Term Sheet Glossary: 20 Terms Founders Should Know
The first time a term sheet lands in your inbox, it can feel like reading a contract in a foreign language. Pre-money, participation, full ratchet, drag-along: every line seems important, and none of them explain themselves. This term sheet glossary translates 20 common terms into plain English, so you can read the document calmly, ask better questions and know when to call your lawyer.
Key takeaways
- A term sheet sets out the main terms of an investment before the full legal documents are drafted.
- Most terms are non-binding, but some clauses, such as confidentiality and no-shop, usually are binding.
- The terms fall into four groups: valuation and ownership, investor economics, control, and deal mechanics.
- Standard templates, such as NVCA in the US and BVCA in the UK, make it easier to spot anything unusual.
A term sheet is a short document, often just a few pages, that summarizes the key terms of an investment in your company. It usually comes with a priced equity round, where investors buy shares at an agreed valuation. If you are raising on a SAFE or convertible note instead, many of these terms appear later, when that money converts. Our guide to SAFEs, convertible notes and priced rounds covers those differences.
Most of a term sheet is non-binding: it records what both sides intend to agree, and the details are finalized in the legal documents that follow. Some clauses, typically confidentiality and no-shop, usually are binding from the moment you sign. That is why it pays to understand every line before you agree to anything. This glossary is general information, not legal or investment advice. Always have a startup lawyer review your term sheet.
Valuation and ownership terms
These terms decide how much of the company the investor gets for their money, and how much you keep.
1. Pre-money valuation
The value of your company immediately before the new investment. It is the starting point for working out how many shares the investor receives and at what price.
2. Post-money valuation
The value of your company immediately after the investment. In simple terms, post-money equals pre-money plus the new money invested. The investor's ownership is their investment divided by the post-money valuation.
3. Option pool
A block of shares reserved for future employee stock options. Investors often ask for a pool of a certain size to be in place at the time of the round, so you can hire without needing to create new shares right away.
4. Option pool shuffle
This is the one that catches founders out. If the term sheet says the option pool must be created or enlarged before the investment, that pool comes out of the pre-money valuation. The investor's percentage stays the same, while the dilution from the new pool falls on existing shareholders, mostly the founders. The headline pre-money valuation can look higher than the value your existing shares effectively receive.
Example
Imagine an example term sheet offering a $4 million pre-money valuation with $1 million invested, giving a $5 million post-money valuation. The investor owns 20%. If the term sheet also requires a new option pool equal to 10% of the post-money company to be created before the round, that 10% comes out of the founders' side. The founders end up with 70% instead of 80%, even though the headline valuation did not change. (All numbers are made up for illustration.)
Investor economics terms
These terms decide who gets paid what, and in what order, if the company is sold or wound up, and how investors are protected if future rounds happen at a lower price.
5. Liquidation preference
The right of investors to get their money back before common shareholders, such as founders and employees, when the company is sold or liquidated. It is expressed as a multiple. As a rule of thumb, 1x non-participating is common in early rounds, which means investors get back the amount they invested, or convert to common shares if that pays more.
6. Participation
Participating preferred shares get their liquidation preference back first and then also share in the remaining proceeds alongside common shareholders. Non-participating shares must choose one or the other. Participation can make a big difference to founders in a modest exit, so read this line carefully.
7. Broad-based weighted average anti-dilution
Anti-dilution protects investors if the company later raises money at a lower price per share (a down round). The broad-based weighted average method adjusts the investor's conversion price by a formula that considers how many new shares are issued and at what price. It is generally the more founder-friendly approach.
8. Full ratchet anti-dilution
A much stronger form of protection. If a later round is priced lower, the investor's conversion price drops all the way to the new, lower price, regardless of how small that new round is. It can heavily dilute founders, so it is worth discussing with your lawyer if you see it.
9. Pro rata rights
The right for an investor to buy enough shares in future rounds to keep their percentage ownership. It is common and often reasonable, but it can limit how much room you have for new investors later.
Control and governance terms
These terms decide who makes decisions, what needs investor approval and what happens to founder shares over time.
10. Board composition
Sets how many seats the board has and who fills them, for example founders, investors and independent members. The balance of the board affects who controls major decisions, so look closely at how it may change in future rounds.
11. Protective provisions
A list of actions the company cannot take without investor approval, such as issuing new shares, selling the company, changing investor rights or taking on significant debt. Some are standard; a very long list can slow down ordinary decisions.
12. Founder vesting
Founder shares earn out over time, so a founder who leaves early does not keep the full stake. Investors often ask for it even if founders already own their shares outright. As a rule of thumb, 4 years with a 1-year cliff is common.
4 years, 1-year cliff
A common founder vesting schedule in early-stage rounds. This is a rule of thumb, not a legal requirement, and terms vary by deal.
Rule of thumb13. Cliff
The period before any shares vest. With a 1-year cliff, nothing vests until the first anniversary, then a full year's worth vests at once, and the rest usually vests in regular installments after that. Check whether you get credit for time already worked on the company.
14. Drag-along
If a defined majority of shareholders agrees to sell the company, a drag-along clause requires the other shareholders to sell too, on the same terms. It prevents a small holder from blocking a sale. Check what majority triggers it and whether founders have a say.
15. Right of first refusal
If a shareholder, often a founder, wants to sell shares, the company or investors get the first chance to buy them on the same terms. It helps keep ownership within a known group.
16. Co-sale
Also called tag-along. If a founder sells shares to a third party, investors can join the sale and sell a proportionate share of their own stock on the same terms.
17. Information rights
The investor's right to receive regular financial statements and other updates, such as annual budgets. If you already send a good investor update, this is rarely a burden, but make sure the frequency and level of detail are realistic.
Deal mechanics terms
These terms govern the process between signing the term sheet and closing the round.
18. No-shop and exclusivity
A no-shop clause stops you from negotiating with other investors for a set period while the deal is completed. It is usually binding. Check the length carefully: a long exclusivity period can leave you stuck if the deal falls through.
19. Conditions
The things that must happen before the investment closes, such as satisfactory due diligence, final legal documents, board and shareholder approvals, and sometimes specific items like new employment agreements. Clear, limited conditions reduce the risk of delays.
20. Expiry
The date the offer in the term sheet lapses if you do not sign. It creates a timeline for your decision, so plan to have your lawyer review the document well before that date.
Common mistake
Focusing only on the valuation. A high headline number can come with a large option pool shuffle, participating preferred shares or full ratchet anti-dilution that cost founders more than a slightly lower valuation with cleaner terms. Read the whole page, not just the first line.
How to review a term sheet
Standard templates help a lot here. In the US, many term sheets are based on the NVCA model documents, and in the UK on the BVCA templates. When a term sheet follows a known template, it is easier for you and your lawyer to spot anything unusual.
- Read it end to end. Highlight every term you do not fully understand.
- Model the numbers. Update your cap table with the new round, the option pool and any convertibles to see the real fully diluted result.
- Mark binding clauses. Note which sections take effect on signing, such as confidentiality and no-shop.
- Compare with a standard template. List anything that differs from NVCA or BVCA style terms.
- Talk to your lawyer. Bring your list of questions and agree which points are worth negotiating.
- Respond before expiry. Keep the conversation professional and on schedule.
A term sheet review template
Use a simple table to keep notes as you read. The rows below are made-up examples.
| Term | What the term sheet says (example) | What it means for us | Question for our lawyer |
|---|---|---|---|
| Option pool | 10% post-money pool created before the round | Pool comes out of founder ownership | Can we size the pool to our actual hiring plan? |
| Liquidation preference | 1x non-participating | Investors get their money back or convert, not both | Is this in line with standard terms? |
| No-shop | Example: 60 days, binding | We cannot talk to other investors during this period | Can we shorten the period? |
Pro tip
Pick your battles. You do not need to negotiate every line. Focus on the few terms that most affect your ownership and control, and be gracious on the rest. Investors notice founders who negotiate thoughtfully.
Your term sheet checklist
- Read the full term sheet and highlight unfamiliar terms
- Check pre-money, post-money and option pool size together
- Confirm the liquidation preference multiple and whether it participates
- Identify the anti-dilution method
- Review board seats, protective provisions and founder vesting
- Note binding clauses, the no-shop period and the expiry date
- Model the round in your cap table
- Review everything with a startup lawyer before signing
Frequently asked questions
Is a term sheet legally binding?
Mostly not. The main commercial terms are usually non-binding, but some clauses, such as confidentiality and no-shop, typically are binding once signed. Your lawyer can confirm which parts apply to your document.
What is the difference between pre-money and post-money valuation?
Pre-money is the company's value before the new investment. Post-money is pre-money plus the new money invested. The investor's ownership is calculated from the post-money figure.
Which terms matter most for founders?
Valuation and the option pool shuffle, liquidation preference and participation, anti-dilution, board composition and founder vesting usually have the biggest effect on founder ownership and control.
Related reading
The bottom line
A term sheet is easier to read once you know the vocabulary. Valuation and option pool terms shape your ownership, economic terms decide who gets paid first, control terms shape how the company is run, and deal mechanics set the timeline to closing.
Use this glossary to prepare your questions, model the numbers in your cap table and compare the document with standard NVCA or BVCA terms. Then sit down with your lawyer, focus on what matters most and sign with confidence.
