How do venture capital term sheets impact your startup?

1 Valuation and dilution

One of the most important and contentious aspects of a term sheet is the valuation of your startup, which determines how much equity you will give up to the investors in exchange for their capital. A higher valuation means you will retain more ownership and control of your startup, but it also sets higher expectations for your future performance and exit. A lower valuation means you will dilute your stake and possibly lose some decision-making power, but it also reduces the pressure and risk of disappointing your investors. You should balance your valuation with your growth potential, market size, traction, and competitive advantage.

2 Equity and vesting

Another key aspect of a term sheet is the equity structure of your startup, which defines how the shares are distributed among the founders, employees, and investors. Equity can be divided into different classes, such as common and preferred, with different rights and preferences. For example, preferred shareholders may have priority in receiving dividends, liquidation proceeds, or conversions to common shares. You should understand the implications of each equity class and how they affect your upside and downside scenarios. Additionally, you should pay attention to the vesting schedule of your equity, which determines when and how you can access your shares over time. Vesting is usually conditional on your continued involvement and performance in the startup.

3 Voting rights and board seats

Another aspect of a term sheet that affects your startup is the voting rights and board seats of the investors. Voting rights determine how much influence the investors have over the major decisions of your startup, such as hiring and firing key personnel, raising more capital, selling the company, or changing the business model. Board seats determine how many representatives the investors have on your board of directors, which oversees the strategic direction and governance of your startup. You should negotiate the voting rights and board seats that align with your vision and values, and that allow you to maintain a productive and collaborative relationship with your investors.

4 Liquidation preferences and anti-dilution

Another aspect of a term sheet that impacts your startup is the liquidation preferences and anti-dilution provisions of the investors. Liquidation preferences define how the proceeds from a sale or dissolution of your startup are distributed among the shareholders. Typically, investors have a preference over common shareholders, meaning they get their money back before anyone else. However, some investors may demand a multiple preference, meaning they get more than their money back, or a participating preference, meaning they get their money back and a share of the remaining proceeds. You should be aware of how these preferences affect your payout and incentives in different exit scenarios. Anti-dilution provisions protect the investors from losing value in their shares if you raise more capital at a lower valuation in the future. These provisions adjust the conversion rate of the preferred shares to common shares, effectively increasing the investors' ownership and decreasing yours. You should be careful of how these provisions dilute your equity and control in future rounds.

5 Other terms and clauses

A term sheet may also include other terms and clauses that impact your startup, such as milestones, drag-along rights, pay-to-play, redemption, and confidentiality. Milestones are specific goals or achievements that the investors expect you to meet in order to receive the full amount of funding or to avoid certain penalties. Drag-along rights allow the investors to force the other shareholders to sell their shares in a certain exit scenario. Pay-to-play requires the investors to participate in future rounds or face unfavorable consequences. Redemption gives the investors the right to demand their money back after a certain period of time. Confidentiality prevents you from disclosing the terms of the deal to third parties. You should review these terms and clauses carefully and understand their implications for your startup.

A term sheet is a crucial document that shapes the relationship between you and your investors. It can have a significant impact on your startup's success and survival. Therefore, you should not sign a term sheet without consulting a lawyer, an accountant, a mentor, or an experienced entrepreneur. You should also be prepared to negotiate and compromise on the terms that matter most to you and your startup.