Term Sheets: What Founders Give Up and Investors Demand — Venture Capital & Startup Investing

§ 01

Term	What It Means	Who It Protects
Liquidation preference	Investors get their money back first in any exit	Investors — downside protection
Anti-dilution	Adjusts price if future rounds are at lower valuation	Investors — protection against down rounds
Board seats	Voting control at the board level	Depends on allocation — key control term
Pro-rata rights	Right to invest in future rounds to maintain ownership %	Investors — maintain exposure to winners
Drag-along	Majority can force minority to sell in an acquisition	Investors — prevents holdouts from blocking exits
Vesting	Founder shares vest over 4 years with 1-year cliff	Company/investors — prevents founder walkaway

§ 02

Liquidation preference is the most impactful term. A 1x non-participating preference means investors get their money back OR convert to common — fair. A 2x participating preference means they get 2x their money PLUS their pro-rata share of remaining proceeds — heavily investor-favored.

§ 03

When reading about VC deals, check for ‘participating preferred’ vs. ‘non-participating preferred.’ The difference can dramatically change how proceeds are split in an exit.

§ 04

An investor puts in $10M for 20% with 1x non-participating liquidation preference. The company sells for $30M. What does the investor get?

§ 05

The headline valuation is often less important than the terms. A $50M valuation with 2x participating preferred and full ratchet anti-dilution may be worse for founders than a $30M valuation with clean 1x non-participating terms.

§ 06

Series B term sheet offers $15M at $60M post-money, with 1x non-participating liquidation preference. Founder asks: 'What does 1x non-participating mean at exit?'

§ 07

Going Deeper — dilution math through Series A → B → C. A founder starts at 100% pre-financing. Series A: VC invests $5M at $20M post-money — the founder is diluted to $15M / $20M = 75%. Series B: a new investor leads with $10M at $50M post-money — every existing holder is diluted by the new-money fraction $10M / $50M = 20%, so the founder goes to 75% × (1 − 0.20) = 60%. Series C: $20M at $100M post-money — dilution factor $20M / $100M = 20%, founder lands at 60% × 0.80 = 48%. Under conventional terms, the founder owns slightly less than half after three rounds. The discipline: model the cap table forward to the round you expect to exit at, including option-pool refreshes (which dilute everyone before the new money enters), and only then judge whether the founder's ownership economics still incentivize the work that matters.

Five questions · AI feedback

Sit with the ideas.

A VC invested $25M at a $100M post-money (25% ownership) with 1x participating preferred. The company sells for $80M. How much does the VC receive?

Why:

Sit with the ideas.

Other lessons in this course.