Term Sheet Provisions VCs Must Pay Attention To

hen you sign a term sheet, you’re doing far more than closing a fundraising round. You’re locking in the rules of the game: how exits are paid out, who steers the ship, and ultimately whether the founders and investors stay aligned over the long haul. Too often it’s treated like “just paperwork,” but in reality the word‑for‑word clauses in that document can shift tens of millions of dollars of value out of founder hands or tilt governance so far that the runway ahead looks very different.

In a recent report from Cooley LLP, 98 % of venture rounds in Q2 2025 reverted to a 1× non‑participating liquidation preference, and yet protective provisions (investor veto rights) remained in over 90 % of deals. That suggests the headline economics (1× pref) may look “standard”, but the subtle governance terms like board structure, veto rights, option‑pool carve‑outs, are still places where alignment between founders and VCs can diverge.

What it means in practice is that a seemingly benign clause, say, “preferred conversion upon change of control” or “fund‑reserved option pool of 15 % pre‑money” might cost the founders 5–10 points of ownership or shift exit proceeds by millions if your company is acquired for $50m or more. It doesn’t matter if the valuation sounds great, if the mechanics favour investors, your take‑home looks very different.

The purpose of this article is to walk you through the term‑sheet terms that really matter; not just the headline “valuation” but the economics, the governance and the alignment layers beneath. Because at the end of the day, a term sheet is more than just the cash you raise, it’s the shape of the outcome you’ll live with.

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Valuation and the Economics Beyond

Valuation gets the headline. But in reality, it’s just one of several levers that determine how much a founder owns, controls, and walks away with. To read a term sheet properly, you have to zoom out. Valuation only tells you what investors are buying into, it says nothing about what you’re giving up.

Let’s break down how valuation works, and why it can be misleading if viewed in isolation.

The Math: Pre-Money, Post-Money, and Ownership

The math seems simple on the surface. Pre-money valuation is the value of the company before the investment. Post-money valuation is pre-money plus new capital invested.

So if an investor puts in $5M at a $20M pre, the post-money is $25M. That means the investor now owns 20% of the company. That’s the headline ownership. Clean and easy.

Except it’s not always that clean.

Enter the option pool.

The Option Pool Shuffle

Most term sheets require a startup to expand or refresh its employee stock option pool before the financing closes, often to 10–20% of the post-money cap table. But here’s the catch: investors almost always want that pool baked into the pre-money, not post-money. That means the dilution comes out of the founders, not the new investors.

Suppose you agree to a $20M pre-money valuation with a 20% post-money option pool. You think the investor is buying 20% for their $5M. But behind the scenes, you're also issuing ~5M new option shares before the money comes in. That 20% pool eats into your stake, not theirs.

The result is that your effective pre-money drops well below $20M. You're selling more of the company than the headline suggests. Carta illustrates this clearly in their guide on pre- vs. post-money: even with the same valuation, changing pool size or timing can shift founder ownership by 5–10 percentage points.

A rule of thumb is to never negotiate valuation in isolation. Always ask, “What’s the option pool size and is it coming in pre- or post-money?”

Liquidation Preferences: The First Money Out

Valuation tells you how the pie is split. Liquidation preferences tell you who eats first.

In Q2 2025, Cooley reported that 98% of venture deals used a 1× liquidation preference, and 95% were non-participating. That’s good news for founders. It means investors get their money back first, equal to what they invested, but don’t double-dip by taking more unless they convert to common. Participating preferred stock, which lets investors take their money and a slice of the upside, is now largely considered off-market in early-stage deals.

But founders should stay vigilant. Even a subtle shift, say, a 1.5× preference, can heavily skew outcomes in middling exits. And if a preference is participating and uncapped, it can eat into founder proceeds well past the breakeven mark.

The best way to protect yourself is to normalize the language. Market standard today is clear: 1× non-participating, full stop. Anything else needs a very good reason.

Dividends: Silent but Dangerous

Another clause to watch is dividends especially if they’re cumulative.

Cooley data shows cumulative dividends were present in just 2.5% of Q2 2025 deals, the lowest level on record. Because they silently accrue over time, compounding the amount investors are owed before common shareholders see anything.

Let’s say an investor puts in $10M with a 6% cumulative dividend. Five years later, they’re owed $13M, not $10M, before anyone else gets paid. That’s 30% more in preference just from time passing. Founders often ignore this clause because startups rarely pay out dividends. But in an exit, those accrued amounts get factored in.

Avoid cumulative dividends unless absolutely necessary. Non-cumulative (or none at all) is standard. If you have to agree to them, cap the total payout or tie them to a redemption event.

Why All of This Matters

A term sheet may lead with a valuation, but it’s not the number that decides your future. Ownership is diluted by pools. Exit returns are filtered by preferences. And dividends, even theoretical, can grow into real costs.

In short, valuation is only the sticker price. The fine print is where real economics live. Founders who don’t model their cap table through the lens of preferences, pools, and payout order often realize too late that their “great valuation” translated to a thin sliver of the upside.

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The Golden Number: Investment Amount

How much a startup raises isn't just a function of ambition or market size, it’s a tactical choice that shapes power, pace, and pressure. Investment size determines who sits at the table, how much risk tolerance exists, and what expectations get baked into the next round.

More Than Just Ownership

Founders often think of the investment amount in terms of dilution; how much of the company they’re giving away. But the number on the term sheet unlocks far more than a cap table formula.

• Control dynamics: Larger checks often come with board seats, veto rights, or de facto control over future financing.
• Pro-rata rights: A bigger initial stake guarantees a more meaningful right to maintain ownership in later rounds, essential for fund math on the VC side.
• Perception signal: A $10M Seed looks impressive, until it creates milestone pressure that the company can’t match, or raises burn to unsustainable levels.

Raising more can bend expectations upwards. Miss the next milestone, and the same headline that gave you leverage last round becomes a liability.

How Terms Shape the Check

Investment amounts can also be structured, quietly and powerfully, through mechanisms that align funding to outcomes:

• Tranching: Funds disbursed in parts, often linked to concrete milestones (e.g., “FDA submission filed”). Common in biotech, but also showing up in frontier tech.
• Use-of-proceeds covenants: Investors may require spend discipline, e.g., limits on debt, headcount, or non-core expansion.
• Milestone-based pricing: A rare but potent clause. Subsequent tranches trigger re-pricing (step-ups or step-downs), essentially embedding feedback loops into the round.

Each lever lets investors balance risk while keeping founders moving with urgency. For the right businesses, especially those crossing regulatory or technical chasms, these structures are essential.

A Simple Fundraising Rule

There’s a rule of thumb that holds up across sectors: Raise for 18–24 months of burn to your next clean milestone, then add 3 months of buffer.

Clean = externally verifiable. Think “Series A termsheet,” “FDA approval,” “$1M ARR.” Internal metrics (like a vague roadmap goal) don’t cut it.

Raise more only if you’re buying down existential risk, e.g., core R&D uncertainty or major regulatory exposure. Otherwise, the weight of that big check might outweigh the freedom it appears to give.

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Equity Ownership and Pro Rata Rights

Ownership isn’t just based on dilution math, it also builds on return math. For a venture fund to make its model work, it needs meaningful exposure to the outliers. And that starts with the entry stake.

Why Ownership Targets Exist

Most VCs aren’t aiming for arbitrary percentages. Their targets are reverse-engineered from portfolio math:

• Seed rounds: 10–15% is typical, enough to return a fund on a $1B+ exit.
• Series A: 15–25% is common, especially for leads who set terms and expect board seats.
• Series B and later: Funds often aim for 5–10% if they’re following on or entering competitively.

Carta’s Q2 2025 data shows median Seed ownership by lead investors hovering around 12.6%, with a sharp drop-off at post-Series A unless pro-rata rights are exercised.

Defending the Stake: Pro-Rata Rights

Term sheets typically include pro-rata rights, the right to invest in future rounds to maintain percentage ownership. For a fund, this is a shield against dilution and a ticket to ride the winners.

Standard pro-rata lets investors keep their stake steady. Super pro-rata allows increasing it. But this can crowd out other investors, trigger allocation fights, and may require negotiation with founders.

While founders may feel pro-rata is simply a formality, it’s actually how investors manage exposure to their best companies. When a breakout happens, these rights determine who gets to double down.

Downturn Clauses: Pay-to-Play and Redemption Rights

In frothy markets, some terms vanish. In more cautious cycles, they return.

Pay-to-play clauses are on the rise again, found in ~10% of Q2 2025 deals per Cooley’s VC report. They require investors to participate in future rounds or lose their preferred protections. It’s a way to ensure ongoing support, especially in turbulent markets.

Redemption rights - the right to demand your money back after a set time - are rare in early-stage venture but occasionally appear in later-stage deals, cross-border financings, or bridge rounds. They’re often structured as long-fuse options (e.g., after 5–7 years), rarely enforced, but quietly shape the power balance if timelines drag.

These terms don’t just fill space on a term sheet. They encode incentives, future behavior, and the soft power dynamics of capital over time. Founders and VCs alike need to know how, and when, to use them.

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Anti-Dilution: Full-Ratchet vs Broad-Based Weighted Average

Down rounds happen. And when they do, anti-dilution protection decides who absorbs the pain.

This clause doesn’t get much attention until it matters, then it determines whether earlier investors hold steady or get wiped alongside the founders. Two mechanisms dominate the discussion: Full-Ratchet and Broad-Based Weighted Average (BBWA).

The Two Common Formulas

• Full-Ratchet: The investor’s conversion price is reset entirely to the new lower price, regardless of how small the round is. It’s blunt force; maximally protective for the investor, devastating for everyone else.
• Broad-Based Weighted Average (BBWA): The conversion price is adjusted downward in proportion to the size and price of the dilutive round. It balances fairness and market function.

The BBWA Formula and Walkthrough

The adjusted conversion price (CP₂) is:

CP₂ = CP₁ × ((A + B) / (A + C))

Where:

• CP₁ = original conversion price (e.g., $2.00/share)
• A = fully diluted shares before the new round (including options, warrants)
• B = total consideration received in the new round ÷ CP₁
• C = number of shares issued in the new round

Example:

• CP₁ = $2.00
• A = 10M shares (fully diluted, including options/warrants)
• New round: 2M shares issued at $1.00 → B = $2M ÷ $2.00 = 1M
• C = 2M shares

Then:

CP₂ = 2.00 × ((A + B) / (A + C))  

      = 2.00 × ((10,000,000 + 1,000,000) / (10,000,000 + 2,000,000))  

      = 2.00 × (11,000,000 / 12,000,000)  

      = 2.00 × 0.9167  

      = $1.83

So the conversion price resets to $1.83, not $1.00, softening dilution impact for all parties.

Why “Broad-Based” Matters

Make sure broad-based explicitly includes all convertible securities like options, warrants, and SAFEs on an as-converted basis. Some term sheets sneak in “narrow-based” mechanics that ignore these, leading to more severe dilution than founders or employees expect.

VC Playbook

Default to BBWA, always with broad-based inclusion. It’s the market standard and reinforces long-term alignment. If you’re leading a tough recap, full-ratchet might be warranted, but never use it in isolation. Pair it with a clean option pool refresh and employee carve-outs to preserve team morale and attract fresh talent.

The math may be mechanical, but its downstream effects are deeply human. Cap table scars from poorly structured anti-dilution clauses can last longer than any product pivot.

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Liquidation Preferences: Downside Protection vs Misalignment

Liquidation preferences are where the economics of venture capital turn from simple math to complex incentive structures. These provisions define who gets paid, in what order, and how much, especially in downside or mid-sized exit scenarios. While often overlooked during the rush to close a round, they can dictate whether a VC fund returns capital, or a founder walks away with nothing.

What the Terms Mean

Let’s break down the three primary types of liquidation preference:

• 1× Non-Participating Preferred: The most common setup in early-stage deals. Investors get their money back (1× the original investment) before common shareholders receive anything. After that, the remaining proceeds go to common. This aligns incentives fairly well.
• Participating Preferred (Uncapped): Investors first get their 1× liquidation preference, then also participate pro-rata in the remaining proceeds as if they held common stock. This is double-dipping; great for downside protection, but misaligned in large exits.
• Participating Preferred (Capped): Same as above, but participation is capped, usually at 2× or 3× total return. After reaching the cap, preferred converts to common. This still creates asymmetry but less distortion than the uncapped version.

Below is a simplified example with $10M investment, 20% ownership, and three exit values. This is illustrative math assumes no other liquidation stack or seniority, just one preferred round.

Why It Matters

At smaller exits, participation boosts investor downside protection. But at larger exits, where founders and teams expect upside, it can feel extractive. An uncapped structure can take tens of millions more off the table before common shareholders see meaningful gains.

For this reason, 1× non-participating has become the market standard for most early-stage deals (Cooley data shows >90% of Seed and Series A rounds use this). Participating terms are more likely in structured later-stage rounds or when a deal is competitive and the investor holds negotiating leverage.

Clear alignment beats clever economics. Be careful what you trade away in the fine print.

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Control and Governance: Who Holds the Steering Wheel

The economics of a term sheet may determine who gets how much, but the governance terms decide who gets to decide. Board rights, protective provisions, and observer roles shape the power dynamics long before an exit. Founders and investors alike must treat these clauses as central, not secondary.

Board Composition: Norms and Nuance

At the Seed stage, boards are often 2F–1I: two founder reps, one investor, and possibly an independent. By Series A/B, the balance typically shifts to 1F–1I–1I or even 2I–1F–1I, as larger investors enter. What matters here isn’t just the headcount, it’s the swing vote.

• Independent Directors must be truly neutral: no prior consulting ties, no significant equity (ideally <1%). Anything else creates covert influence.
• Investor-led “independents” who lean heavily toward one side undermine board integrity.

Directors vs. Observers

Board observers don’t vote or hold fiduciary duties, but they do attend meetings and gain information rights. Observers are useful in multi-investor rounds where only one firm gets a board seat but others want insight. That said, observers must be subject to confidentiality carve-outs to prevent IP or sensitive strategy leaks, especially in competitive sectors.

Committees and Their Triggers

Post-Series B, investors may request formal audit or compensation committees, especially in regulated, clinical, or pre-IPO environments. These sub-groups often carry real oversight power and are composed only of independent directors or investor reps. Be clear on what triggers their formation, and what authority they hold.

Protective Provisions: Guardrails or Handcuffs?

Investors typically secure veto rights, called protective provisions, over critical actions like:

• M&A or asset sales
• Issuing new stock (especially preferred)
• Incurring debt above a threshold
• Amending charter documents
• Declaring dividends

These clauses are standard. The problem arises when they balloon to cover hiring, pricing, or product decisions. Overreaching vetoes stall execution and block agility. Founders should negotiate for materiality thresholds and limit vetoes to existential business shifts.

Governance is where alignment either compounds or breaks. A clean cap table won’t save you if decisions stall behind closed doors.

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Founder and Employee Alignment

The term sheet doesn’t just offer insights on who funds the company; it also tells you who builds it, owns it, and stays motivated to grow it. Behind the board seats and preferences, there’s a second layer of provisions designed to secure long-term commitment from the people who make the company work - founders and employees.

Reverse Vesting: Locking in Founder Commitment

Most early-stage VCs expect founder shares to reverse vest over four years, typically with a one-year cliff. This isn’t punishment, it’s alignment. If a founder leaves in year one, they shouldn’t walk away with 100% of their equity. Reverse vesting ensures equity is earned over time, just like employee stock options.

In change-of-control scenarios, founders often negotiate double-trigger acceleration: a sale event plus termination (or role reduction) must occur for unvested shares to accelerate. This protects founders from being pushed out the moment the company is sold, without giving them an early exit before the hard part is over.

IP Assignment: Chain of Ownership Must Be Clean

One non-negotiable is that founders and employees must sign Proprietary Information and Invention Assignment Agreements (PIIAs). Without these, a startup’s IP ownership can be challenged during due diligence, stalling or killing an acquisition. VCs will often delay closing until a clean IP chain is confirmed. That includes side projects, open-source contributions, and anything built with company resources.

Restrictive Covenants: Navigating the Legal Map

Restrictive covenants like non-competes and non-solicits exist to prevent key people from walking across the street and replicating the company. But they’re heavily state-dependent. California bans non-competes outright; other states allow them with limits.

The FTC’s 2024 rule attempting a federal ban on non-competes was struck down in 2025, so it remains a state law issue. Term sheets should reflect that, especially in remote or distributed teams. Focus on enforceable agreements like NDAs, IP ownership, and narrowly tailored non-solicits.

Founder Secondaries: Liquidity With Guardrails

At later stages, typically post-Series B, it’s common to allow founders to sell a small portion of their equity in secondary transactions. This helps reduce financial pressure and lets founders go long. But smart VCs tie liquidity to milestones: product-market fit, Series B completion, or hitting revenue goals. Because early liquidity without progress misaligns incentives. No one wants a founder who’s already cashed out before the real value has been built.

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Exit Terms That Shape Liquidity

The term sheet, apart from informing how a journey is funded, also dictates how the journey ends. Exit terms are where early-stage alignment can turn into late-stage friction, or smooth liquidity. These clauses determine who has a say during a sale, who gets to tag along, and what happens when the public markets come calling.

Drag-Along Rights: Getting Everyone Across the Finish Line

Drag-along provisions allow a majority of shareholders, usually the preferred holders and a founder group, to force a sale of the company, dragging minority holders with them. This prevents a single investor (or early employee) from holding up a lucrative acquisition for the sake of better terms.

But smart term sheets build in safeguards:

• Fiduciary-out clauses: allow the board to walk away if the deal isn’t in the company’s best interest.
• Equal treatment of common stock: especially important for employees holding options; they shouldn’t be left behind in a forced sale.
• Some founders negotiate “drag light,” drag applies only above a certain valuation threshold.

Tag-Along Rights: Don’t Get Left Behind

Tag-along rights protect investors when founders or early stakeholders sell secondary shares. If a founder is selling 5% of their stake to a new strategic buyer, tag-along ensures major investors can sell on the same terms, proportionally. Without it, investors risk being sidelined while insiders de-risk quietly.

Automatic Conversion: The Public Market Trigger

Preferred shares don’t go public, they convert to common during an IPO. But the term sheet defines when that conversion happens via a “Qualified IPO” clause. This sets thresholds for:

• Minimum capital raised (e.g., $50M–$100M)
• Minimum price per share (often 2–3× the last round’s preferred price)

If an IPO doesn’t meet these bars, investors may not convert automatically, which can stall the deal. Most Series A and B term sheets now peg Qualified IPO triggers to $75M+ in primary capital, based on the average scale of successful tech IPOs in the last few years.

Lock-Up Periods: Everyone Waits, or No One Does

After an IPO, insiders typically face a 180-day lock-up; they can’t sell their shares until the window expires. Investors want parity here. If the founders or execs negotiate shorter lock-ups, major VCs expect the same terms. Uneven lock-up durations send bad signals and can fracture internal alignment post-IPO.

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The SAFE Landscape

Not all money comes with a price tag upfront. The SAFE (Simple Agreement for Future Equity) was designed to simplify early-stage fundraising, but its implications compound quietly in the background. If you're not modeling it, you're not managing it.

YC Post-Money SAFEs: Simple, But Costly

The most common form today is the YC post-money SAFE, which offers clarity to investors by calculating ownership after all SAFEs convert, but that clarity comes at a cost to founders.

In a priced round, you know your dilution when you set the valuation. With a post-money SAFE, each new SAFE stacks additional dilution on top of the last. If, sya for instance, you are signing three SAFEs with a $10M cap, you’re not giving away 30% in total, you might be handing out 40–45% once everything converts. YC’s own primer lays it out.

Founders love speed; SAFEs give speed. But they often trade off awareness for urgency and the compound effect shows up right when you’re trying to close your priced round.

MFN Clauses: A Hidden Landmine

Some SAFEs include a Most Favored Nation (MFN) clause, which allows earlier SAFE holders to adopt the better terms of a later SAFE. That sounds fair until it triggers an unplanned repricing cascade.

MFNs can spook priced-round investors, complicate cap tables, and delay closings. They’re especially risky when paired with uncapped SAFEs or inconsistent discount terms.

Conversion Mechanics: Where Theory Hits Reality

All SAFEs convert at the next equity financing, but how, and into what class of stock?

• SAFEs typically convert into shadow preferred; same economics, no voting rights.
• Conversion happens at the valuation cap or discount, whichever yields more equity.
• If multiple SAFEs are outstanding, pro-rata participation rights can get messy fast.

Sophisticated investors model every outstanding SAFE before investing; founders should do the same.

The Real Takeaway: Model Before You Sign

A SAFE may not be priced, but it still sets a claim on your future. Before signing multiple SAFEs, build a cap table simulator, layer in different valuation caps and amounts, and see the actual dilution at your next raise.

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The Goldilocks Approach for VCs in 2025

The best term sheets don’t favor one side; they create the foundation for durable alignment. In today’s venture climate - more selective, less forgiving - terms that are too aggressive don’t just burn bridges; they burn outcomes.

What’s Market, What’s Smart

The data is clear: most successful rounds in 2025 are built on terms that are founder-friendly and protect core investor interests. Here’s what that balance looks like:

• 1× Non-Participating Liquidation Preference: Clean downside protection without misaligned upside incentives.
• Broad-Based Weighted Average Anti-Dilution: Protects investor equity without overly punishing founders in a down round.
• Balanced Board Composition: 2F–1I early, shifting to 2F–2I–1 founder or 1 investor–1 founder–1 independent at Series A/B.
• Pro Rata Rights for Major Investors: Maintains alignment without over-clustering ownership.
• Protective Provisions (Scoped): Blocking real risks, like M&A, debt, charter changes, without stifling normal business ops.
• Double-Trigger Acceleration: Fair to founders; doesn’t create a “golden parachute” that scares acquirers.
• Standard Lockups and Clear Conversion Mechanics: Keeps incentives aligned around public listings or M&A.

Alignment Is the True Protection

Terms that overcorrect for risk like full-ratchet anti-dilution, uncapped participation, or oppressive veto rights might protect downside in theory. In practice, they signal mistrust, deter future investors, and crush founder morale.

Great VCs know the goal isn’t control for its own sake. It’s partnership that scales. The real protection in venture isn’t paper, it’s aligned ambition.