Term sheets
What is a term sheet?
An investor likes our numbers and emails a three-page document: a term sheet. It is a short summary of the deal they propose, written before the long legal contracts, which can run to a hundred pages.
Most of a term sheet is non-binding: it is a plan, and either side can still walk away. A few parts are usually binding, like confidentiality (keep the details secret) and a no-shop period (don't look for other investors for, say, 30 days).
Quick check
Once a term sheet is signed, the investment legally has to go ahead.
- True
- False
Show the answer
False
Most of a term sheet is non-binding, so either side can still walk away before the final contracts. Usually only parts like confidentiality and the no-shop period are binding.
The headline, then the fine print
Every term sheet starts with the amount and the pre-money valuation, and the investor's share is amount / post-money (How studios are valued does the maths). Founders often stop reading there. They shouldn't.
One piece of fine print is anti-dilution protection. If a later round is priced lower, a down round, it gives the investor extra shares to make up for part of the drop, which dilutes the founders more. The usual, milder kind is broad-based weighted average. The harsh kind, full ratchet, resets the investor's price all the way down to the new, lower price.
Read the fine print
Same valuation as the other offer, but our anti-dilution is full ratchet.
Kai and Remy have two offers at the same valuation. Why might they prefer the other one?
- If a later round is priced lower, full ratchet hands this investor far more extra shares and dilutes the founders much more
- Full ratchet means the investor can never sell
- There is no difference, because only the valuation matters
Show the answer
If a later round is priced lower, full ratchet hands this investor far more extra shares and dilutes the founders much more
Full ratchet resets the investor's price to the lower round's price, so the founders pay for the whole drop. Broad-based weighted average shares the pain more fairly. Same headline number, very different deal.
Liquidation preference
Investors usually get preferred shares, a class of shares with extra rights. The biggest is the liquidation preference: it decides who gets paid first if the company is sold or closes. Preferred shareholders get their money back before founders and the team, who hold common shares.
The common kind is 1x non-participating: the investor takes either their money back or their percentage, whichever is bigger. Made-up example: they put in $200,000 for 20%. If the studio sells for $500,000, 20% would be $100,000, so they take $200,000 and the other owners share the remaining $300,000.
More terms to know
- Board seatsHow many seats on the board the investor gets. This is about control.
- Pro rata rightsThe right to buy enough new shares in future rounds to keep the same percent.
- Option poolShares set aside for future teammates. If it is created in the pre-money, it dilutes the founders, not the new investor.
- Preferred sharesThe share class the investor gets, carrying the extra rights listed in the term sheet.
- Participating preferredA tougher preference: the investor takes their money back and also their percent of what is left. Founders usually push back.
Quick check
What do pro rata rights give an investor?
- The right to invest in future rounds so their percent does not shrink
- The right to a share of every sale on the App Store
- The right to sell their shares back to the studio at any time
Show the answer
The right to invest in future rounds so their percent does not shrink
Pro rata means "in proportion". It lets an investor buy their share of new shares in later rounds, so dilution does not shrink their percent.
Read the term sheet
1Company: Our studio, Inc.2Investor: Example Seed Fund3Amount: $200,0004Pre-money: $800,0005Shares: Series Seed Preferred6Liquidation: 1x, non-participating7Board: 2 founders, 1 investor8Pro rata: Yes9Option pool: 10%, in the pre-money10Binding: Confidentiality, 30-day no-shop
A few years later, the studio is sold for only $150,000. Under line 6, how much goes to the founders?
- $0, because the investor gets up to their $200,000 back first
- $120,000, because the founders own most of the shares
- $30,000, because the investor owns 20%
Show the answer
$0, because the investor gets up to their $200,000 back first
With a 1x preference, the investor is paid back first, up to $200,000. A $150,000 sale is less than that, so all of it goes to the investor and the common shareholders get nothing.
SAFEs and convertible notes
Very early investors sometimes skip agreeing a valuation. A SAFE (simple agreement for future equity, created by the startup program Y Combinator in 2013) gives money now in exchange for shares later, at the next priced round. A convertible note is similar, but it is a loan, with interest and a due date, that usually turns into shares.
Both often have a valuation cap. Made-up example: a $50,000 SAFE with a $1,000,000 cap. If the next round values the studio at $2,000,000, the SAFE converts as if it were $1,000,000, so it buys shares at about half the new price.
Always get a lawyer
Term sheets look short, but every line changes who gets what. Studios always hire their own startup lawyer, never the investor's, to explain each term and say which ones are normal.
The company signs through its adult founders and directors, and a parent or guardian signs for any minor where the law requires it. You read it together and ask questions. And never sign because someone says the offer expires tonight. A good investor gives you time to think.
Bolt says: Investors buy a slice. Sometimes a company wants to buy the whole studio. Last lesson: exits.
Fact-checked 9 October 2026
- NVCA model legal documents (term sheet) nvca.org
- Y Combinator: Announcing the safe ycombinator.com
- Y Combinator: The SAFE ycombinator.com
- SBA: Fund your business sba.gov