Startup Term Sheet Explained — Every Clause a Founder Signs Before the Money Arrives: Valuation and Investment Amount, Instrument (CCPS/CCD/Equity), Liquidation Preference (1× Non-Participating vs Participating, the Worked Example Where 80% Ownership Returns Zero), Anti-Dilution (Full Ratchet vs Broad-Based Weighted Average), Board Seats, Pro-Rata, Drag and Tag, Vesting, Exclusivity and Binding Clauses, and How the Term Sheet Becomes the SHA/SSA
Video Explanation & Insights
Startup term sheet explained in 60 seconds — Day 9 of the 21-day startup series
4 videos on this topic
What a term sheet is — and which parts bind
The investor has said yes, the money has not arrived, and a document sits between the two: the term sheet. It is the summary of the commercial terms — valuation, amount, instrument, rights — on which the lawyers then draft the share-subscription agreement (SSA, the sale of new shares to the investor) and the shareholders' agreement (SHA, the rules between shareholders). Most of its clauses are expressly non-binding; a few bind from the day it is signed: exclusivity or 'no-shop' (the founder cannot negotiate with other investors for 30–60 days), confidentiality, governing law, and often the allocation of due-diligence and legal costs. A term sheet is an offer — everything in it is negotiable before signature and very little after, because the SHA is drafted 'in accordance with the term sheet'. Get it reviewed by a chartered accountant (for the cap table, waterfall and tax) and a lawyer (for the rights) before signing.
The clauses, one by one
| Clause | What it means | Founder position |
|---|---|---|
| Valuation and amount | Pre-money valuation + investment = post-money; the investor's percentage = investment ÷ post-money. Check whether the ESOP pool is created pre-money (dilutes founders only) or post-money | Negotiate the pool size and timing, not just the headline; ask for a fully diluted cap table |
| Instrument | CCPS (compulsorily convertible preference shares — the Indian standard, carrying the preference rights), CCDs, or plain equity; conversion ratio and triggers | CCPS at a 1:1 conversion with rights limited to those in the SHA; avoid open-ended conversion adjustments |
| Liquidation preference | On a sale, merger or winding up, who is paid first and how much (see the worked example below) | 1× non-participating; no multiples; preference falls away on conversion |
| Anti-dilution | If a later round is priced lower (down round), the investor's conversion price is adjusted to protect them | Broad-based weighted average; never full ratchet; carve-outs for ESOPs and small rounds |
| Board and reserved matters | Investor director/observer seats; a list of decisions needing investor consent (budgets, debt, new shares, senior hires, exits) | Keep the list short and threshold-based; founders retain a board majority at seed/Series A |
| Pro-rata / pre-emptive rights | Right to invest in future rounds to maintain percentage | Standard; limit to major investors |
| Drag-along and tag-along | Drag: majority can force all to sell in an exit; tag: minority can join a sale on the same terms | Drag only above a minimum price/valuation and after a period; tag for founders too |
| Founder vesting / reverse vesting | Founders' shares vest over 3–4 years with a cliff; unvested shares are bought back cheaply if a founder leaves | Credit for time already served; acceleration on an exit; 'good leaver' protection |
| Information rights and audit | Monthly MIS, audited accounts, budgets | Reasonable cadence; align with statutory audit |
| ROFR / ROFO and lock-in | Investor's first right to buy founder shares; founders cannot sell for a period | Founder secondary carve-out for small amounts |
| Exit rights | IPO/strategic sale timelines; buy-back or put option if no exit by year 5–7 (limited under Indian law) | Avoid guaranteed-return put options — they are not enforceable as equity and create tax/FEMA issues |
| Conditions precedent | DPIIT recognition, clean cap table, key agreements, ESOP scheme, IP assignment | Close them before signing so the money is not delayed |
| Exclusivity, confidentiality, costs | Binding: no-shop period, NDA, who pays the lawyers | 30–45 days exclusivity; costs capped |
Liquidation preference — the line below the valuation
From Day 10 of the series: an investor puts ₹10 crore for 20% with a 1× preference. Two years later the company sells for ₹10 crore. Non-participating: the investor chooses the better of the ₹10 crore preference or 20% of ₹10 crore (₹2 crore) — takes ₹10 crore; the founder, holding 80%, receives zero. Participating: the investor first takes ₹10 crore and then 20% of whatever remains — in a ₹30 crore exit, ₹10 crore + 20% of ₹20 crore = ₹14 crore, versus ₹10 crore or ₹6 crore under non-participating. A 2× or 3× preference multiplies the first take. The preference matters most in small and medium exits, which is where most Indian exits land.
| Exit value | 1× non-participating: investor / founders | 1× participating: investor / founders | 2× participating: investor / founders |
|---|---|---|---|
| ₹10 crore | ₹10 Cr / ₹0 | ₹10 Cr / ₹0 | ₹10 Cr / ₹0 |
| ₹30 crore | ₹10 Cr / ₹20 Cr (investor takes preference, 20% would be ₹6 Cr) | ₹14 Cr / ₹16 Cr | ₹22 Cr / ₹8 Cr |
| ₹100 crore | ₹20 Cr / ₹80 Cr (investor converts — 20% beats ₹10 Cr) | ₹28 Cr / ₹72 Cr | ₹36 Cr / ₹64 Cr |
Anti-dilution — full ratchet vs weighted average
- •Trigger: a later round at a lower price per share than the investor paid (a down round). The investor's CCPS conversion price is reduced so they receive more equity shares on conversion — founders and ESOP holders absorb the dilution.
- •Full ratchet: the conversion price resets to the new round's price regardless of how few shares were issued — a ₹1 crore top-up at half price can double an early investor's stake. Day 11's warning: it can hand the investor the company.
- •Broad-based weighted average: the conversion price is adjusted in proportion to the size of the down round relative to the fully diluted capital — the market norm and what to accept.
- •Carve-outs: ESOP issuances, conversions, shares issued for acquisitions and small bridge rounds should not trigger anti-dilution; the investor's own participation in the down round ('pay-to-play') can waive it.
- •Indian mechanics: adjustments are effected through the CCPS conversion ratio (the Companies Act does not allow issuing shares below par or without consideration), and the FEMA pricing rules apply to foreign investors — the SHA must be drafted so the adjustment is legally executable.
Term sheets: questions we are asked
The commercial terms are not; exclusivity, confidentiality, costs and governing law usually are — and the SHA will follow the term sheet, so treat every clause as if it binds.
Model the waterfall — in most realistic exits the founder does better with a lower valuation and 1× non-participating.
A pool created after the round so the investor shares the dilution; investors usually ask for the pool pre-money, which dilutes founders alone — negotiate the size and timing.
Assured-return put options on equity are restricted for foreign investors under FEMA and are generally treated as debt-like; avoid them.
30–45 days is typical for a seed/Series A; longer periods leave you without alternatives if the investor delays.
Yes — cap-table and waterfall modelling, clause-by-clause negotiation support, coordination with counsel on the SHA/SSA, CCPS structuring, valuation reports and the tax/FEMA side of the round.