You’ve pitched, you’ve impressed, and a VC has sent you a term sheet. For many Australian founders, this is the first time they’ve seen one — and the instinct is to sign it before anyone changes their mind.
That instinct is understandable. It’s also how founders give away rights they didn’t know they had.
A term sheet is a non-binding document that outlines the key commercial and legal terms of a proposed investment. It’s not the final agreement — the binding shareholders’ agreement and subscription agreement come later — but it sets the rails for everything that follows. What you agree to in the term sheet is almost always what ends up in the binding documents. Renegotiating later is technically possible but practically difficult.
Here are the 10 clauses that matter most, what they actually mean, and where Australian founders should focus their negotiation energy.
1. Valuation and Investment Amount
This is the headline number: the pre-money valuation of your company, the amount the investor is putting in, and the resulting post-money valuation and ownership percentage.
In Australia, early-stage rounds typically use a pre-money valuation — the agreed value of the company before the new investment. If your pre-money is $8 million and the VC invests $2 million, the post-money valuation is $10 million and the investor gets 20%.
The trap for founders is fixating on the valuation number without considering the other terms. A higher valuation with aggressive liquidation preferences and anti-dilution protections can leave you worse off than a lower valuation on cleaner terms. Evaluate the term sheet as a package, not a single number.
2. Share Class and Preference Rights
VCs almost never invest in ordinary shares. They subscribe for a new class — typically Series A Preferred — that carries specific rights ordinary shares don’t have. These include priority on liquidation (see below), conversion rights, and sometimes enhanced voting rights.
Under the Corporations Act 2001 (Cth), a company’s constitution must authorise the issue of different classes of shares, and the rights attaching to each class should be clearly defined. Any term sheet proposing preference shares should specify exactly what those preferences are, because “preference shares” is a label, not a standardised package.
3. Liquidation Preference
This is the clause many founders overlook because they’re focused on growth, not exit. A liquidation preference determines how the proceeds are divided when the company is sold, wound up, or undergoes another liquidity event (including, often, an IPO).
The most common structure in Australian deals is a 1x non-participating preference: the investor gets their money back first (1x their investment), and then the remaining proceeds are split among all shareholders (including the investor on an as-converted basis). This is considered founder-friendly.
What you want to avoid — especially at an early stage — is a participating preference, where the investor gets their money back and then participates pro rata in the remaining proceeds. This effectively gives the investor a double dip. Also watch the multiple: a 2x or 3x liquidation preference means the investor gets two or three times their investment before anyone else sees a cent.
The cumulative effect across multiple rounds is significant. If Series A, B, and C investors all have 1x preferences, a modest exit can leave founders with very little after the preference stack is satisfied.
4. Anti-Dilution Protection
Anti-dilution clauses protect investors if the company raises a future round at a lower valuation (a “down round”). They adjust the investor’s conversion price — effectively giving them more shares — to compensate for the decreased value.
There are two common mechanisms:
- Weighted average (the standard in most Australian deals): adjusts the conversion price based on the size and price of the down round relative to the existing capitalisation. This is the more founder-friendly option.
- Full ratchet: adjusts the conversion price to the lower price of the new round, regardless of how many shares are issued. This can be devastating for founders and is unusual in the Australian market, but it appears.
The practical impact of anti-dilution hits hardest if your company goes through a rough patch and needs to raise at a reduced valuation. Make sure you understand the mechanics before agreeing.
5. Board Composition and Governance
The term sheet will typically specify how the board of directors is constituted after the investment. A common structure for an early-stage Australian startup post-Series A is:
- Two seats appointed by the founders
- One seat appointed by the lead investor
- One independent director (agreed by both parties)
What matters isn’t just the numbers but the reserved matters — the list of decisions that require investor board member or shareholder approval. These typically include issuing new shares, taking on significant debt, making acquisitions, changing the business plan, and approving budgets above a threshold.
Negotiate the reserved matters list carefully. Too broad, and the investor has an effective veto over day-to-day operations. Too narrow, and the investor may push for additional protections elsewhere.
6. Pre-Emptive Rights (Pro-Rata Rights)
Pre-emptive rights give existing investors the right to participate in future funding rounds to maintain their percentage ownership. In Australian practice, these are sometimes called pro-rata rights.
From the investor’s perspective, this is essential — they don’t want to be diluted by a later round they weren’t given the chance to join. From the founder’s perspective, strong pre-emptive rights can complicate future fundraising because new investors may want the ability to take a larger allocation.
The key negotiation points are the scope (does it apply to all future issuances or just priced equity rounds?) and whether the rights are transferable if the investor sells their stake.
7. Founder Vesting
Even though founders have typically been working on the company for months or years before a VC round, investors will often require that some or all of the founders’ shares be subject to reverse vesting. If a founder leaves, the company can repurchase their unvested shares — usually at cost or nominal value.
A typical vesting schedule is four years with a one-year cliff: if the founder leaves within the first year, they forfeit all shares subject to vesting. After that, shares vest monthly or quarterly. Many term sheets credit founders for time already served (“acceleration credit”).
This clause exists to protect all shareholders — including co-founders — from someone walking away with a full equity stake after a short tenure. It’s reasonable in principle, but the details matter: the cliff period, the acceleration triggers on change of control, and the treatment of vested shares if a founder is terminated without cause.
8. Employee Share Option Plan (ESOP)
VCs will almost always require that the company establish or expand an ESOP — a pool of options reserved for future employees and advisors. The size of the pool is typically expressed as a percentage of the fully diluted share capital, and it’s usually set at 10–15% for an early-stage Australian startup.
The critical question is whether the ESOP is carved out of the pre-money or post-money valuation. If it comes out of the pre-money (which is standard), the dilution falls entirely on the existing shareholders — meaning you, the founders. This is one of the most significant but least discussed sources of founder dilution in a Series A.
Since 1 July 2022, Australia’s employee share scheme (ESS) tax rules (Division 83A of the Income Tax Assessment Act 1997) have been significantly simplified, particularly for startups. Options issued under a compliant ESOP can attract concessional tax treatment if structured correctly, so it’s worth getting the plan right at the term sheet stage.
9. Information Rights and Reporting
Investors will require regular financial and operational reporting. A typical term sheet specifies:
- Monthly or quarterly management accounts
- Annual audited financial statements
- Annual budgets and business plans
- Prompt notification of material events (litigation, key departures, IP issues)
These obligations are reasonable and most well-run startups should be doing this anyway. The negotiation points are around the frequency and detail of reporting, and whether the company needs to adopt specific accounting standards or engage particular auditors.
What founders should watch for is the inspection rights clause — this can give investors (or their representatives) the right to access the company’s books and records at any time. Make sure this is subject to reasonable notice and doesn’t extend to commercially sensitive information about other investors or customers.
10. Exclusivity and Confidentiality
While the term sheet itself is generally non-binding, the exclusivity (or “no-shop”) and confidentiality clauses are almost always binding — even though the rest of the document isn’t.
Exclusivity means you can’t negotiate with other potential investors for a specified period (typically 30–60 days). This gives the VC comfort that you won’t use their term sheet to leverage a better deal from a competitor.
The risk for founders is an extended exclusivity period combined with slow due diligence. If the deal falls through after 90 days of exclusivity, you’ve lost valuable fundraising momentum. Negotiate the exclusivity period down to the minimum you can, and include a drop-dead date after which exclusivity lapses automatically.
A Note on What’s Not in the Term Sheet
Term sheets are deliberately high-level. They don’t usually address every clause that will appear in the shareholders’ agreement, subscription agreement, and amended constitution. Warranties and indemnities, intellectual property assignments, restraint of trade obligations, and detailed tag-along and drag-along mechanics are typically left to the binding documents.
That’s why the term sheet negotiation is important but not sufficient. The binding documents need their own careful review — ideally by a lawyer who understands venture capital and not just corporate law generally.
Getting It Right
A term sheet isn’t just a formality between the handshake and the cheque. It’s the architecture of your relationship with your investor for the next 5–10 years. Every clause interacts with the others, and what seems immaterial at a Series A can become critical at a Series C or on exit.
If you’ve received a term sheet and want a second pair of eyes — or you’re preparing for a raise and want to understand what’s coming — get in touch. We work with Australian startups and investors on venture capital transactions, from first term sheet to exit.
