A term sheet sets out the proposed deal between a company and its investors. Founders tend to focus on the valuation, which is understandable, but how much they receive on a sale and which decisions they can take without investor approval often matter just as much. I have seen a higher valuation with harsh terms leave founders worse off than a lower valuation with fair terms.
The approach I find most useful is to read a term sheet against the events it will govern. That means starting with ownership after completion, and then thinking through a later round and a sale, including a sale at a disappointing price, because a modest exit is where liquidation preferences have their real effect on ordinary shareholders.
How much money is actually committed?
The term sheet should identify the investing entity and how much it is committing, separately from any money expected from other investors in the round. If completion depends on a minimum total raise, the term sheet should state that minimum and a deadline, and the founders should ask what happens if the lead investor is ready to complete but the others do not arrive.
If the money is paid in tranches, each tranche should be linked to a milestone that can be checked objectively, with a clear process for deciding whether it has been met. "Signed contracts with three new enterprise customers" can be measured, while "satisfactory progress in the investor's opinion" leaves the decision entirely with the investor, so the company's budget should be based only on the money it is entitled to receive at each stage.
The conditions to funding and a longstop date should be agreed, including how regulatory approvals will be handled. Some term sheets require the company to pay the investor's legal costs even if the deal does not complete, and founders should know that before they agree to a period of exclusivity.
Ownership after the whole transaction
The valuation needs to be read together with the definition of the share count it applies to. Every SAFE and note that will convert should be included, with interest where relevant, and the treatment of the option pool should be checked, because a pool increase counted in the pre‑money share count is paid for by the founders even though the headline valuation stays the same.
It is reasonable to ask for a pro forma cap table showing the position before and after completion. I explain the basic calculation in how a funding round changes your ownership, and the conversion assumptions that often change it in how pre‑money and post‑money SAFEs affect ownership, and the model should be kept in line with the draft documents as the terms change.
Pro rata rights allow the investor to maintain its percentage in later rounds, while super pro rata rights allow it to buy more than that, which can reduce the room available for a new lead investor. The notice process and any threshold at which the right ends should also be checked.
Who gets paid on a sale?
The liquidation preference should always be tested against a modest sale price. Suppose an investor paid $2 million for 20% of the company with a 1x preference, and the company is later sold for $5 million. With a non‑participating preference, the investor takes the greater of $2 million or 20% of $5 million, which is $2 million, and the ordinary shareholders share the remaining $3 million. With a participating preference, the investor takes $2 million and then 20% of the remaining $3 million, so it receives $2.6 million in total and the ordinary shareholders receive $2.4 million. Participation is sometimes capped, and any senior preferences from earlier rounds must also be included in the waterfall.
Cumulative dividends add to the amount the investor can claim, and redemption rights allow the investor to demand its money back after a set date, so those dates should be compared with the company's likely cash position. Under CAMA, a company can only redeem or buy back shares in limited circumstances, mainly out of distributable profits or the proceeds of a new issue of shares, which means a redemption right may not work in practice as the investor expects.
Anti‑dilution terms adjust the investor's price if a later round is priced lower. A full ratchet resets the price to the new lower price and can be very costly for founders, while a broad‑based weighted average is the market norm and has a much gentler effect. Pay‑to‑play terms penalise investors who do not take part in later rounds, and a down round should be worked through under the actual wording before any of these terms are agreed.
Who decides after completion?
The governance terms should explain who appoints and removes directors and what makes a quorum, including whether the board can still meet if an investor director does not attend. An observer has no vote, but the terms still need to deal with the observer's access to sensitive information and any conflicts with the observer's other investments.
Protective provisions, sometimes called reserved matters, list the decisions that need investor consent. Their financial thresholds should be compared with the company's budget, and there should be a way to obtain consent quickly in an emergency. A consent drafted to cover "any acquisition of assets", for example, would catch the purchase of a new laptop as easily as the acquisition of a competitor.
Reporting obligations should be ones the company can actually meet, and investor‑appointed directors still owe their duties to the company under CAMA. The NVCA model documents show how these terms are usually drafted in the United States, but the company's own law and articles decide how they operate for a Nigerian company.
What changes for founders and other shareholders
Investors sometimes ask founders to put their shares back on a vesting schedule. I see that as a real concession, especially for founders who have already spent years building the company, so they should negotiate credit for past work and the treatment of shares that have already vested, and read the leaver definitions for their effect on price. I cover this in more detail in how founder vesting works.
The transfer terms should be checked as well, including any rights of first refusal or first offer and their exceptions. Tag‑along rights allow minority holders to join a sale, while drag‑along rights allow an agreed majority to require everyone to sell, so the warranties and liability a dragged shareholder would have to give should be read carefully, particularly by minority holders.
What is binding now and what is not
Most of a term sheet is not legally binding, but the clauses on exclusivity, confidentiality, costs and governing law usually are, and they take effect as soon as the term sheet is signed. The founders should agree how long exclusivity lasts and whether existing conversations with other investors can continue, as well as who approves announcements and who pays the transaction costs.
When the full documents arrive, they should be compared line by line with the term sheet and with the worked examples used during negotiation. Any difference should be raised before signing and the outcome recorded, because this is the last opportunity to make sure the final share numbers and decision rights reflect the deal that was agreed.
This article is general information and not legal advice. For guidance on your specific circumstances, speak with us directly.