The term sheet is where the deal is made
A term sheet is non-binding on most points, but once signed, it sets the parameters for the definitive agreements that follow. Renegotiating after a term sheet is signed is expensive and damages trust. The time to understand — and push back on — terms that do not work for you is before you sign.
Red Flag 1: Participating preferred (double-dipping)
This is the clause founders most frequently underestimate. Non-participating preferred means investors receive either their liquidation preference OR their pro-rata share of proceeds as if converted to common — whichever is higher. This is the founder-friendly version.
Participating preferred means investors receive their liquidation preference AND THEN participate in remaining proceeds alongside common shareholders. At a $50M acquisition with $10M invested at 1x liquidation preference, participating preferred investors receive $10M first, then share in the remaining $40M pro-rata. Non-participating investors receive either $10M or their pro-rata share — not both.
At modest exits (2–3x the invested amount), participating preferred can take the majority of proceeds away from founders and employees with common shares. Always push for non-participating preferred, or if participation is unavoidable, negotiate a cap (e.g., 3x).
Red Flag 2: Full ratchet anti-dilution
Anti-dilution provisions protect investors if the company raises a future round at a lower valuation (a down round). Broad-based weighted-average anti-dilution is the market standard and moderately adjusts the investor's conversion price. Full ratchet anti-dilution resets the conversion price to the new lower price — effectively giving the investor as many shares as if they had invested at the lower valuation. This can massively dilute founders in a down round and is considered aggressive.
Red Flag 3: Broad protective provisions
Protective provisions are actions the company cannot take without investor approval. A reasonable list covers: issuing shares senior to the investor's class; amending the company's articles in a way that adversely affects investor rights; selling the company; incurring debt above a threshold. Broad protective provisions that cover routine operational decisions — new hires above a salary threshold, any new contracts above a dollar amount, any IP licensing — give investors effective veto over operations and create friction every time the company needs to move quickly.
Red Flag 4: Vague information rights
Term sheets often include information rights provisions that sound reasonable but are loosely drafted. Investors may interpret broad information rights as entitlement to real-time access to financial systems, customer data, or employee information. Define information rights specifically: what is provided, in what format, and on what schedule.
Red Flag 5: Overly broad drag-along
Drag-along allows a majority of shareholders to force all shareholders to approve and participate in a sale. A well-drafted drag-along specifies: what threshold triggers the right (typically majority of common plus majority of preferred, voting separately), and what protections apply to minority shareholders (same price and terms, no representations beyond ownership). A drag-along triggered by preferred shareholders alone, without common shareholder participation in the threshold, can allow investors to force a sale over founder objection.
What to do
Hire legal counsel to review the term sheet before signing, not after. An experienced startup lawyer will spot these provisions immediately. The cost of a term sheet review is a small fraction of the value at stake.