Just like applying for innovation tax credits, navigating VC term sheets takes both expertise and fluency in very specific legal language—a skill most founders don’t use in their day-to-day startup operations.
As we recently explained on our blog, while every funding agreement is unique, there are certain key VC terms you should expect (and review carefully) before signing with a venture capital partner.
If you haven’t already, read Part 1 of this series to discover some of the main pitfalls founders should watch for when reviewing the most important sections of their VC term sheets. In this post, we’ll go a step further and highlight a few more conditions you’ll want to review and negotiate closely before you sign.
Anti-Dilution Protection
These protections can be tricky, since VCs often use them as a way to protect themselves if the company underperforms in the future.
The bottom line with these agreements is to protect VCs if the company later issues stock at a lower valuation than what was set in the original term sheet (that is, your VC’s initial investment).
Weighted average anti-dilution protections are the most common type you’ll see in these negotiations. Here, if your company later sells shares at a lower valuation, the conversion price of the preferred stock is reduced—effectively increasing the conversion rate for early investors (like your VC). This means that each time new shares are issued at a lower price, the preferred shares held by early investors are adjusted accordingly.
A more aggressive anti-dilution protection—often called a “death spiral” clause—is something founders should avoid at all costs. In this setup (also known as a full ratchet anti-dilution clause), the conversion price of existing preferred shares drops to match the new, lower price, no matter how many shares are issued. This can lead to near-total dilution—and could spell the end for your startup.
Redemption Rights
While these VC terms are usually used as negotiation points (and rarely enforced once agreed upon), they still give investors the option to essentially “cash out” their investment. In most cases, Redemption Rights allow investors to have their investment “bought back” or redeemed at the original price, typically starting five years after the initial funding round.
It’s worth noting that most investors won’t include this in their Series A agreements. You’re more likely to see it in later funding rounds. Still, if Redemption Rights do end up in your initial term sheet, make sure to negotiate a repayment plan (for example, over three years) instead of an immediate payout.
Right of First Refusal
Under these common terms (often called ROFR), if you want to sell any of your shares, you must first offer them to the company, then to investors, before looking for an outside buyer. This lets founders reduce their ownership without changing the current shareholder structure.
Founders can often negotiate ROFR terms (for example, if they want to transfer shares to a family member), but these clauses are usually included to discourage founders from making a quick exit. That’s because a potential buyer is less likely to want to deal with ROFR agreements unless the buyout is especially attractive and worth the extra effort.
Co-Sale Rights
Similar to ROFR, Co-Sale Rights give investors a say when founders sell their shares. These rights are usually applied on a prorated basis and typically come into play when a founder is selling at a high price.
Drag-Along Rights
Another safeguard in case a founder wants to sell, Drag-Along Rights allow all shareholders to vote on the sale of the company. In most cases (such as Series A), board members, common shareholders, and preferred shareholders all get a vote. In later-stage deals, sometimes only VC investors have this right.
VC Terms: What to Expect Going Forward
No two VC term sheets are exactly alike, but you’ll start to notice patterns. Even if you have legal advisors reviewing your term sheets, it’s crucial to pay close attention to the terms we’ve covered here and in our previous post to protect your stake in your company.
If research and development is at the core of your business—whether you’re an early-stage company in a new market or a fast-growing startup constantly evolving your product—you have access to a range of non-dilutive funding options that can extend your runway without giving up equity.
Speak with a Boast AI expert today to learn how we combine cutting-edge technology, years of expertise, and a founder’s perspective to optimize your R&D and fund your innovation.
To truly unlock the power of AI and get the most from your R&D, you need to adopt responsible practices. How can your business use AI efficiently and responsibly to boost your R&D?We break it all down in our ebook.
