How a VC term sheet works: what's binding, how valuation, option pools and liquidation preferences shape the economics, and which control terms matter.
Term sheets are where a VC's yes turns into something concrete. In this Scout Academy session, Suzie Melkonyan-Griffith, an investor on Flashpoint's Venture Growth team in New York, went through what a term sheet is, where it sits in the deal process, and which terms actually move the needle.
Here's the recap, written for founders, scouts and anyone who wants to read a term sheet without a lawyer next to them.
A term sheet is a short summary of the terms an investor wants to offer for a specific round. It usually comes right after the investment committee says yes, and before full due diligence.
When the investor leads the round, the term sheet matters even more. Other investors in the round usually come in on the same terms the lead sets.
Mostly no. Two clauses are typically binding: no-shop (exclusivity) and confidentiality. Everything else is a directional agreement on what the final deal will look like.
That doesn't make the rest meaningless. Once signed, it's the basis for negotiation. If an investor tries to change a term later, the founder can point back to the term sheet and push back.
In the US, most deals follow the NVCA (National Venture Capital Association) model documents, so nobody starts from scratch. The term sheet feeds into the full closing set:
Post-money is pre-money plus the new money. Put in $5M at a $50M post-money, and the pre-money was $45M.
Which number the term sheet fixes changes the outcome. If the pre-money is fixed and the round gets oversubscribed, the post-money goes up and each investor's percentage goes down. Fixing the post-money locks in the investor's ownership even if the round grows.
In practice the price per share is what everyone calculates from, because it already reflects any SAFEs and convertible notes converting in the round.
Investors want enough unallocated options (ESOP) to hire the team the plan needs. A 15% pool after a Series A is common, and founders usually want it too.
The catch: if the pool is created or topped up before the investment, the dilution falls on existing shareholders. In a simple example, founders holding 80% before a new 15% pool would drop to 65%, while the new investor's stake stays the same.
Preferred shareholders get paid before common shareholders when the company is sold or wound down. The standard is 1x non-participating: the investor takes the greater of its money back or its pro rata share as if it converted to common.
Example: an investor puts in $10M at a $40M post-money for 25%. At a $60M exit, 25% is $15M, so it converts. At a $30M exit, 25% is $7.5M, so it takes its $10M back instead. The break-even is the entry valuation.
Participating preferred lets the investor take its money back and then also share in what's left. Founders call it double dipping. It shows up mostly when a company is struggling to raise. Capped participation (for example at 2x or 3x total return) is the middle ground. Some deals also use a 1.5x preference for extra downside protection.
When new investors come in later, they either rank pari passu (side by side) with earlier preferred holders, or senior to them, meaning they get paid first.
Whatever you agree here sets a precedent. If a Series B investor demands seniority over the Series A, expect the Series C to ask the same. Term sheet negotiations are often really about what standard the company is setting for the next rounds.
Sometimes, but rarely in a way that matters at venture stage. Options include as-converted dividends, non-cumulative, and cumulative (for example 8% a year that accrues and gets added to the preference). Cumulative dividends are uncommon in growth-stage venture, and Flashpoint usually doesn't ask for them.
Most VCs hold a minority stake, so control comes from contract terms instead of share count.
Board seats: a typical Series A board has three or five seats, always an odd number to avoid ties. Often that's two founders plus an investor. A new lead usually wants a board seat, or at least an observer seat, and quarterly board meetings are where hiring, firing and strategy get decided.
Protective provisions: vetoes over specific actions like issuing new stock, expanding the option pool, paying dividends or selling the company. Investors sometimes negotiate a veto on an early sale below a set return multiple, because they invested for a bigger outcome. In practice vetoes are rarely used. A healthy board makes decisions without anyone reaching for them.
If the board and the required investors approve a sale, drag-along forces the other significant holders to vote for it and sell too. That stops a small holder from blocking a deal.
Standard protections for the people being dragged: each holder is only liable for its own shares, liability is capped at its share of proceeds, and proceeds follow the charter's liquidation preference waterfall.
Preferred shares convert to common, usually one to one, and convert automatically on a qualified IPO or an approved sale. Anti-dilution adjusts that conversion price if a later round is priced lower (a down round).
Broad-based weighted average is the NVCA default. It moves the conversion price part of the way toward the new, lower price, weighted by how many new shares are issued relative to the whole company.
Full ratchet resets the conversion price all the way down to the new price, however small the new round. It's aggressive and outside the standard template.
Looking at the NVCA template, the front page covers the target closing date, conditions to closing (usually satisfactory financial and legal diligence), the investors, the amount raised and the valuation.
Two practical additions came up. First, a lead can require a minimum amount from other investors, so the round doesn't end up as the lead's money alone. Second, some term sheets include a milestone-based option: if the company hits a set target by a set date, the investor can put in more money at a pre-agreed, higher valuation. Sometimes it works both ways and the company can call the capital. Either way, it saves everyone a new fundraise and a new valuation fight.
You don't need to draft a term sheet to be a good scout. Knowing what's standard (1x non-participating, broad-based weighted average, a sensible option pool) helps you spot when a company's past rounds came with unusual terms, and that tells you a lot about how hard the raise was.
Usually only no-shop (exclusivity) and confidentiality. The rest is non-binding, but it becomes the basis for the closing documents and for any later negotiation.
At an exit, the investor takes the greater of its original investment or its pro rata share as if it converted to common. It's the most common preference in venture rounds.
Non-participating investors choose between their money back and converting. Participating investors get their money back and then also share in the remaining proceeds, which can leave founders with much less.
A binding exclusivity period, often 30 to 60 days, during which the company can't seek competing term sheets. After it expires, the company is free to talk to other investors.
Usually the company, up to a capped amount set in the term sheet, and only if the deal closes.
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