Term Sheet Review — Investor Side

Term Sheet Review — Investor Side

When to use this

Use when a VC fund, family office, or angel investor needs to review a term sheet (whether drafted by them or by the company's lawyers) from the investor's perspective. The investor's goals are: downside protection (liquidation preference, anti-dilution), governance rights (board seat, protective provisions, information rights), accountability mechanisms (founder vesting, IP assignment), and exit alignment (drag-along, ROFR, co-sale).

For the founder-side perspective, use [[review-term-sheet-founder-side]].

Inputs

Review Methodology

1. Liquidation Preference — Adequacy

The liquidation preference determines investor return in a sale, wind-down, or distribution event.

Minimum acceptable: 1× non-participating — investor gets back invested capital (or pro-rata proceeds if higher) before any distribution to common. This is the market floor for institutional investors.

Stage-appropriate expectations:

Flag:

• 1× non-participating with no cap on distribution proceeds — investor misses growth upside in a pure exit scenario; check whether preferred converts to common for IPO/high-value exits (standard)
• Liquidation preference applies on IPO — generally unacceptable; preferred should convert to common upon IPO

2. Anti-Dilution — Minimum Standard

Acceptable minimum: broad-based weighted-average anti-dilution. Any round that provides less protection than this is a deal-killer for institutional investors.

What to verify:

• Is the formula clearly specified? (Not just "weighted average" — verify it is "broad-based weighted average" incorporating all shares outstanding including option pool)
• Are carve-outs appropriate? (Anti-dilution should not be triggered by: option pool shares; conversion of existing convertible notes; shares issued as M&A consideration; certain lender warrants)
• Is the anti-dilution protection automatically applied or does it require shareholder approval? (Auto-apply is investor-protective)

Red flag: company proposing a narrow-based weighted-average (only shares of the same series) — provides less protection than broad-based. Reject.

3. Board Composition

Minimum for lead investor (Series A, 15–30% ownership):

• 1 board seat for the lead investor
• Observer right (no voting) for follow-on investors or co-investors who did not lead

Acceptable early-stage structure:

• 2 founder seats
• 1 investor seat
• 1 independent seat (investor has meaningful role in independent director selection)

Flag:

• No board seat for the lead investor on a significant round — unacceptable for institutional Series A+
• Independent director can be removed by founder majority without investor consent — weakens governance
• No mechanism for investor to appoint additional board members as investor's ownership percentage grows (e.g., if anti-dilution triggers additional shares)

4. Protective Provisions — Coverage

Protective provisions are investor veto rights over specific company actions. A complete list for institutional investors:

Core protective provisions (non-negotiable):

• Sale of the company (merger, acquisition, asset sale, change of control)
• Issuance of any new class of security ranking senior to or pari passu with investor's preferred series
• Amendment to articles/charter that adversely affects the investor's preferred series
• Taking on financial indebtedness above a specified threshold (typically USD 500K to USD 2M depending on stage)
• Any material change in the nature of the company's principal business
• M&A transactions above a specified value
• IPO or public listing (to protect investor's preferences / conversion mechanics)

Additional protective provisions (common but often negotiated):

• Issuance of any new equity beyond the reserved option pool
• Entry into any joint venture or partnership
• Licensing of core IP on an exclusive basis
• Related-party transactions above a defined threshold

Flag:

• Protective provisions that require a simple majority of preferred to exercise — should require the lead investor's specific consent to avoid being overridden by small holders of preferred
• Missing any of the core provisions above
• Protective provisions that sunset after a defined period (unusual; flag)

5. Information Rights

Investors need visibility into the company's performance to manage their portfolio and meet their own fund reporting obligations.

Standard investor information rights:

Flag:

• Monthly management accounts absent — investor is flying blind
• Information rights limited to annual audited accounts only — inadequate for active portfolio management
• Budget review right absent — investor cannot anticipate cash needs or track against plan
• No notification obligation for material events (litigation, regulatory action, insolvency risk)

MENA context: Gulf-based family offices may be less demanding on monthly management accounts; institutional GPs and LPs expect them. Calibrate against fund type.

6. Pro-Rata Rights

The right to participate in future funding rounds to maintain ownership percentage.

Standard: pro-rata right through at least Series B (or through all rounds for lead investors).

Variants:

• Super pro-rata: right to invest more than one's ownership percentage in future rounds — often contested by founders
• Pro-rata notification requirement: company must notify investor of forthcoming round sufficiently in advance for investor to participate

Flag: no pro-rata right at all for a meaningful ownership stake investor — creates unacceptable dilution risk.

7. Pay-to-Play

Pay-to-play provisions require existing investors to participate in follow-on rounds (at least pro-rata) or face consequences:

• Light pay-to-play: preferred converts to common (loses economic preference) if investor does not participate
• Heavy pay-to-play: preferred converts to ordinary shares and loses all protective provisions and board rights

Investor's perspective:

• Pay-to-play is acceptable as a company-protection mechanism to ensure pro-rata participation from early investors in difficult rounds
• However, investor should ensure the pay-to-play trigger has a minimum round size threshold (does not apply to small bridge rounds or insider rounds)
• Ensure there is a 30-60 day notice period before the pay-to-play obligation crystallizes

8. Drag-Along — Investor Alignment

Minimum drag-along structure from investor's perspective:

• Investor (as preferred holder) is part of the majority that can trigger drag-along
• Drag-along applies to all shareholders including founders (prevents a minority of founders blocking a value-creating exit)
• Drag threshold: majority of preferred + majority of common + board approval (prevents investor dragging without board support)

Flag:

• No drag-along at all — founders can block a sale that the investor wants
• Drag-along requires all-holders consent — unanimity is unworkable for exits
• Drag threshold set so high that it is practically unusable (e.g., 90% of all shares)

9. Founder Vesting and IP Assignment

Required from investor's perspective:

• Founder vesting: 4-year, 1-year cliff; unvested shares subject to company repurchase right at cost if founder departs without cause. This protects the company (and therefore investors) from a founder walking away with a large unearned equity stake.
• Double-trigger acceleration: acceptable; single-trigger acceleration is a red flag — means a founder gets full equity on any acquisition regardless of whether they continue post-CiC
• IP assignment: all founders must have assigned all company-related IP to the company, including pre-incorporation work and work done on personal equipment. A missing IP assignment can affect the company's ability to raise future rounds or achieve a clean exit.

Flag:

• No founder vesting (founders already fully vested pre-investment) without a vesting restart on acceptable terms
• Single-trigger acceleration on CiC — investor pays for future value; founder captures it on day one of a CiC
• IP assignment incomplete or missing

10. Exclusivity, Fees, and Longstop

Standard:

• Exclusivity: 30–60 days; should not exceed 90 days without milestone-based extension
• Legal fees: company pays investor's legal fees up to a cap (USD 25–50K for Series A; USD 75–150K for Series B+)
• Longstop: if definitive documents are not signed within 90 days of term sheet, term sheet expires

Flag:

• No longstop date — deal drags indefinitely, investor is in limbo
• No legal fee reimbursement — unusual for institutional investors
• Exclusivity with no termination right for investor — investor cannot exit the process if diligence reveals problems

Deal Killers — Walk-Away Scenarios

Output Format

{
  "findings": [
    {
      "provision": "<section>",
      "issue": "<description>",
      "severity": "critical|high|medium|low",
      "market_standard": "<benchmark>",
      "recommended_redline": "<what investor should push for>"
    }
  ],
  "deal_killers": ["<list of walk-away issues>"],
  "overall_investor_protection": "strong|adequate|weak|unacceptable",
  "priority_redlines": ["<ranked negotiation priorities>"]
}

Related Skills

• [[review-term-sheet-founder-side]]
• [[review-msa-deep-review]]
• [[review-unusual-terms-detector]]
• [[draft-sha]]
• [[draft-safe-note]]
• [[review-ip-ownership-clarity]]