5 Things to Check Before Signing a Startup Term Sheet

You have a term sheet on your screen and a partner saying you should sign by Friday. Slow down. How to raise startup funding is half negotiation and half avoiding the five clauses that hurt founders for years after the cheque clears.

The valuation gets all the attention. The five items below decide who actually controls your company afterwards. None of them are optional reads.

1. Liquidation preference, not just multiple but participation

Liquidation preference says investors get their money back first in any sale or wind-up. Two variables matter: the multiple and whether it is participating or non-participating.

• 1x non-participating: standard, founder-friendly
• 1x participating: investor takes their money first AND shares in the rest
• 2x or 3x preference: investor takes 2-3 times their money before anyone else

A 2x participating preference can leave a founder with almost nothing on a 50-crore exit even if the cap table says they own 60%. Push hard for 1x non-participating; treat anything else as a yellow flag.

2. Anti-dilution — full ratchet vs broad-based weighted average

Anti-dilution kicks in if you raise the next round at a lower price than the current one (a down round). Two flavours:

• Full ratchet: investor's share price re-prices to the new lower round; founders get crushed
• Broad-based weighted average: a softer formula; standard market practice

Full ratchet is poison in any meaningful down round. Broad-based weighted average is the only acceptable form for a healthy startup. Walk away from full ratchet unless valuation is materially higher to compensate.

3. Board composition and protective provisions

The cap table says who owns the company. The board controls it. These are different things.

Watch for:

1. How many board seats does the investor get?
2. Is there an independent director, and who chooses them?
3. What decisions need investor approval (protective provisions)?
4. Can the investor veto a future fundraise, sale, or hire?

A reasonable Series A might give the investor 1 of 5 seats and veto over major decisions like sale, IPO, and hiring the CFO. An aggressive term sheet might give them 2 of 4 seats plus veto over hiring directors and approving the annual budget. The latter limits your ability to operate.

4. Vesting and reverse vesting on founder shares

Many founders are surprised to learn the term sheet often imposes vesting on the founders' own shares. That is reverse vesting.

If your existing equity is now subject to a 4-year vesting schedule, leaving the company before 4 years means losing some of your own holdings back to the company. This is reasonable in moderation; it becomes punitive if combined with other clauses.

Negotiate:

• A meaningful credit for the time you have already spent (1 to 2 years credited)
• A double-trigger acceleration on acquisition (vest fully if both the company is acquired and you are terminated without cause)
• A clear cause-only forfeit clause

5. Exit and drag-along rights

Drag-along lets a majority shareholder force the rest to sell in an exit. This is normal, but the threshold matters.

A drag-along that triggers at 51% effectively gives the investor exit control if they later cross that threshold. A drag-along that triggers at 75% requires consensus. Most healthy term sheets sit at 65 to 75%.

Also check:

• Tag-along rights (the right to join an investor sale)
• Right of first refusal (ROFR) on share sales
• Co-sale rights
• Information rights (what data the investor sees and how often)

What "investor friendly" actually means

An investor-friendly term sheet has 2-3 of the following:

• 2x or higher liquidation preference
• Participating preference
• Full-ratchet anti-dilution
• Multiple board seats with broad veto rights
• Founder-share vesting with no time credit
• Aggressive drag-along thresholds

One of these is acceptable as a trade for a high valuation. Three is a red flag. Five means the investor wants control more than they want value creation.

How to negotiate without burning the relationship

Two ground rules:

1. Use a startup lawyer who has done at least 20 deals — not a generalist firm. Cost: 1 to 3 lakh rupees, recovered many times over by deal terms
2. Negotiate as the smartest, most cooperative version of yourself. Hostile founders get worse terms or walked away from

The Indian startup legal community is small. Reputation travels. Tough but fair beats aggressive every time.

Where to verify market practice

Talk to two founders who closed at similar stage and sector in the last 6 months. Their actual terms are the best benchmark for what is reasonable. Reading templated articles online is useful background but not a substitute.

Frequently asked questions

Should I sign a term sheet without a lawyer?
No. The term sheet, even though non-binding on most clauses, becomes the basis for the binding shareholders' agreement. Errors get cemented.

Is a higher valuation always better?
No. A higher valuation paired with a 2x participating preference is often worse than a lower valuation with a 1x non-participating preference.

Can a term sheet be re-negotiated after signing?
Some terms can shift in the SHA negotiation, but anything in the term sheet is heavily anchored. Get it right before signing.