moonklabs Term Sheet Knowledge
⚠️ Disclaimer: This skill explains term sheet terminology for educational purposes. It does not provide legal advice. All investment agreements must be reviewed by a startup-focused lawyer.
Term sheet key conditions, SAFE/convertible note structures, cap table dilution calculations, negotiation strategy, and red flags.
How It Works
┌─────────────────────────────────────────────────────────────────┐
│ TERM SHEET KNOWLEDGE │
├─────────────────────────────────────────────────────────────────┤
│ Information Provided │
│ ✓ Term sheet key terms explained (15 critical items) │
│ ✓ SAFE vs convertible note vs Equity comparison │
│ ✓ Cap table dilution calculations (round-by-round simulation) │
│ ✓ Negotiation points & priorities │
│ ✓ Red Flags (conditions to avoid) │
└─────────────────────────────────────────────────────────────────┘
Term Sheet Key Terms
1. Valuation
Pre-money vs Post-money
Pre-money: Company value before investment
Post-money: Company value after investment
Post-money = Pre-money + Investment amount
Example:
- Pre-money: $8M
- Investment: $2M
- Post-money: $10M
- Investor stake: $2M / $10M = 20%
Negotiation Points:
- Higher pre-money → Lower dilution
- But risks "down round" in next round
- Fair valuation > Inflated valuation
2. Investment Amount & Dilution
Investor stake (%) = Investment amount / Post-money valuation
Example:
- Pre-money: $8M
- Investment: $2M
- Post-money: $10M
- Dilution: 20%
Founder's existing stake 80% → After investment 64% (80% × 80%)
Dilution Benchmarks:
- Pre-seed: 10-20%
- Seed: 15-25%
- Series A: 20-30%
- Series B: 15-25%
Red Flag:
- Single round dilution > 30%
- Cumulative dilution leaves founder < 50% stake (pre-Series A)
3. Liquidation Preference
Definition: Amount investor recovers first at exit
Types:
1x Non-Participating
Exit $20M, Investment $2M (20% stake):
- Investor chooses:
Option A: $2M (1x preference)
Option B: $4M (20% stake)
→ Investor: chooses $4M
→ Founders: $16M
1x Participating
Exit $20M, Investment $2M (20% stake):
- Investor:
Step 1: $2M (1x preference)
Step 2: ($20M - $2M) × 20% = $3.6M
→ Investor: $5.6M
→ Founders: $14.4M
2x Non-Participating
Exit $20M, Investment $2M (20% stake):
- Investor chooses:
Option A: $4M (2x preference)
Option B: $4M (20% stake)
→ Investor: $4M
→ Founders: $16M
Red Flag:
- Participating (double-dipping)
- 2x or higher multiple
- Participating in Seed/Series A is abnormal
Negotiation:
- 1x non-participating is standard
- Strongly oppose if participating
- Set cap (e.g., 1x participating with 2x cap)
4. Anti-Dilution Protection
Definition: Protects investor in down rounds
Types:
Full Ratchet (Most Harmful)
Original: $10M valuation, $1/share, 1M shares
Down round: $5M valuation, $0.50/share
Full Ratchet → Investor shares adjusted to $0.50
→ Investor shares double, founders heavily diluted
Weighted Average (Standard)
Broad-based: Based on all issued shares (founder-friendly)
Narrow-based: Based on preferred shares only (investor-friendly)
Broad-based is industry standard
Red Flag:
- Full Ratchet (must avoid)
- Narrow-based (try to avoid)
Negotiation:
- Demand broad-based weighted average
- Pre-seed/Seed can sometimes avoid entirely
5. Board Composition
Typical Structure:
Seed:
Total: 3 seats
- Founders: 2 seats
- Investor: 1 seat
Series A:
Total: 5 seats
- Founders: 2 seats
- Investors: 2 seats (Seed 1 + Series A 1)
- Independent: 1 seat (mutual agreement)
Series B:
Total: 7 seats
- Founders: 2 seats
- Investors: 3 seats
- Independent: 2 seats
Red Flag:
- Investor majority (founders lose control)
- Independent director selection power only with investor
Negotiation:
- Founders + Independent ≥ Investors
- Independent director selection by mutual consent
6. Protective Provisions
Definition: Requires investor consent for certain actions
Standard Items:
- New fundraising
- M&A, liquidation
- Charter amendments
- Adding board members
- Changing preferred stock terms
Red Flag:
- Excessive items (e.g., executive hiring, budget approval)
- Single investor veto power
Negotiation:
- Define "Major Investor" threshold (e.g., 10%+ stake)
- Require majority preferred shareholder consent (not single investor)
7. Conversion Rights
Definition: Preferred to common stock conversion
Automatic Conversion:
Converts automatically at IPO
Conditions:
- IPO price > $X (e.g., $50M valuation)
- Raise > $Y (e.g., $10M)
Optional Conversion: Investor can choose to convert anytime
Red Flag:
- Automatic conversion conditions too high
- Only investor can optionally convert (not founders)
8. Redemption Rights
Definition: Investor can force company to buy back shares
Red Flag:
- Redemption rights in Seed/Series A (abnormal)
- Redemption timing too soon (e.g., 3 years)
Negotiation:
- Demand redemption rights removal
- Minimum 5+ year period if required
9. Dividends
Types:
Cumulative:
X% accrues annually, paid at exit
→ Effective interest (investor-favorable)
Non-Cumulative:
Paid only if board decides
→ Rarely paid in startups
Red Flag:
- Cumulative dividends (must avoid)
- Dividend rate > 8%
Negotiation:
- Remove dividends or non-cumulative only
10. Founder Vesting
Standard Structure:
4-year vesting, 1-year cliff
Example:
- Year 0: 0%
- Year 1 (Cliff): 25%
- Year 2: 50%
- Year 3: 75%
- Year 4: 100%
Monthly vesting (after Year 1): 1/48 each month
Single Trigger vs Double Trigger:
Single Trigger:
M&A triggers immediate 100% vesting
→ Founder-friendly
Double Trigger:
M&A + Termination → 100% vesting
→ Acquirer-friendly (can retain founder)
Negotiation:
- Demand single trigger (early rounds)
- Accept double trigger (later rounds)
- Acceleration amount (50% vs 100%)
11. Right of First Refusal & Co-Sale
Right of First Refusal (ROFR):
Investor gets first chance when founder wants to sell shares
→ Standard provision, acceptable
Co-Sale / Tag-Along:
When founder sells shares, investor can sell under same terms
→ Standard provision
Drag-Along:
If investor majority approves, all shareholders forced to sell
→ Facilitates M&A
→ Standard provision, acceptable
12. Pro-Rata Rights
Definition: Right to participate in next round to maintain stake
Negotiation:
- Grant only to Major Investors
- Limit over-allotment
13. Information Rights
Standard:
- Monthly financial statements
- Annual audited financials
- Annual budget
- Board materials (observer rights)
Red Flag:
- Excessive reporting (e.g., weekly reports)
- Sensitive information to potential competitors
14. Expense Reimbursement (No-Shop & Expenses)
No-Shop:
30-60 days after term sheet, cannot negotiate with other investors
→ Standard provision, acceptable
Expenses:
Company pays investor's legal fees
→ Set cap ($10K-$25K)
15. Employee Option Pool
Pre-money vs Post-money:
Pre-money Pool (Investor-favorable):
Pre-money: $8M
Option pool: 15% (pre-money basis)
→ Option pool dilutes only founders
Actual calculation:
- Founders: 80% × (1 - 15%) = 68%
- Option pool: 15%
- Investor: 20% (post-money basis)
→ Only founders diluted
Post-money Pool (Founder-favorable):
Post-money: $10M
Option pool: 15% (post-money basis)
→ Founders and investors both diluted
Negotiation:
- Demand post-money option pool
- Keep to what's needed (avoid excessive pool)
SAFE (Simple Agreement for Future Equity)
SAFE Structure
Basic Principle:
Current investment → Converts to equity in next equity round
No valuation now (avoids current negotiation)
4 Types:
1. Valuation Cap (Most Common)
Cap: $5M
Next round: $10M pre-money
→ SAFE investor converts at $5M basis (2x favorable)
2. Discount (Standalone or Cap + Discount)
Discount: 20%
Next round: $1/share
→ SAFE investor converts at $0.80/share
3. Valuation Cap + Discount
Choose whichever is more favorable
4. MFN (Most Favored Nation)
Not worse than next SAFE
→ Protects early investor
SAFE Dilution Calculation
Example:
- SAFE investment: $500K, Cap $5M
- Series A: $2M at $10M pre-money
SAFE conversion:
- SAFE Cap $5M basis → 10% stake ($500K / $5M)
- Series A $10M pre-money basis → 20% ($2M / $10M)
Post-money:
- $10M + $2M + SAFE dilution adjustment = $12M+
- Founders: ~66%
- SAFE: ~10%
- Series A: ~20%
- Option pool: ~4%
SAFE vs Equity
| Item | SAFE | Equity |
|---|---|---|
| Valuation | Pending (cap only) | Confirmed |
| Negotiation | Simple (2 weeks) | Complex (2 months) |
| Cost | Low ($2K) | High ($20K+) |
| Investor Rights | None | Board, protective provisions |
| Conversion | Next round | Immediate |
| Best Stage | Pre-seed | Seed+ |
SAFE Advantages:
- Fast, inexpensive
- Defers valuation negotiation
- Standard document (YC SAFE)
SAFE Disadvantages:
- Complex cap table (multiple SAFEs overlap)
- Dilution uncertain until next round
- No investor rights (board, information)
Convertible Note
Structure
Debt → Converts to equity in next round
Key terms:
- Principal
- Interest Rate: 5-8%
- Maturity: 18-24 months
- Conversion Discount: 15-25%
- Valuation Cap: Optional
SAFE vs Convertible Note
| Item | SAFE | Convertible Note |
|---|---|---|
| Legal Form | Contract | Debt/Bond |
| Interest | None | 5-8% |
| Maturity | None | 18-24 months |
| Repayment Obligation | None | Must repay or convert at maturity |
| Complexity | Low | Medium |
Regional Preference:
- USA: Prefers SAFE (simpler)
- Korea/Asia: Prefers convertible notes (legally established)
Cap Table & Dilution Calculations
Initial Cap Table
Founding:
- Founder A: 60% (6M shares)
- Founder B: 40% (4M shares)
Total: 10M shares (Fully Diluted)
Pre-seed (SAFE)
SAFE investment: $500K at $5M Cap
Assumption: Converts at Series A
Cap table unchanged for now
Seed Round
Investment: $2M at $8M pre-money
Option pool: 10% (pre-money)
Post-money: $10M
Dilution calculation:
1. Create option pool (pre-money)
- Existing: 10M shares
- Options: 1.11M shares (10% / 90%)
- Total: 11.11M shares
2. Investor shares
- Investor stake: 20% (post-money)
- Investor shares: 2.78M shares (20% / 80%)
- Total: 13.89M shares
Cap table (after Seed):
- Founder A: 54% (6M / 11.11M × 80%)
- Founder B: 36% (4M / 11.11M × 80%)
- Option pool: 8% (1.11M / 13.89M)
- Seed investor: 20% (2.78M / 13.89M)
- SAFE: Not yet converted
Series A
Investment: $5M at $20M pre-money
Option pool: 15% (post-money)
SAFE conversion:
- SAFE $500K at $5M Cap
- $500K / $5M = 10% (based on cap)
- But pre-money $20M → requires adjustment
- SAFE shares ≈ 2.5% (post-money)
Series A shares:
- Investment: $5M
- Post-money: $25M (pre $20M + $5M)
- Stake: 20%
Cap table (after Series A):
- Founder A: 37.8%
- Founder B: 25.2%
- Option pool: 15%
- SAFE: 2.5%
- Seed: 14%
- Series A: 20%
Dilution Simulator
Spreadsheet templates:
https://captable.io
https://carta.com
Key variables:
- Investment amount
- Pre-money valuation
- Option pool size
- SAFE Cap & Discount
Negotiation Strategy
Priorities
Must-Have (Non-Negotiable):
- 1x non-participating liquidation preference
- Broad-based weighted average anti-dilution
- Founder board control or parity
- Post-money option pool
Important: 5. Single Trigger Acceleration 6. Limit investor rights scope 7. Minimize No-Shop period 8. Cap on expenses
Nice-to-Have: 9. Remove dividends 10. Remove redemption rights
Negotiation Tips
1. Hire a Lawyer
Retain startup-focused lawyer
Cost: $10K-$25K (worth it)
2. Use Standard Documents
NVCA standard documents
YC SAFE
→ Be suspicious of non-standard clauses
3. Compare Multiple Term Sheets
Get 2-3 term sheets minimum
Create comparison table
Don't just look at valuation—examine full terms
4. Reference Checks
Ask investor's portfolio CEOs:
- How active on board?
- Support during difficult times?
- Follow-on investment?
Red Flags (Conditions to Avoid)
🚩 Participating Liquidation Preference
Double-dipping (preference + equity stake)
→ Unfavorable to founders at exit
→ Absolutely not acceptable in Seed/Series A
🚩 Full Ratchet Anti-Dilution
Massive founder dilution in down round
→ "Death spiral"
→ Must never accept
🚩 Investor Board Majority
Founders lose control
→ Risk of being fired
→ No strategic decision power
🚩 Excessive Protective Provisions
Investor consent needed for daily operations
→ Decision-making paralysis
→ Must limit scope
🚩 Personal Guarantee
Founders' personal assets as collateral
→ Abnormal in startups
→ Refuse
Korea-Specific: Convertible Notes & Stock Purchase Agreement
Korean Convertible Note Structure
Typical terms:
- Conversion price: Discount vs issue price (20-30%)
- Conversion request period: 1 year after ~ before maturity
- Maturity: 3 years
- Interest rate: 0-3%
- Early redemption: Partially allowed
Stock Purchase Agreement (SPA)
More common in Korea (similar to US Stock Purchase Agreement)
Key provisions:
- Stock issue price
- Representations & Warranties
- Conditions Precedent
- Liability for damages
Related Skills and Commands
- financial-modeling — Dilution simulations, cap table modeling
- fundraising-process — Term sheet received at Week 7
/fundraise-pipeline— Compare multiple term sheets/dd-prep— Prepare for term sheet negotiation during DD stage