Don’t take VC money if you see these 5 red flags in a term sheet

Gagan Singh is the founder and CEO of digital investment bank WOWS Global.

As a founder, safeguarding your startup’s future is paramount and scrutinizing term sheets is your armor against potential pitfalls.

While it might be tempting to jump on the first chance you have to secure funding, closing a contract with the wrong investor could scupper your company.

Photo credit: Bruno Neurath-Wilson / Unsplash

Here are five red flags to watch out for in a term sheet before you leap into a VC partnership:

🚩 1. Draconian liquidation preferences

Be wary of term sheets that feature exorbitant liquidation preferences such as “participative rights” or “higher multiples.”

While it’s natural for VC firms to want to protect their investments, negotiating a liquidation preference that is fairly balanced is crucial to avoid getting the short end of the stick during exit scenarios. You don’t want to cash out and suddenly discover that your payout isn’t anywhere near the level you thought it would be.

🚩 2. Founder-unfriendly vesting schedules

If you’re a founder worth your salt, you will pour blood, sweat, and tears into your startup. That sweat equity should be rewarded accordingly.

If the term sheet proposes a vesting schedule that locks you into your role for too long or leaves you with a meager equity stake, consider whether the trade-off is worth the investment you’re being offered.

🚩 3. Opaque anti-dilution provisions

Anti-dilution provisions are another instrument to protect investors and they do have their place. However, they have to be crystal clear.

Keep an eye out for complex anti-dilution clauses that could lead to substantial equity dilution for you and your team. Make sure any anti-dilution provisions are clearly defined and equitable.

Always opt for weighted average anti-dilution rights whenever possible.

🚩 4. Restrictive board control

A VC firm is investing in your vision for the company when it parts with its money. That doesn’t mean it now owns your vision – that should stay intact even after VC investment.

Term sheets that grant VC firms excessive control over your company’s board might hinder your ability to make important strategic decisions down the line. Strive for a balanced board structure that your investors can accept and, more importantly, one that aligns with your growth plans.

🚩 5. Excessive protective provisions

‘No’ seems to be the hardest word