round-by-round simulation) │
│  ✓ Negotiation points & priorities                             │
│  ✓ Red Flags (conditions to avoid)                             │
└─────────────────────────────────────────────────────────────────┘

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Term Sheet Key Terms

1. Valuation

Pre-money vs Post-money

Pre-money: Company value before investment
Post-money: Company value after investment

Post-money = Pre-money + Investment amount

Example:
- Pre-money: $8M
- Investment: $2M
- Post-money: $10M
- Investor stake: $2M / $10M = 20%

Negotiation Points:

• Higher pre-money → Lower dilution
• But risks "down round" in next round
• Fair valuation > Inflated valuation

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2. Investment Amount & Dilution

Investor stake (%) = Investment amount / Post-money valuation

Example:
- Pre-money: $8M
- Investment: $2M
- Post-money: $10M
- Dilution: 20%

Founder's existing stake 80% → After investment 64% (80% × 80%)

Dilution Benchmarks:

• Pre-seed: 10-20%
• Seed: 15-25%
• Series A: 20-30%
• Series B: 15-25%

Red Flag:

• Single round dilution > 30%
• Cumulative dilution leaves founder < 50% stake (pre-Series A)

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3. Liquidation Preference

Definition: Amount investor recovers first at exit

Types:

1x Non-Participating

Exit $20M, Investment $2M (20% stake):
- Investor chooses:
  Option A: $2M (1x preference)
  Option B: $4M (20% stake)
→ Investor: chooses $4M
→ Founders: $16M

1x Participating

Exit $20M, Investment $2M (20% stake):
- Investor:
  Step 1: $2M (1x preference)
  Step 2: ($20M - $2M) × 20% = $3.6M
→ Investor: $5.6M
→ Founders: $14.4M

2x Non-Participating

Exit $20M, Investment $2M (20% stake):
- Investor chooses:
  Option A: $4M (2x preference)
  Option B: $4M (20% stake)
→ Investor: $4M
→ Founders: $16M

Red Flag:

• Participating (double-dipping)
• 2x or higher multiple
• Participating in Seed/Series A is abnormal

Negotiation:

• 1x non-participating is standard
• Strongly oppose if participating
• Set cap (e.g., 1x participating with 2x cap)

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4. Anti-Dilution Protection

Definition: Protects investor in down rounds

Types:

Full Ratchet (Most Harmful)

Original: $10M valuation, $1/share, 1M shares
Down round: $5M valuation, $0.50/share

Full Ratchet → Investor shares adjusted to $0.50
→ Investor shares double, founders heavily diluted

Weighted Average (Standard)

Broad-based: Based on all issued shares (founder-friendly)
Narrow-based: Based on preferred shares only (investor-friendly)

Broad-based is industry standard

Red Flag:

• Full Ratchet (must avoid)
• Narrow-based (try to avoid)

Negotiation:

• Demand broad-based weighted average
• Pre-seed/Seed can sometimes avoid entirely

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5. Board Composition

Typical Structure:

Seed:

Total: 3 seats
- Founders: 2 seats
- Investor: 1 seat

Series A:

Total: 5 seats
- Founders: 2 seats
- Investors: 2 seats (Seed 1 + Series A 1)
- Independent: 1 seat (mutual agreement)

Series B:

Total: 7 seats
- Founders: 2 seats
- Investors: 3 seats
- Independent: 2 seats

Red Flag:

• Investor majority (founders lose control)
• Independent director selection power only with investor

Negotiation:

• Founders + Independent ≥ Investors
• Independent director selection by mutual consent

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6. Protective Provisions

Definition: Requires investor consent for certain actions

Standard Items:

• New fundraising
• M&A, liquidation
• Charter amendments
• Adding board members
• Changing preferred stock terms

Red Flag:

• Excessive items (e.g., executive hiring, budget approval)
• Single investor veto power

Negotiation:

• Define "Major Investor" threshold (e.g., 10%+ stake)
• Require majority preferred shareholder consent (not single investor)

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7. Conversion Rights

Definition: Preferred to common stock conversion

Automatic Conversion:

Converts automatically at IPO
Conditions:
- IPO price > $X (e.g., $50M valuation)
- Raise > $Y (e.g., $10M)

Optional Conversion: Investor can choose to convert anytime

Red Flag:

• Automatic conversion conditions too high
• Only investor can optionally convert (not founders)

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8. Redemption Rights

Definition: Investor can force company to buy back shares

Red Flag:

• Redemption rights in Seed/Series A (abnormal)
• Redemption timing too soon (e.g., 3 years)

Negotiation:

• Demand redemption rights removal
• Minimum 5+ year period if required

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9. Dividends

Types:

Cumulative:

X% accrues annually, paid at exit
→ Effective interest (investor-favorable)

Non-Cumulative:

Paid only if board decides
→ Rarely paid in startups

Red Flag:

• Cumulative dividends (must avoid)
• Dividend rate > 8%

Negotiation:

• Remove dividends or non-cumulative only

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10. Founder Vesting

Standard Structure:

4-year vesting, 1-year cliff

Example:
- Year 0: 0%
- Year 1 (Cliff): 25%
- Year 2: 50%
- Year 3: 75%
- Year 4: 100%

Monthly vesting (after Year 1): 1/48 each month

Single Trigger vs Double Trigger:

Single Trigger:

M&A triggers immediate 100% vesting
→ Founder-friendly

Double Trigger:

M&A + Termination → 100% vesting
→ Acquirer-friendly (can retain founder)

Negotiation:

• Demand single trigger (early rounds)
• Accept double trigger (later rounds)
• Acceleration amount (50% vs 100%)

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11. Right of First Refusal & Co-Sale

Right of First Refusal (ROFR):

Investor gets first chance when founder wants to sell shares
→ Standard provision, acceptable

Co-Sale / Tag-Along:

When founder sells shares, investor can sell under same terms
→ Standard provision

Drag-Along:

If investor majority approves, all shareholders forced to sell
→ Facilitates M&A
→ Standard provision, acceptable

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12. Pro-Rata Rights

Definition: Right to participate in next round to maintain stake

Negotiation:

• Grant only to Major Investors
• Limit over-allotment

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13. Information Rights

Standard:

• Monthly financial statements
• Annual audited financials
• Annual budget
• Board materials (observer rights)

Red Flag:

• Excessive reporting (e.g., weekly reports)
• Sensitive information to potential competitors

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14. Expense Reimbursement (No-Shop & Expenses)

No-Shop:

30-60 days after term sheet, cannot negotiate with other investors
→ Standard provision, acceptable

Expenses:

Company pays investor's legal fees
→ Set cap ($10K-$25K)

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15. Employee Option Pool

Pre-money vs Post-money:

Pre-money Pool (Investor-favorable):

Pre-money: $8M
Option pool: 15% (pre-money basis)
→ Option pool dilutes only founders

Actual calculation:
- Founders: 80% × (1 - 15%) = 68%
- Option pool: 15%
- Investor: 20% (post-money basis)
→ Only founders diluted

Post-money Pool (Founder-favorable):

Post-money: $10M
Option pool: 15% (post-money basis)
→ Founders and investors both diluted

Negotiation:

• Demand post-money option pool
• Keep to what's needed (avoid excessive pool)

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SAFE (Simple Agreement for Future Equity)

SAFE Structure

Basic Principle:

Current investment → Converts to equity in next equity round
No valuation now (avoids current negotiation)

4 Types:

1. Valuation Cap (Most Common)

Cap: $5M
Next round: $10M pre-money
→ SAFE investor converts at $5M basis (2x favorable)

2. Discount (Standalone or Cap + Discount)

Discount: 20%
Next round: $1/share
→ SAFE investor converts at $0.80/share

3. Valuation Cap + Discount

Choose whichever is more favorable

4. MFN (Most Favored Nation)

Not worse than next SAFE
→ Protects early investor

SAFE Dilution Calculation

Example:
- SAFE investment: $500K, Cap $5M
- Series A: $2M at $10M pre-money

SAFE conversion:
- SAFE Cap $5M basis → 10% stake ($500K / $5M)
- Series A $10M pre-money basis → 20% ($2M / $10M)

Post-money:
- $10M + $2M + SAFE dilution adjustment = $12M+
- Founders: ~66%
- SAFE: ~10%
- Series A: ~20%
- Option pool: ~4%

SAFE vs Equity

Item	SAFE	Equity
Valuation	Pending (cap only)	Confirmed
Negotiation	Simple (2 weeks)	Complex (2 months)
Cost	Low ($2K)	High ($20K+)
Investor Rights	None	Board, protective provisions
Conversion	Next round	Immediate
Best Stage	Pre-seed	Seed+

SAFE Advantages:

• Fast, inexpensive
• Defers valuation negotiation
• Standard document (YC SAFE)

SAFE Disadvantages:

• Complex cap table (multiple SAFEs overlap)
• Dilution uncertain until next round
• No investor rights (board, information)

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Convertible Note

Structure

Debt → Converts to equity in next round

Key terms:
- Principal
- Interest Rate: 5-8%
- Maturity: 18-24 months
- Conversion Discount: 15-25%
- Valuation Cap: Optional

SAFE vs Convertible Note

Item	SAFE	Convertible Note
Legal Form	Contract	Debt/Bond
Interest	None	5-8%
Maturity	None	18-24 months
Repayment Obligation	None	Must repay or convert at maturity
Complexity	Low	Medium

Regional Preference:

• USA: Prefers SAFE (simpler)
• Korea/Asia: Prefers convertible notes (legally established)

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Cap Table & Dilution Calculations

Initial Cap Table

Founding:
- Founder A: 60% (6M shares)
- Founder B: 40% (4M shares)
Total: 10M shares (Fully Diluted)

Pre-seed (SAFE)

SAFE investment: $500K at $5M Cap

Assumption: Converts at Series A
Cap table unchanged for now

Seed Round

Investment: $2M at $8M pre-money
Option pool: 10% (pre-money)
Post-money: $10M

Dilution calculation:
1. Create option pool (pre-money)
   - Existing: 10M shares
   - Options: 1.11M shares (10% / 90%)
   - Total: 11.11M shares

2. Investor shares
   - Investor stake: 20% (post-money)
   - Investor shares: 2.78M shares (20% / 80%)
   - Total: 13.89M shares

Cap table (after Seed):
- Founder A: 54% (6M / 11.11M × 80%)
- Founder B: 36% (4M / 11.11M × 80%)
- Option pool: 8% (1.11M / 13.89M)
- Seed investor: 20% (2.78M / 13.89M)
- SAFE: Not yet converted

Series A

Investment: $5M at $20M pre-money
Option pool: 15% (post-money)

SAFE conversion:
- SAFE $500K at $5M Cap
- $500K / $5M = 10% (based on cap)
- But pre-money $20M → requires adjustment
- SAFE shares ≈ 2.5% (post-money)

Series A shares:
- Investment: $5M
- Post-money: $25M (pre $20M + $5M)
- Stake: 20%

Cap table (after Series A):
- Founder A: 37.8%
- Founder B: 25.2%
- Option pool: 15%
- SAFE: 2.5%
- Seed: 14%
- Series A: 20%

Dilution Simulator

Spreadsheet templates:
https://captable.io
https://carta.com

Key variables:
- Investment amount
- Pre-money valuation
- Option pool size
- SAFE Cap & Discount

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Negotiation Strategy

Priorities

Must-Have (Non-Negotiable):

1. 1x non-participating liquidation preference
2. Broad-based weighted average anti-dilution
3. Founder board control or parity
4. Post-money option pool

Important: 5. Single Trigger Acceleration 6. Limit investor rights scope 7. Minimize No-Shop period 8. Cap on expenses

Nice-to-Have: 9. Remove dividends 10. Remove redemption rights

Negotiation Tips

1. Hire a Lawyer

Retain startup-focused lawyer
Cost: $10K-$25K (worth it)

2. Use Standard Documents

NVCA standard documents
YC SAFE
→ Be suspicious of non-standard clauses

3. Compare Multiple Term Sheets

Get 2-3 term sheets minimum
Create comparison table
Don't just look at valuation—examine full terms

4. Reference Checks

Ask investor's portfolio CEOs:
- How active on board?
- Support during difficult times?
- Follow-on investment?

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Red Flags (Conditions to Avoid)

🚩 Participating Liquidation Preference

Double-dipping (preference + equity stake)
→ Unfavorable to founders at exit
→ Absolutely not acceptable in Seed/Series A

🚩 Full Ratchet Anti-Dilution

Massive founder dilution in down round
→ "Death spiral"
→ Must never accept

🚩 Investor Board Majority

Founders lose control
→ Risk of being fired
→ No strategic decision power

🚩 Excessive Protective Provisions

Investor consent needed for daily operations
→ Decision-making paralysis
→ Must limit scope

🚩 Personal Guarantee

Founders' personal assets as collateral
→ Abnormal in startups
→ Refuse

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Korea-Specific: Convertible Notes & Stock Purchase Agreement

Korean Convertible Note Structure

Typical terms:
- Conversion price: Discount vs issue price (20-30%)
- Conversion request period: 1 year after ~ before maturity
- Maturity: 3 years
- Interest rate: 0-3%
- Early redemption: Partially allowed

Stock Purchase Agreement (SPA)

More common in Korea (similar to US Stock Purchase Agreement)

Key provisions:
- Stock issue price
- Representations & Warranties
- Conditions Precedent
- Liability for damages

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Related Skills and Commands

• financial-modeling — Dilution simulations, cap table modeling
• fundraising-process — Term sheet received at Week 7
• /fundraise-pipeline — Compare multiple term sheets
• /dd-prep — Prepare for term sheet negotiation during DD stage