Term sheet terms explained: the clauses that actually matter
Liquidation preference, pro rata, vesting, anti-dilution, the board. A plain-English walkthrough of the term sheet clauses that change real outcomes, and the ones that exist to comfort lawyers.
TL;DR: A term sheet has two kinds of clauses. There are the ones that decide real outcomes: liquidation preference, pro-rata, vesting, anti-dilution, and the board. Then there are the ones that exist so the lawyers feel thorough. If you read five clauses carefully and accept everything else as standard, you have done better than most first-time founders.
What a term sheet is
A term sheet is a letter of intent. It is not the final contract, but every number in it will reappear in the final documents. Review the terms seriously while they can still be changed. After signatures, the bar for change is much higher.
The five clauses that decide outcomes
1. Liquidation preference. The order money comes out at an exit.
Standard is 1x non-participating: the investor gets their money back first, and everything after that splits as equity. That is fair.
The trap is a participating preference, where the investor gets their money back and then also gets their share of the remaining pool. On a good exit the investor is paid twice. Refuse it.
2. Pro rata. The right to invest in the next round to keep their percentage.
Founders often read pro rata as bad news. It is not. It means the investor wants to stay involved, and that is a healthy sign. A reasonable version of the clause is paired with a condition: the right stays only if the investor participates fully in this round. That is a fair trade.
3. Vesting. The schedule on which equity is earned.
Standard is four years with a one-year cliff, applied to everyone holding more than a few percent, founders included. That is normal. Ask for what happens to the shares when the company is sold: whether they vest at closing. That one is worth reading.
4. Anti-dilution. What happens if the next round prices lower than this one.
The standard is broad-based weighted average. It limits the extra shares the investor receives with a formula that counts employee options too. That is fair.
The outlier is full ratchet, which gives the investor enough shares to match the lowest future price. It is aggressive and not standard. Do not sign it.
5. The board. Who sits in the seats.
The common early structure is three seats: the CEO, one founder, and one investor-nominated director. Never sign a term sheet where the investor side of the board has more seats than the founder side. It is the slowest and most permanent term on the page.
The standard pile
The rest of the sheet is busywork: the no-shop clause, legal fees, representations, drag-along rights. Drag-along is worth knowing about because it lets a majority sale force all shareholders to sell, which is how every deal closes. But these clauses rarely cause a dispute in a seed round.
The three that deserve your attention
The price and the cap (see the SAFE explained and how founders value a pre-revenue company). The liquidation preference discussed above. And the board seats.
Everything else in a seed term sheet matters at the margin. Those three decide what the company does with the money and who gets to say so.
The full picture
The term sheet is the end of the pipeline, not the start. It arrives after the outreach email (templates that work) and the deck that survives a three-minute skim (slide by slide). If the pipeline before it was honest, the term sheet is usually the easy part.
Frequently asked questions
What is the most important clause in a term sheet?
For most founders it is the liquidation preference, because it decides who gets money first when the company is sold. Read that one first, then the pro-rata rights, then the board composition.
What does pro rata mean in investing?
It is the right of an existing investor to buy enough shares in your next round to keep their ownership percentage unchanged. It protects investors from dilution and lets them double down on winners.
What is a liquidation preference?
It decides the order money comes out when the company exits. A 1x non-participating preference returns the investor's money first, then the rest is split like normal shares. A participating preference also takes from the common pool — that is the clause to refuse.
What is broad-based weighted average anti-dilution?
A protection that gives investors more shares if you raise a future round at a lower price. Broad-based weighted average counts most shares, including employee options, in the formula, and it is the standard. Anything called a full ratchet is aggressive.