# Term Sheet Knowledge

> Explains term sheet key terms, SAFE/convertible note structures, cap table dilution calculations, and negotiation red flags for startup fundraising.

- Skill: `moonklabs/term-sheet-knowledge` (Agent Skill)
- Install (CLI): `npx skillmds@latest add moonklabs/term-sheet-knowledge`
- Raw SKILL.md: https://api.skillmd.com/api/skills/moonklabs/term-sheet-knowledge/raw
- Safety review: PASS (external: skill-scanner PASS, skillspector PASS)
- Works with: Claude Code, Claude.ai, OpenAI Codex
- Category: Finance & Business, Coding & Dev Tools, Trading & Investing
- Tags: Cap Table, Convertible Note, Dilution, Fundraising, Safe, Startup, Term Sheet, Valuation
- Author: moonklabs (https://skillmd.com/u/moonklabs)
- Updated: 2026-08-22
- Page: https://skillmd.com/skills/moonklabs/term-sheet-knowledge

---


# 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):**
1. 1x non-participating liquidation preference
2. Broad-based weighted average anti-dilution
3. Founder board control or parity
4. 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