Understanding term sheets is very important for the founding team. It helps both investors and startups to work with each other using the same language. However, many terms are hard to understand for first time founders. 

To help founders understand term sheets with ease, we have curated a list of important terms, as shared below:

1. Valuation: It refers to the net worth of the company at which the funding has been raised. Pre-money valuation provides details of valuation before funding is given to the company. Valuation after adding the funds raised is called post money valuation. 
2. Board of Directors: Most of the crucial decisions are taken by the board of directors of the company. This section includes details of the composition of the board, along with investor’s expectation, i.e. 1-2 seats, non affiliated board members, etc. It gives the investor more control over the company
3. Capitalization Table: Also called cap table, it provides details of how the company share is distributed among different stakeholders, i.e. investors, co-founders, employees, ESOP Pool, etc. It’s quite useful to understand the shareholding dynamics of the startup, and how it can be influential in the next stages of funding. 
4. Option Pool: Building a startup with high standards and scale requires acquiring and retaining high quality talent. To ensure this, investors expect the founders to keep a chunk of equity separated specifically for future employees. This ensures that the startup has enough equity available to acquire and retain good talent. 
5. Liquidation Preference: It includes details of how the investors and founding team will be compensated in case of an exit, i.e. if the company raises the next round of funds, or the startup decides to get acquired by another company, etc. Generally, it is mentioned in multiples of investment. For example, if an investor invests 5 million dollars under 2x liquidation preference, and the company exits at 20 million dollars, the investor will be 10 million dollars, and the founding team will receive the rest. The values will vary based on the multiple, the investment and the startups’ value at exit.
6. Dividend: It refers to the interest payments that the startup needs to make for the investment. The payment isn’t done monthly or annually, but the dividend amount is accumulated and paid once the startup receives an exit, i.e. through future funding rounds, or an acquisition, etc.  
7. Preferred Participation: Having this clause would mean that the investor would get both, i.e. invested amount and pro-rata share of the remaining proceeds. For example, if there are preferred participation shares worth 8 million dollars at company valuation of 40 million. It means that 20% of the overall holding is under preferred participation shares. At an exit of 120 million valuation, the investor would get 8 million first, and the remaining 112 million will be distributed. 20% of 112 million will go to the investor and the rest to the founders. 
8. Protection Clauses: Investors add clauses to prevent any chances of losing the value of their investment. For example, anti-dilution rights ensure that the value of investors’ shares won’t be reduced even if the startup raises funds at lower valuation in the future. There are many other terms like weighted-anti dilution, pro-rata rights, right of first refusal, etc. that deal with protection for investors. 
9. Founder Vesting: To prevent loss of equity for any co-founder leaving the team, the investors establish vesting conditions on the shares assigned to founders. For example, if one of the co-founders leaves the company within a year, the co-founder will lose all of its shares. This way, the co-founder would prefer to stick longer, and in case the co-founder leaves, the shares can be used to find a good replacement. Such clauses will vary based on the interaction between the startup founders and investors.
10. Conversion: It refers to the right of an investor to convert their preferred shares into common stock. A specific conversion rate is specified, i.e. 2:1, 3:1, etc., which helps the investor get the best out of the investment deal. These clauses can be either ’optional’ or ‘mandatory’ to the investor, depending on how it is specified in the contract.
11. Due Diligence: This includes different disclosures the startup needs to do in order to close the deal. This is done in order to ensure the startup isn’t involved in anything that might risk their investment, i.e. IP infringement, money laundering, etc.
12.  Fees and Expenses: Refers to the expenditure involved in executing the deal, i.e. legal costs, due diligence costs, advisory support, etc. The expenditure can be dealt by any party depending on the terms discussed before extending the deal.
13.  Non-Compete: To avoid any possibility of future IP related issues, investors include a non-compete clause for founders, where in case of moving out of the team, the individual would not work in another company working in the same field. There can be other conditions also based on different scenarios, i.e. in case of a merger, or acquisition, or early exit by a co-founder, etc.
14. Confidentiality: Both parties agree that none of the details of the deal will be disclosed to any third party until the legal contract has been signed.
15.  Termination: This clause ensures that both the parties have an option to back down from the deal at any point of time before signing the agreement, through a simple notice. It can be because of any reason, i.e. difference of opinions between parties, issues with due diligence, etc.  

In this article, we have ensured that we explain the important concepts in the easiest way possible. We hope this acts as a good guide for every first time founder to get started.