Basic, lesson 1 of 3
Reading a term sheet
A term sheet is a few pages that set the price and the rules. Economic terms decide who gets the money; control terms decide who gets to decide.
9 min, 3 checks
1Economic terms
A term sheet is a short, mostly non binding summary of a financing. The lawyers turn it into long documents later, but the deal is set here. Read it in two passes: the money, then the control.
| Term | What it sets | Market default for a US Series A |
|---|---|---|
| Amount and pre money | How much is raised and at what valuation | Varies with the market |
| Option pool | Shares reserved for hires, usually counted in the pre money | 10 to 15 percent post money |
| Liquidation preference | What preferred gets back before common in a sale | 1x non participating |
| Anti dilution | Price protection if a later round is cheaper | Broad based weighted average |
| Dividends | A return on the preferred | Non cumulative, only if declared |
| Pro rata | Right to buy into future rounds | For major investors |
Worked example
An 8 million dollar Series A at a 32 million pre money
- 1Post money: 32 + 8 = 40 million. The investor owns 8 / 40 = 20 percent.
- 2There are 16 million fully diluted shares before the round, so the price is 32,000,000 / 16,000,000 = 2.00 dollars a share.
- 3New shares: 8,000,000 / 2.00 = 4 million. Post money shares: 20 million, and 4 / 20 = 20 percent.
The ownership from the dollar math and from the share math match. If they do not, something is hiding in the pre money, usually a pool.
Check 1
A company with 12 million fully diluted shares raises 6 million dollars at an 18 million pre money. What is the price per share, in dollars?
2Control terms
| Term | What it does |
|---|---|
| Board composition | Who sits on the board, often two founders, one investor, and later one independent |
| Protective provisions | Actions that need preferred holders' consent: new senior shares, a sale, changing the charter |
| Drag along | If the board and a majority approve a sale, everyone must sell on the same terms |
| Right of first refusal and co-sale | Company or investors can buy a founder's shares first, or sell alongside |
| Information rights | Regular financial statements and a budget |
| Founder vesting | Founder shares earn out over time, often four years with a one year cliff |
Control terms matter most when things go badly. A founder who wins on valuation but gives up a board majority and broad vetoes can lose control of a sale or of their own job.
Check 2
Which of these is a control term?
Check 3
A board has two founders, two investors, and one independent. Who decides a close vote on replacing the CEO?
Terms in this lesson: Term sheet, Series A, Option pool, Liquidation preference, Dilution, Pro rata rights, Vesting.
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