The Term Sheet Is Where Control Gets Decided, Not Price

Two Categories

Each term sheet is divided into economy that is who receives what money and when and control that is who decides what happens

Founders always focus on the former since valuation is the number that will be reported and compared. Experienced investors focus on the latter because control provisions determine outcomes in situations where money is actually at stake

Why Founders Read the Wrong Half

The imbalance is not a failure of intelligence. It emerges from how differently both parties perceive the document

A founder signs perhaps four term sheets over the course of his career each under time pressure each for the company that represents his entire professional life. An investor signs several a year has watched a portfolio of them develop and knows which clauses were quoted by someone in a conference room three years later

The founder also reads the document in the state that describes it worst. By signing the company is succeeding;otherwise the term sheet would not exist. Each controlling provision is written for the state in which the company is not succeeding which is a state that the founder has no current reason to imagine

So the asymmetry is more about experience than attention. The investor is reading a document that he has seen work. The founder is reading one that they hope will never work

The Economic Terms

Valuation is the least important item on that list in most actual outcomes. A generous valuation combined with a preferred stock at a multiple of 2x and a pre-money option set is worse than a lower valuation with clean terms in almost all exit scenarios except the exceptional one

Each of those rows carries its own arithmetic and the arithmetic is the subject of its own analysis. What follows is the half of the document that decides who is in the room when something applies

Board Composition

The composition of the board of directors is the most important provision of the document and it is the one most frequently granted from the beginning because it sounds like a procedure

A five-person board with two founder positions two investor positions and a mutually appointed independent director means that the independent director decides all controversial issues. Therefore it all depends on the appointment process and that process is a phrase in the final documents and not a headline in the specifications

Board seats are negotiated not proportional and the gap between ownership and board representation opens immediately

In Series A the founders own a clear majority of the company and a clear minority of the board of directors a difference of twenty points opened by a single financing. They will lose control of the board two rounds before losing financial control and the first of those losses is what decides who runs the company

The mutual agreement clause is where the remaining influence lies. An independent seat that requires the consent of both founders and investors leaves a genuine negotiation. One appointed only by the preferred or filled by an anonymous candidate that the investor will nominate later is a third investor position with a different label

Protective Provisions

Protective provisions give preferred holders a veto over specific shares regardless of overall ownership. Typical elements include selling the company raising more capital changing the share structure incurring debt above a threshold and changing the business

These are separate from the board. A seat on the board of directors is a vote among the directors who have duties to the company. A protective provision is a right that the investor has in his capacity as an investor which he can exercise in his own interest and which survives what happens at the board level

That's why a minority shareholder can block a sale that the majority of the company wants

Along with them are two other rights that are better understood as a couple. Information rights Forcing the company to deliver financial statements and budgets on a defined schedule. That is considered administrative until a founder in a bad quarter discovers that the obligation is contractual that the deadline is not negotiable and that the figures will be read by people who can act accordingly

Prorated rights They entitle the investor to maintain their percentage by participating in future rounds and this is the right that founders most consistently underestimate. It is an option on the company's own success exercisable only in rounds worth joining and eats up allocation the founder might want to offer elsewhere. A round that is completed because three existing holders exercised pro rata is a round in which the founder has lost the ability to choose who else joins the table

What a Minority Veto Looks Like in Practice

The abstract version of this seems unreasonable. Arithmetic explains why it isn't and why it joins exactly when it does

An illustrative company has a Series B investor who put up $10 million for twenty percent maintaining a standard preference times non-participant with $18 million of total preferences across the stack. An offer of $35 million comes in

Below fifty million dollars Series B prefers conversion so it receives exactly ten million dollars at each price in that range. Between thirty-five and fifty million the investor's income does not change at all while the available pool increases by fifteen million

That gap is the entire mechanism. Throughout the band the founders have fifteen million dollars at stake and the investor has zero so the founders want to make transactions and the investor is economically indifferent to the price. What does not leave the investor indifferent is the alternative which is to wait for a result greater than fifty million where his money finally begins to multiply

A fund that returns its money once in a position has failed on its own terms. The founder who owns a third of the common capital has a life-changing sum on the table. Both behave rationally and the protective disposition decides which rationality prevails

Drag Along and Tag Along

Drag The rights force minority holders to accept a sale approved by a defined majority preventing a small holder from blocking an agreed exit. accompany The rights go the other way allowing a minority holder to join a sale that a majority has negotiated rather than being left with illiquid shares alongside a new controlling owner

The definition of majority approval is where an obstacle becomes dangerous. A drag that requires a majority of the preferred and a majority of the common is a coordination device. A drag that requires only the majority of the preferred is a transfer of the decision

According to the second version with eighteen million dollars of outstanding preferences the preferred can approve a sale for eighteen million dollars in which the common receives nothing and then require the founders to sign the documents carrying it out. The founders are contractually obligated to execute a transaction that pays them zero

That scenario is not exotic. It is the usual form of a disappointing acquisition and the only word that decides it is whether the resistance threshold says preferred alone or preferred and common

Founder Terms

Several provisions apply to the founders personally and not to their shares in the abstract

Acquisition of rights on founders' shares often with the clock reset at the time of funding means that the founders gain their own capital over time and lose any unvested shares upon exit. A three-year founder at a company accepting a new four-year schedule has agreed to work seven years for shares he already owned and the reset is presented as standard as it usually is

Non-compete and intellectual property assignment terms are generally non-negotiable and are worth reading anyway as their scope varies more than their presence

Single Versus Double Trigger

acceleration determines whether the acquisition is completed with an acquisition and the choice is more controversial than most founders expect

Single-trigger acceleration vests unvested stock in a change of control. Acquirers resist it and resistance is not stubbornness. A buyer paying for equipment that is now fully vested by closing has purchased an asset that can be retired in the first quarter so it values that risk either by reducing the purchase price or creating a retention fund from it. Single-trigger acceleration does not create value. It moves who has retention risk andThe acquirer charges for maintaining it

Double trigger acceleration requires both a change of control and a termination without cause within a defined period commonly twelve months. It has become the market standard because it solves the real problem which is the firing of a founder shortly after closing a deal without eliminating the retainer paid by the acquirer

A founder who strongly advocates for single triggering is typically advocating for a lower headline price on his own acquisition

What Is Actually Binding

A term sheet is mostly non-binding an agreement to proceed toward definitive documents on these terms. There are generally two binding provisions: confidentiality and confidentiality. exclusivity also called no shop which prevents the company from talking to other investors for a defined period

The rest of the document describes what the parties intend. Those two describe what they already agreed to and one of them eliminates the founder's alternatives while it is in effect

Most non-binding ones are still worth reading carefully because a term sheet is a template and a template reveals how its author operates. The standard clear terms of an established company say something about how the relationship will develop once the money has arrived.An unusual structure this early also says something and is the more reliable sign of the two as a company seeking a Series A participation preference is outlining what it expects to need down the road

Exclusivity Against the Clock

Exclusivity should be measured by track and not custom and the measurement is relentless

An enlightened company has five months of cash call it twenty-two weeks and knows from experience that executing a new financing process takes about three and a half months call it fifteen weeks. The difference between those two figures is about six and a half weeks or forty-six days. That's all the window in which the company can afford to find out that this investor is not going to close

A sixty-day no-store period exceeds that window by two weeks. Signing it means that when the exclusivity expires restarting will already be arithmetically impossible

Play forward. On day fifty the investor returns with revised conditions. The company has about fourteen and a half weeks of runway and needs fifteen to execute a process. There is no alternative left with which to threaten anyone which is precisely the position for which no store was bought

Shortening exclusivity from sixty days to thirty is one of the most valuable things a founder can negotiate and it costs the investor almost nothing to grant it which is a rare combination in a term sheet

The Bottom Line

Term sheets establish economics and control and founders systematically overvalue the former because they are reading a document written for conditions they have no reason to imagine. Board seats are negotiated rather than proportional so a single financing can leave founders with sixty percent of the shares and forty percent of the board. Protective provisions apply most strongly in the band where an investor is indifferent to the sales price and the founders are not which in a typical stack can be a differenceof fifteen million dollars with respect to the common price and nothing at all with respect to the preferred. Check if the resistance threshold requires both the common and the preferred accelerate the double trigger and keep the non-shop shorter than your runway minus the time it takes for a new process. Model the exit scenarios before discussing the valuation