Term Sheet Traps That Could Cost You Your Company
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The Term Sheet Trap: What Every Founder Needs to Know
The moment that changed everything wasn't in a boardroom.
It was October 2019, and Adam Neumann, the founder of WeWork, was staring at what's called a "term sheet" - essentially a blueprint for how investors put money into your company. Think of it like buying a house: the price gets the headlines, but the real story lives in the fine print.
SoftBank was offering WeWork $9.5 billion to keep the company alive. But buried in those pages was something that would change everything: carefully worded provisions about who could make what decisions. These provisions would later spark an epic legal battle over who actually controlled the company.
The company's value dropped from $47 billion to $8 billion overnight. But that wasn't the real story.
You see, when investors want to put money into your company, they send over what looks like a simple document - usually 5-10 pages outlining the deal. Most founders immediately flip to one number: the valuation (how much their company is worth). But just like that fine print when you buy a house, the real story is in the details.
Let me show you how this keeps happening:
In 1985, Steve Jobs lost control of Apple. Not because someone outmaneuvered him in a boardroom, but because of specific rules about decision-making he had agreed to in earlier investment documents - rules that seemed harmless at the time.
In 2009, Mark Zuckerberg nearly lost control of Facebook's future to Microsoft. Not because Microsoft offered the most money, but because of one critical clause about who could make what decisions.
In 2017, Travis Kalanick found himself pushed out of Uber - the company he founded. Why? Because of voting rights he had agreed to years earlier when he was desperate for investment.
Different decades. Different companies. Same trap.
Here's what fascinates me: Even today, most founders make the same mistake. They focus on how much money they're getting, when they should be focusing on what they might be giving up.
Look at Snap's 2017 public offering. Everyone celebrated that the company was worth $24 billion. What nobody talked about? Regular shareholders would get zero voting rights - meaning they had no say in company decisions. All because of agreements made years earlier that seemed "standard" at the time.
In the next few minutes, I'm going to show you:
Why even experienced founders miss the crucial parts of these documents
Where the real power in these agreements actually lives
How to understand what you're really being asked to sign
A practical system for protecting your company's future
How to Actually Read a Term Sheet
When Discord walked away from Microsoft's $10 billion acquisition offer in 2021, most people thought they were crazy to turn down that much money. But Discord's team understood something crucial: A term sheet isn't just about the money - it's about who controls your company's future.
Let's break down what's really happening in these documents.
Think of a term sheet like a house deed that not only says who owns the house, but also who can decide what color to paint it, when to renovate it, and whether you can ever sell it. The money is just the beginning of the story.
The Three Parts That Actually Matter
Who Makes the Big Decisions When Pinterest was negotiating with PayPal in 2021, they found something interesting buried in the standard-looking language. PayPal would get to approve any changes to Pinterest's payment systems. That might sound reasonable - until you realize payments are the heart of Pinterest's business model.
What Happens When Things Go Wrong Uber's 2017 term sheet with SoftBank seemed straightforward. But when the company hit trouble, those same "standard" terms gave investors the power to force a change in leadership. That's how Travis Kalanick lost control of his own company.
What You Can Do in the Future Square's early investment agreements included what seemed like normal protection for investors. But these same terms later limited Jack Dorsey's ability to raise emergency money when the company needed it most. The power to act quickly in a crisis is often worth more than any amount of money.
Understanding Term Sheets: What's Really At Stake
When investors hand you a term sheet, they're not just offering money. They're proposing a complicated set of rules that will govern your company's future. While the money might help you grow, the terms attached to it might limit your ability to make crucial decisions independently.
Think about it this way: Every term in that document answers a fundamental question about control. Not just who owns what, but who gets to decide what happens next.
Before you dive into the legal language, ask yourself these three essential questions:
"If everything goes wrong, who has the power to decide what happens next?"
"If we need emergency money, can we raise it without permission?"
"If we get a great offer to sell the company, who gets to make that call?"
These aren't just legal questions - they're about who actually controls your company's destiny. Understanding these terms isn't about being paranoid; it's about knowing exactly what you're agreeing to before you sign.
Here's what each of these key terms really means...
Important: This is a plain-English guide to help you understand term sheet language. It's not legal advice. Always work with an experienced startup lawyer to review and negotiate your actual term sheet. Terms can interact in complex ways, and their implications vary based on your specific situation.
Core Terms You'll See
"Protective Provisions"
What it sounds like: Reasonable safeguards for investors
What it often means: Investors must approve major decisions like selling the company, creating new share classes, or changing the board size
"Liquidation Preference"
What it sounds like: Who gets paid first if the company is sold
What it often means: Investors get their original investment back before anyone else gets paid, sometimes with additional rights to share in remaining proceeds
"Anti-dilution Protection"
What it sounds like: Keeping ownership percentages fair
What it often means: If you raise at a lower price, investors get additional shares based on a formula - the most common being "broad-based weighted average"
"Pro-rata Rights"
What it sounds like: Investors can keep their percentage ownership
What it often means: Investors have the right (but not obligation) to invest in future rounds to maintain their ownership percentage
"Vesting Schedule"
What it sounds like: How long it takes to earn your shares
What it often means: You earn ownership over time (usually 4 years, with 1-year cliff). Leave early, and you lose unvested shares
"Board Structure"
What it sounds like: A simple outline of who sits on your board
What it often means: Defines who picks board members and what decisions need board approval versus just management
"Participating Preferred Stock"
What it sounds like: A type of investment share
What it often means: After getting their money back first, investors also get to share in the remaining proceeds like common stock holders
"Information Rights"
What it sounds like: Keeping investors updated
What it often means: Regular delivery of financial statements, budgets, and business updates, with specific requirements about what and when
"Drag-Along Rights"
What it sounds like: Everyone agrees together on a sale
What it often means: If a specified group (usually board + majority of preferred) approves a sale, other shareholders must vote for it too
Additional Terms to Watch For
"Full-Ratchet Anti-dilution"
What it sounds like: Another way to adjust share prices
What it often means: If you raise money at a lower price, early investors' shares get repriced to the lowest price ever paid
"No-Shop Clause"
What it sounds like: Don't look for other investors during negotiations
What it often means: You can't create competition for better terms, often for 30-60 days
"Redemption Rights"
What it sounds like: Investors can get their money back
What it often means: After a certain date, investors can force you to buy back their shares - even if it would bankrupt the company
"Option Pool"
What it sounds like: Shares reserved for future employees
What it often means: You need to set aside shares for future hires, but it could out of your ownership, not the investors'
"Most Favored Nation Clause"
What it sounds like: Everyone gets the best terms
What it often means: If you give better terms to a later investor, you have to offer the same terms to earlier ones
"Pay-to-Play"
What it sounds like: Investors must keep investing to keep their rights
What it often means: Investors who don't invest in future rounds lose their special rights and protections
"Super Pro-rata Rights"
What it sounds like: Rights to invest more than their fair share
What it often means: Certain investors can take more than their proportion of future rounds, potentially blocking new investors
"Cumulative Dividends"
What it sounds like: Regular payments if the company makes money
What it often means: A potential guaranteed return that accumulates even if you don't have the cash, creating a growing debt to investors
"Conversion Rights"
What it sounds like: Ability to convert preferred shares to common
What it often means: Investors can choose the better outcome between their preferred rights and common stock rights in any scenario
Remember
Terms interact with each other in complex ways
The same term can mean different things in different contexts
Market conditions can make certain terms more or less negotiable
Always get a good lawyer - this guide helps you understand the conversation, but it's not a replacement for legal counsel
Take your time reviewing terms - the most expensive mistakes happen when founders rush
When Reddit raised money in 2021, their term sheet included what looked like normal protective provisions. But translated into plain English, these terms meant Reddit would need investor approval to:
Take out a loan
Change how the company was run
Raise more money
Sell the company
That's a lot of control to give up for money that's supposed to help you grow independently.
How to Protect Yourself
When Figma received Adobe's $20 billion offer in 2022, they didn't just focus on the number. They spent the first 48 hours doing something most founders skip: mapping out every way the deal could affect their ability to run the company.
Let me show you how to read a term sheet like your company's future depends on it - because it does.
Step One: Ignore the Money (For Now)
This sounds crazy, but stay with me. When Figma's team first looked at Adobe's offer, they started by covering up the numbers completely. Instead, they asked three basic questions:
"What can we still do without permission?" They listed every major business decision they might need to make in the next five years.
"What happens if things go wrong?" They mapped out worst-case scenarios and who would have the power to make decisions in each case.
"What options are we giving up?" They looked at what other companies might want to do with Figma in the future - and whether these terms would prevent that.
Step Two: Create Your Protection Map
When GitHub negotiated with Microsoft, they created what I call a Protection Map. Think of it as a simple checklist of what matters most:
Decision Rights
Which decisions can you make alone?
Which ones need investor approval?
Who gets the final say when opinions differ?
Future Freedom
Can you raise more money if needed?
Can you sell the company if you want to?
Can you hire and fire key people?
Team Protection
What happens to employee stock options?
Who controls future compensation decisions?
What commitments can you make to your team?
Step Three: Read the Invisible Ink
The most dangerous terms are often hidden in seemingly innocent phrases. Here's how to spot them:
"Subject to investor approval" - Pause here. List out everything you might need approval for.
"Customary restrictions" - There's no such thing. Ask for specific examples of what's restricted.
"Standard protective provisions" - Always ask: Standard for who? A term that's standard for a struggling company might be unusually restrictive for a growing one.
Your Next Steps
If you're looking at a term sheet right now:
Stop focusing on the valuation: Put a sticky note over it. Seriously. You need to understand the terms first.
Create your Power Map: Use the three columns we discussed. Be ruthlessly honest about what matters.
Do the founder calls: Not tomorrow. Today. You need real experiences from people who've been there (even better if they’ve raised from the same investor)
If you're not looking at a term sheet yet:
Start your term sheet database: Save and study term sheets that become public. What terms did other companies agree to?
Build your founder network: The time to build relationships is before you need them. Who can you call for advice when the time comes?
Know your non-negotiables: Write them down now, before there's money on the table clouding your judgment.
Remember this: The best time to understand a term sheet is long before someone slides one across the table.
The founders who keep control of their companies aren't always the ones who raise the most money. They're the ones who understand exactly what they're giving up in return.
The Final Word
Let me leave you with a story that changed how I think about all of this.
Last year, I sat across from one of the most successful founders I know. Someone who'd built and sold multiple companies, each bigger than the last. I asked her what she wished she'd known earlier in her journey.
Her answer surprised me.
"I wish I'd understood that every term sheet is a story about the future," she said. "The numbers tell you what your company is worth today. But the terms? They tell you what freedom you'll have tomorrow."
She pulled out the term sheet from her first company's acquisition - $50 million, all cash. Looked like a dream deal. But buried in those pages were terms that prevented her from starting her next company for three years.
"The price was what I thought I wanted," she said. "The terms were what actually mattered."
Think about that for a second.
Every term sheet that lands in your inbox is really two documents:
The one everyone sees - with its big numbers and exciting possibilities
The one hiding in plain sight - with its quiet clauses about who controls what happens next
Here's what I want you to remember:
The best founders aren't the ones who get the highest valuations. They're the ones who maintain the freedom to build what they envision.
The smartest negotiators aren't the ones who win on every term. They're the ones who know which terms actually matter.
The most successful companies aren't the ones that take the most money. They're the ones that keep the power to decide their own future.
Your move.
The next time someone slides a term sheet across the table, remember: The number at the top isn't the price of the investment. It's the opening bid for your company's future.
Choose wisely.
Scott