What A Term Sheet Really Decides
Valuation is the term founders negotiate and the one that matters least in a bad outcome.
A term sheet sets out the principal terms of a venture investment. Founders concentrate on the valuation because it is the number that describes their success. The terms that determine what happens if things go less well sit further down the page and are negotiated far less.
Liquidation preference
The preference determines who is paid first on a sale and how much. A standard non-participating preference gives the investor the greater of their money back or their converted share of the proceeds.
A participating preference gives them their money back and their share of what remains. In a modest exit the difference between these two structures can be most of what the founders receive. A higher valuation with a participating preference is frequently worse than a lower one without.
Board composition
Who sits on the board determines who can replace management. Founder seats, investor seats and independent seats, and how the independent is chosen, decide control more directly than share percentages do.
It is possible to hold a majority of the shares and not control the company. Read the board and the protective provisions together.
Protective provisions
These list decisions requiring investor consent — new financing, a sale, changes to the share structure, sometimes budgets above a threshold. Individually reasonable, collectively they define how much freedom management has.
Look at the thresholds. A consent right over spending above a low limit is an operational veto, not a governance protection.
Anti-dilution
If a later round prices below this one, anti-dilution provisions adjust the earlier investor's conversion price. Broad-based weighted average is the common and reasonable form. Full ratchet is aggressive and shifts nearly all the pain of a down round onto founders and employees.
The practical advice
Model a mediocre exit, not a good one. At two times the money raised, work out what each party receives under the proposed terms. Founders who do this arrive at different priorities than founders who negotiate only the headline valuation.