Term Sheet
A term sheet is a non-binding document that outlines the key terms and conditions of a potential investment. You can think of a term sheet as the blueprint for an investment deal, which all parties agrees to before drafting the final legal documents. Term sheets typically cover key stipulations such as valuation, investment amount, investor rights, and governance terms. Although term sheets are generally not legally binding (except for certain provisions like confidentiality), they serve as the foundation for the legal documents that will formalize the investment and signal serious intent (but not necessarily a commitment to invest).
SAFE (Simple Agreement for Future Equity)
A SAFE is a financing instrument that provides rights to future equity in a company without determining a specific price per share at the time of initial investment. In plain language, investors give money now and get shares later when the company raises a priced round. Created by Y Combinator in 2013 as a simpler alternative to convertible notes, SAFEs typically include a valuation cap and/or discount rate that determine the conversion terms. SAFEs are particularly common in pre-seed and seed stage investments due to their simplicity and have become increasingly popular in the last decade.
Convertible Note
A convertible note is a debt instrument that converts into equity upon specific triggering events (typically a later financing round). Think of it as a loan that turns into ownership shares down the road — instead of being repaid in cash. The terms of a typical convertible note include interest rate, maturity date, and usually a discount rate and/or valuation cap to determine the equity conversion. Unlike SAFEs, convertible notes are technically debt and can be repaid if they don’t convert, though this rarely occurs in practice (esp. since they typically include a “voluntary conversion” clause that gives investors the right to choose equity instead of cash + interest repayment). Convertible notes are commonly used in early-stage seed funding rounds (ie. for pre-revenue startups) when setting a specific valuation may be premature.
Data Room
A data room is a secure, organized collection of company documents and information provided to potential investors during the due diligence process. It’s essentially a digital filing cabinet for your startup, containing everything investors need to evaluate the company. This typically includes financial statements, corporate documents, intellectual property information, employee agreements, and market analysis. Today, data rooms are usually virtual (VDR), with controlled access and document tracking capabilities to maintain confidentiality during the fundraising process.
Due Diligence
Due diligence is the comprehensive evaluation process that investors undertake when considering a potential investment opportunity. It’s essentially a thorough background check on all aspects of the business. After you receive a term sheet, the next step is typically to begin the due diligence process. Prospective investors will examines financial records, legal documents, intellectual property, market positioning, team experience, and other critical aspects of the business. The scope often increases with investment size, ranging from basic verification for angel investments to extensive investigations for later-stage VC rounds.
Cap Table (Capitalization Table)
Cap tables offer a detailed breakdown of a company’s ownership structure, including all shareholders and their respective ownership percentages. Cap tables are usually structured as a simple spreadsheet (check out our free template) showing who owns what percentage of the company. This spreadsheet will typically breakout ownership by common stock, preferred stock, warrants, option pool allocations, and convertible instruments. Maintaining an up-to-date cap table is crucial for understanding how new investments impact dilution and managing equity incentives, which usually becomes more complex with each financing round.
Vesting Schedule
A vesting schedule is a timeline that determines when shareholders (typically founders and employees) earn full rights to their equity. In simple terms, vesting requires people earn their shares over time, rather than owning them all immediately. This structure helps align long-term incentives and protect the company if key stakeholders decide to leave early. The industry standard vesting for founders and employees often follows a four-year schedule with a one-year cliff, meaning 25% vests after one year, with the remainder vesting monthly thereafter.
Option Pool
An option pool is a slice of company equity that is reserved for issuance to employees, directors, advisors, and strategic partners down the road. Option pool shares are set aside to incentivize, hire, and retain key talent as your company grows. The size of the option pool (typically 10-20% of total equity) is factored into the pre-money valuation. Although it impacts founder and investor ownership, maintaining a sizable option pool is crucial for talent recruitment and retention.
Right of First Refusal (ROFR)
Right of First Refusal gives the holder a contractual right that they have the option to enter into a transaction before any third party can. In the context of a startup, this typically means the investors who hold siad ROFR rights can purchase shares that other shareholders wish to sell before any other buyers have the opportunity. Right of First Refusal rights are generally in place to give investors the opportunity to increase their ownership in a startup. ROFRs are commonly paired with co-sale or tag-along rights to protect both company and investor interests.
Anti-dilution Rights
Anti-dilution rights are provisions that protect investors from equity dilution in case there are later financing rounds at lower valuations (often referred to as “down rounds”). In basic terms, anti-dilution clauses give investors insurance against future investments at lower prices. These rights typically adjust the conversion price of preferred stock, effectively giving investors more shares to compensate for the lower valuation. The two main types of anti-dultion rights are “weighted average” (more common) and “full ratchet” (more severe), both of which significantly impact the ownership stake of all other shareholders (ie. founders or other investors) in the event of a down round.
Most Favored Nation (MFN) Clause
A Most Favored Nation clause is a provision that automatically grants a party the best terms that are given to any other party in similar agreements. For example, in the context of SAFEs or convertible notes, if a startup issues notes with better terms to later investors (usually indicative of a down round or bridge round), early investors will automatically receive those better terms. This protection is particularly common in convertible instrument-based fundraising rounds, ensuring early investors aren’t disadvantaged if later investors get a better deal / lower valuation.
Pro-rata Rights
Pro-rata rights grant existing investors or shareholders the ability to maintain their ownership stake by participating in future funding rounds. With each round of capital investment, the existing shareholders and investors will be diluted. Pro-rata rights allow existing investors to mitigate ownership dilution by investing additional capital in later rounds, which can be particularly important for successful startups where access to future rounds may be competitive. Pro-rata rights typically specify a minimum ownership threshold for eligibility.
