What Every Startup Founder Misses in a Term Sheet

Most founders know anti-dilution protection exists. Fewer understand that full-ratchet protection — where investors' conversion price resets to the new round price on any down round — is dramatically more punishing than weighted-average. A down round with full-ratchet anti-dilution can convert preferred shares at a price that gives early investors the majority of the company at the expense of founders and employees.

If investors don't participate pro-rata in future rounds, pay-to-play provisions convert their preferred shares to common — or to a lower tier of preferred. This is designed to force continued participation from all investors. For founders, it's useful because it prevents free-riders in later rounds. But the mechanics can vary significantly and affect who retains their preferred economics.

With non-participating preferred, investors choose between their liquidation preference and their pro-rata share of the proceeds. With participating preferred (also called 'double-dipping'), investors get their liquidation preference FIRST, then participate in the remaining proceeds as if they'd converted to common. On a smaller exit, this can leave founders with significantly less than they expected.

Drag-along lets a majority of shareholders force all shareholders to approve a sale. The question is: who constitutes the majority that can drag? If preferred shareholders can drag alone, they can force a sale at their liquidation preference even over founder and common shareholder objections. The trigger threshold matters enormously.

These seem administrative but create real obligations. Monthly financials, annual audited statements, access to books and records — each requirement has compliance costs and creates potential liability if you fall short. Information rights also typically survive into future rounds, creating an expanding group of people with access to sensitive company data.

Pro-rata rights let existing investors maintain their ownership percentage in future rounds. For founders, this can be beneficial (it keeps engaged investors in the deal) or burdensome (it reduces the allocation available for strategic new investors). Major pro-rata rights — rights to participate beyond the investor's current ownership — are particularly restrictive.

Most founders accept single-trigger acceleration (accelerate on acquisition) but don't negotiate double-trigger (accelerate if you're also terminated without cause post-acquisition). Single-trigger acceleration is often removed by acquirers as a condition of the deal. Without double-trigger, you could spend 2 years earning stock you were supposed to have already.