What Am I Actually Signing Away in My Startup’s Term Sheet?

A startup term sheet is usually a short summary, mostly non-binding, but it is where control between founder and investor is really settled. The long-form shareholders agreement and share subscription agreement that follow tend to record what the term sheet already fixed. What you are signing away is rarely just a slice of equity. It is the order in which people get paid on an exit, who holds the veto on major decisions, how much of your own shareholding you must earn back, and how long you are locked out of talking to other investors. Founders who read only the valuation line are the ones who are surprised later.

Valuation is only half the number that matters

The pre-money valuation gets the headline, but the post-money figure, which is the pre-money valuation plus the new investment, decides your percentage once the round closes. If a startup is valued at KES 40 million pre-money and takes in KES 10 million, the post-money value is KES 50 million and the investor holds 20 percent. Check that the percentage in the startup term sheet matches that arithmetic on a fully diluted basis.

The employee option pool is the other half. If the pool is created or topped up before the investment, the new shares dilute existing shareholders, not the incoming investor, so the effective pre-money valuation is lower than the headline figure. Ask where the pool sits in the calculation and how large it is, because the answer can be worth as much as the headline number.

Liquidation preference decides who is paid first

A liquidation preference lets the investor recover their money, sometimes with a multiple on top, before proceeds are shared with ordinary shareholders on a sale or winding up. The key terms to read are the multiple and whether the preference is participating. With a non-participating preference, the investor takes either its preference or its share of proceeds as a shareholder. With a participating preference, the investor takes its preference and then also shares in what is left. A higher multiple or a participating preference can leave a founder with far less than the headline valuation suggests, even in a genuinely successful exit. These terms are negotiated, not fixed by statute, and market practice varies with the stage and the investor.

The preference also has a company-law footprint. It usually means creating a separate class of shares with its own rights, which would normally be written into the company’s articles. A company may amend its articles only by special resolution (section 22 of the Companies Act, 2015), which is a resolution passed by a majority of not less than seventy-five percent (section 257). See our guide to the shareholders agreement and the articles of association for how the two documents divide the work.

New shares, pre-emption and who must agree

A startup term sheet for a funding round contemplates the company issuing new shares to the investor, and the Companies Act has rules for that. Section 338 provides that a company shall not allot equity securities to a person unless it has first offered each holder of ordinary shares a proportionate share on the same or more favourable terms and the acceptance period has run out or every offer has been accepted or refused. For a private company with only one class of shares, section 346 permits the articles or a resolution to disapply or modify that right. Section 328 lets the directors of such a company exercise the power to allot shares of that class unless the articles prohibit it, and section 329 deals with authorisation by the company. Your founders need to know which of these routes the round will use, because the term sheet should not assume pre-emption rights away without a decision to do so.

Board seats and reserved matters are where control lives

A board seat is rarely just a seat. It usually comes with a list of reserved matters, such as raising further capital, taking on debt, hiring or removing the chief executive, or selling the company, that need investor consent however the founders vote as shareholders. Read the list as carefully as anything else in the document, because it is often where practical control sits, more than in the equity split.

Reserved matters are normally set out in the shareholders agreement and sometimes in the articles. Section 144(2) of the Companies Act says a director does not breach the duty to exercise independent judgment by acting in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or in a way authorised by the company’s constitution. So consent rights in a properly authorised agreement are legally workable, which is why you should negotiate them before you sign and not after.

Anti-dilution, vesting and exclusivity in a startup term sheet

An anti-dilution clause protects the investor’s percentage if you later raise money at a lower valuation, usually at the founders’ expense. Founder vesting, where you earn your shares over time instead of owning them immediately, protects the company and the investor if a co-founder leaves early. Vesting is common, but confirm what happens to unvested shares on a departure and whether an acquisition accelerates vesting.

Most of a startup term sheet is stated to be non-binding, but exclusivity or “no-shop” clauses are often drafted to be binding, locking you out of talking to other investors for a set period. Check the wording that says which clauses bind. If the exclusivity period runs long and the deal then fails, you have lost real time in your fundraising window. A shorter period is one of the points founders can usually press at little cost to the investor.