A term sheet is not a binding contract — but every number and clause in it will shape your company for years. Founders who sign without understanding every line often spend years paying the price. This guide decodes the most important terms in plain language.
Valuation: Pre-Money vs Post-Money
The most fundamental term in any sheet is valuation, and the most common confusion is between pre-money and post-money.
The Core Formula
Post-Money Valuation = Pre-Money Valuation + Investment Amount
Founder Ownership After Round = Pre-Money Valuation ÷ Post-Money Valuation
Example: If an investor offers ₹2 Cr at a ₹8 Cr pre-money valuation: Post-money = ₹10 Cr Investor owns = 20% Founders retain = 80% (before any ESOP)
Always confirm which valuation the investor is quoting. "₹10 Cr valuation" is ambiguous — it could mean pre-money (good for you) or post-money (dilutes you more than it sounds).
Liquidation Preference: The Clause That Changes Everything
Liquidation preference determines who gets paid first — and how much — if the company is sold or wound down. It is the most consequential economic term in a term sheet and the most frequently misunderstood.
- →1x non-participating: Investor gets their money back OR converts to equity, whichever is higher. This is founder-friendly.
- →1x participating: Investor gets their money back AND a pro-rata share of remaining proceeds. This is investor-friendly.
- →2x liquidation preference: Investor gets 2x their investment back before founders see a rupee. Avoid this unless you have no alternatives.
If you exit for less than the post-money valuation, liquidation preference determines whether you walk away with anything. Model the scenarios before you sign.
Anti-Dilution: Weighted Average vs Full Ratchet
Anti-dilution provisions protect investors if you raise a future round at a lower valuation (a "down round"). There are two types:
- →Broad-based weighted average: The most common and founder-friendly. It adjusts the investor's conversion price based on all outstanding shares. Founders lose a little ownership but remain reasonable partners.
- →Full ratchet: The investor's price adjusts to the new (lower) round price in full. In a bad down round, this can wipe out founder equity entirely. Reject full ratchet unless you have absolutely no leverage.
Always ask which type of anti-dilution your sheet uses. If it does not specify, negotiate for broad-based weighted average.
Pro-Rata Rights
Pro-rata rights give the investor the right to participate in future rounds to maintain their ownership percentage. For founders, this is generally neutral at the seed stage — it means your existing investors stay involved.
However, at Series A and beyond, pro-rata rights can complicate fundraising if early investors exercise their rights aggressively and crowd out new investors. Negotiate a cap on pro-rata rights for very small cheques at the seed stage.
Board Composition and Control
Early-stage term sheets often include provisions on board composition. The standard for an Indian seed-stage company:
- →2 founder seats
- →1 investor seat
- →1 independent seat (mutually agreed)
Be careful of any term that gives investors the right to replace the CEO, veto hiring decisions, or require investor approval for expenses above a low threshold (e.g., ₹5 Lakh). These protective provisions are normal at Series B but should be minimal at the seed stage.
The 5 Red Flags in Any Term Sheet
- →Full ratchet anti-dilution
- →Participating preferred liquidation with a preference above 1x
- →Investor approval required for day-to-day operational decisions
- →Founder vesting cliff longer than 1 year
- →"Super voting" rights that override the board on major decisions
If you see any of these, do not panic — but do not sign without independent legal advice.
Hire a startup-specialist lawyer to review your term sheet. The ₹30,000–₹50,000 fee is the best investment you will make. A bad liquidation preference can cost you crores on exit.