How Do You Negotiate a VC Term Sheet?

Updated 2023

Receiving a term sheet from a venture capital firm is a major step towards scaling your startup. Negotiating these terms is all about striking a careful balance between founder and investor interests. The goal is to find terms that set both parties up for success. 

In simple terms, a VC term sheet is an investment proposal for startups. However, it is not a legally binding commitment to investment. The investment is contingent on the startup passing the VC fund’s due diligence checks as well as a successful negotiation. 

Here are some of our top recommendations to help you successfully negotiate a VC term sheet in your fundraising process.

Economics and Control Are Key During Negotiations

When negotiating, there are two overarching factors to keep in mind: economics and control.

When considering the economics, think critically about how much founder dilution will happen as a result of the investment, and whether the investment is worth it. While some investments may come with a large dollar amount, it may make the venture less profitable in the long run for founders when looked at through this perspective. 

The question of control is simple—how much control will your investors have, and how will that affect your operations? Factors such as board seats or spending permissions are two critical control considerations. 

Understanding the ins and outs of VC term sheets will put you in a better position to negotiate for yourself when it’s time to raise funds. Consider this your ultimate guide to jumpstarting that knowledge and your first step towards raising capital as an early-stage startup.

The Most Popular Methods for Raising Early-Stage Capital

Before you start seeking out venture capital investments for your organization, it’s important to understand the most popular methods for raising early-stage capital. 

The three primary approaches are SAFE, convertible note, and priced equity rounds. 

SAFE

A Simple Agreement for Future Equity, or SAFE, was popularized in 2013 by startup accelerator Y Combinator, which wanted a simpler alternative to convertible notes. This is the preferred method of many early-stage startups because of its straightforward approach. It uses simple legal documents to make the process transparent and efficient. 

The SAFE is very similar to a convertible note in terms of structure, but it offers some distinct advantages for startup founders. 

SAFEs do not have a specific maturity date—instead, they convert when a predefined event happens. SAFEs also do not accrue interest, which makes them financially advantageous. However, some investors do not like working with SAFEs for that same reason. 

Convertible Note

A convertible note is a form of debt that converts into stock later on when your organization offers equity funding. The investor provides a loan to the startup, and instead of paying that loan back in cash, the organization pays it back in future equity. 

Investors often use convertible notes when the organization isn’t ready for valuation, which is the case for many early-stage startups. Convertible notes give them a way to raise capital without forcing this decision to happen too early. 

VC funds use convertible notes when they feel that equity in a high-growth startup will eventually be worth far more than their initial investment. 

Convertible notes are usually faster to close than other types of early-stage investing because they require fewer documents to complete. They also tend to have lower transaction costs, with the average amount sitting at less than $1 million.

As with any loan, startups will need to pay interest on convertible notes. However, this interest is paid in equity rather than cash. The structure of a convertible note varies depending on the individual transaction, and they are often very complex. Investor demands like board seats or protective provisions need to be taken into account.

Negotiation points for convertible notes include interest rate, note maturity, conversion rate, and automatic conversion options. 

Priced Equity Rounds

Priced equity rounds are structured very differently than SAFEs or convertible notes, and they happen later in a startup’s development. One of the main differentiators is that you receive a VC term sheet for a priced equity round, whereas SAFEs and convertible notes use different documentation. 

This process is used for Series Seed or Series A fundraising and is a relatively straightforward one. Your organization provides shares to investors in exchange for a predetermined amount of money.

However, compared to SAFEs or convertible notes, these rounds take longer to complete because they involve agreeing on a valuation and undergoing extensive due diligence.