Understanding Term Sheets from New York’s Top Tech Investors

Understanding Term Sheets from New York’s Top Tech Investors

After a successful pitch, you get the document that can make or break your company: the term sheet. This is not a formal contract, but a “non-binding” letter of intent that outlines the proposed terms of an investment. It is the single most important negotiation of your startup’s life. A high valuation with bad terms is a loss, not a win.

NYC investors are financially sophisticated. Their term sheets are built to maximize their upside and protect their downside. At AZ New York, we guide founders to look past the valuation and focus on the *control* and *economic* terms. This guide is your pedagogical breakdown of what truly matters.

---

The “Big 3” Terms You Cannot Ignore

Founders obsess over valuation. VCs obsess over these three terms. You should too. Your legal counsel (from a firm like Cooley or Gunderson Dettmer) will be your primary guide here.

1. 1. Price (Pre-Money Valuation):

   This is the “sticker price.” A Pre-Money Valuation is what the VC values your company at *before* their investment. If a VC invests $5M on a $20M “pre-money,” your “post-money” valuation is $25M, and the VC owns 20% ($5M / $25M). This is the number that gets the headlines, but it’s the least important of the “Big 3.”

2. 2. Liquidation Preference:

   This is the most important *economic* term. It dictates who gets paid first when the company is sold. A “1x Non-Participating” preference is standard. It means the VC gets their “1x” ($5M) back *first*, and the rest is split among founders and employees. Be wary of “Participating” or “Multiple” preferences (e.g., 2x), which can wipe out the founders in a small or medium-sized exit.

3. 3. Protective Provisions (The “VC Veto”):

   This is the most important *control* term. These are a list of actions the company *cannot* take without a special vote from the Preferred Stock (the VCs). This list is your main point of negotiation. A standard list includes things like selling the company or changing the board. An overly aggressive list might include “hiring/firing executives” or “taking on debt,” which severely limits your ability to run your own company.

---

The Core Conflict: “Founder-Friendly” vs. “VC-Friendly” Terms

The term sheet is a negotiation. Your goal is a “balanced” deal. This table shows the two extremes.

Term	“Founder-Friendly” (A “Clean” Term Sheet)	“VC-Friendly” (A “Dirty” Term Sheet)
Liquidation Preference	1x, Non-Participating. This is the market standard.	>1x (e.g., 2x) or “Participating.” This lets the VC “double-dip” and is highly punitive.
Board of Directors	3 or 5 members. (e.g., 2 Founders, 1 VC, 2 Independents). Founder-controlled or balanced.	3 members. (1 Founder, 2 VCs). VC-controlled. This means you can be fired as CEO.
Anti-Dilution	Broad-Based Weighted Average. Standard, offers some protection from a “down round.”	Full Ratchet. A “dirty” term. If you sell *one* share at a lower price, *all* of the VC’s shares re-price to that new, lower price.
Protective Provisions	A short, standard list related *only* to selling the company, issuing new stock, or changing the board.	A long list that includes vetoes over the annual budget, executive hiring/firing, and taking on any debt.

---

The Expert’s View: The “Speculator’s Valuation” vs. The “Investor’s Terms”

This is where founders get trapped.

• The Speculator (The Naive Founder): A founder who “speculates” on their valuation is focused only on the pre-money number. They will take a $30M valuation with “3x participating preference” over a $20M valuation with “1x non-participating.” This is a fatal error. In a $100M exit, the “lower” valuation deal might pay them *more*.
• The Investor (The Smart Founder): A founder who thinks like an “investor” knows that *terms dictate outcomes*. They know that a clean, 1x non-participating preference aligns everyone. They are willing to accept a “fair” valuation to get clean terms, because they are building for a massive, 10x outcome, not a quick, misaligned flip.

The AZ New York team’s advice is simple: You can’t fix bad terms. A high valuation is just a number. A bad liquidation preference is a permanent mortgage on your company’s future.

---

Real-World NYC Scenarios: How Terms Play Out

1. The “Small Exit” Trap (Liquidation Preference)

Profile: A founder takes $5M at a $25M post-money valuation. To get this high price, he accepts a “2x Participating” liquidation preference.

The Outcome: The company struggles and sells for $40M (a “disappointment”).

• The VC gets “2x” their money back *first*: $10M.
• Then they “participate” in the rest. They own 20% of the company, so they get 20% of the remaining $30M, which is $6M.
• VC Total: $16M.
• Founder & Team Total: $24M.
• (With a “1x Non-Participating” term, the VC would have just taken 20% of $40M, or $8M. The founder gave up $8M to get a “higher” valuation.)

2. The “Loss of Control” Trap (The Board)

Profile: Two founders raise $3M. The term sheet from a NYC VC creates a 3-person board: 1 Founder, 1 VC, and 1 “Independent” *chosen by the VC*.

The Outcome: The founder *thinks* he has control. But the VC controls the “independent” seat. Six months later, the founder and VC disagree on strategy. The VC and the “independent” vote 2-to-1 to fire the founder from his own company. The founder should have insisted on a 5-person board or an independent he *mutually* agreed to.

3. The “Down Round” Death Spiral (Anti-Dilution)

Profile: A founder raises at a high “bubble” valuation. The term sheet has “Full Ratchet” anti-dilution.

The Outcome: The market crashes. The company must raise a “down round” at a lower price (see our guide here). Because of the “Full Ratchet” clause, the first VC’s shares all re-price to the new low, massively diluting the founder and all the employees. It wipes out their equity. A standard “weighted average” clause would have been painful, but not fatal.

---

Frequently Asked Questions (FAQ)

Q: What is the “Option Pool”?

A: This is a key part of the valuation negotiation. The VC will insist that you create an “option pool” (e.g., 10-20% of the company) for future employees. Crucially, they will demand this pool be created *before* their investment, which means it comes out of the *founders’* equity. This is a standard, but sharp-elbowed, part of the negotiation.

Q: What is a “SAFE” or “Convertible Note”?

A: These are tools used *before* a priced seed round (like the term sheets we’re discussing). A SAFE (Simple Agreement for Future Equity) or Convertible Note is a fast way to raise money *without* setting a valuation. The money “converts” to equity at the *next* round, usually at a discount. They are faster, but just delay the valuation fight.

Q. Is a term sheet *really* non-binding?

A: Mostly, yes. The economic terms (valuation, etc.) are non-binding. However, two clauses are *always* binding: 1. Confidentiality (you can’t share the term sheet) and 2. No-Shop / Exclusivity (you must *stop* talking to other VCs for 30-60 days). This “no-shop” is why it’s so important to get the terms right *before* you sign.

---

Keywords for Your Next Internet Search

Understanding VC term sheets, term sheet negotiation, founder-friendly terms, liquidation preference explained, 1x non-participating vs participating, protective provisions VC, anti-dilution weighted average vs full ratchet, pre-money vs post-money valuation, seed-stage term sheet, what is a SAFE, Y Combinator SAFE, convertible note, startup option pool explained, VC board control, AZ New York startups, Cooley, Gunderson Dettmer

---

---

Read Next: NYC’s Top 10 FinTech Accelerators and What They Look For

---

NYC’s Top 15 Private Wealth Management Firms