Term sheet basics: valuation and dilution

A term sheet is a short, mostly non-binding summary of an investment. Once signed, lawyers turn it into the final documents. Most of the important negotiation happens at the term sheet, so understand every line.

Pre-money and post-money

• Pre-money valuation: what the company is worth before the new money.
• Post-money valuation: pre-money + the investment.
• Investor ownership = investment ÷ post-money valuation.

Worked example

1. 1
   Starting pointTwo founders own 4,000,000 shares together (2,000,000 each, 50/50).
2. 2
   The offerAn investor puts in 1,000,000 € at a 4,000,000 € pre-money valuation. Post-money = 5,000,000 €.
3. 3
   Share price4,000,000 € ÷ 4,000,000 shares = 1 € per share. The investor gets 1,000,000 new shares.
4. 4
   Ownership afterTotal 5,000,000 shares. Investor 20%, each founder 40%. The founders were diluted from 100% to 80%, but own 80% of a company worth more.

The option pool

Investors often ask for an option pool for future employees, for example 10% of the company after the round, created before their money comes in. That means the founders carry all of it.

Other terms to understand

• Liquidation preference: who gets paid first if the company is sold. '1× non-participating' is the founder-friendly standard.
• Board composition: who sits on the board and who appoints them.
• Protective provisions: decisions that need investor approval.
• Anti-dilution: protection for investors if a later round is at a lower price. 'Broad-based weighted average' is common and fair.
• Pro rata rights: the investor's right to invest in future rounds.
• Founder vesting: investors may ask founders to re-vest some shares.
• Exclusivity: a period in which you can't negotiate with other investors.