Negotiating the Term Sheet

Liquidation preference and participation

The liquidation preference decides who is paid first, and how much, when the company is sold or wound up. In the NVCA model Certificate of Incorporation (updated October 2025), each series of preferred stock is entitled, before any payment to common stock, to a multiple of its original issue price — the model leaves the multiple as a blank to be negotiated — plus declared but unpaid dividends. The model treats a sale of the company as a deemed liquidation event, so the preference applies to an acquisition, the usual exit, not only to a shutdown.

The model offers two alternatives for what happens next. With non-participating preferred, the investor takes either its preference or what it would receive by converting to common, whichever is more. With participating preferred, the investor takes its preference and then also shares in what remains as if converted — downside protection plus upside.

The difference is large in a middling sale. Suppose investors put in 10 million dollars for 25 percent and the company sells for 30 million. With a 1x non-participating preference, they compare 10 million with 25 percent of 30 million (7.5 million) and take the 10 million; the common holders share 20 million. With 1x participating, they take 10 million and then 25 percent of the remaining 20 million, 15 million in all, leaving common 15 million. At a 300 million dollar exit the two barely differ. Participation bites exactly in the modest outcomes where founders most need the proceeds.

The 2016 survey of venture capitalists by Gompers and co-authors reports that a 1x preference is typical, that 2x or greater appeared in 19 percent of their investments, and that participation rights were used on average 53 percent of the time — less often in information technology and in California, where the authors found terms more founder-friendly overall.

Anti-dilution

Anti-dilution protects preferred holders if the company later sells shares at a lower price than they paid. It works by lowering the price at which their preferred converts into common, so they receive more common shares on conversion.

The NVCA model gives two versions. The standard one is broad-based weighted average. The model's formula is CP2 = CP1 × (A + B) ÷ (A + C), where CP1 is the conversion price before the new issue; A is the common outstanding before the issue, counted broadly to include options and convertible securities; B is the number of shares the new money would have bought at the old price; and C is the number of shares actually issued. A small down round moves the price a little; a large one moves it more, in proportion.

The alternative is full ratchet, which resets the conversion price to the new, lower price regardless of how few shares were sold at it. A tiny round at a low price can hand the earlier investors a large transfer of ownership from everyone else. The 2016 survey found weighted average to be the more standard choice and full ratchet used in 27 percent of investments. A founder seeing full ratchet should ask why, and expect to give something to remove it.

Control: the board and the voting agreement

Control terms often matter longer than economics. In the NVCA model Voting Agreement — most recently updated in June 2026 — stockholders agree to vote their shares so that the board is composed as the agreement specifies: one or more directors designated by named preferred investors for so long as they hold a threshold of shares, and one or more common directors — the model's examples include a director designated by key holders of common stock and a seat held by the chief executive. The same agreement can include a drag-along provision, under which holders agree to support a sale of the company approved by specified holders.

The arithmetic of the board is the arithmetic of control. A five-person board with two investor seats, two common seats and one independent is a different company from one with three investor seats. Founders should model the board not just after this round but after the next one, when another lead will usually want a seat.

Pro rata, information rights — and where to spend effort

The model Investors' Rights Agreement (October 2025) gives each Major Investor a right of first offer on new securities the company proposes to sell, letting them keep their percentage in future rounds — the pro rata right — subject to listed exceptions. It also sets the information rights covered in Lesson 3.2. Pro rata rights are close to universal: the survey found them in 81 percent of investments. Lesson 2.2 showed how they compound dilution for everyone else when several investors exercise them.

The survey also asked how flexible investors are on each term. The least negotiable, in order, were pro rata rights, liquidation preferences, anti-dilution protection, vesting, valuation and board control. They were more flexible on the option pool, participation rights, the investment amount, redemption rights and, most of all, dividends. That is a map for a founder's effort. Do not spend goodwill trying to remove pro rata or a 1x preference; the market treats them as standard. Spend it on the terms that are both costly and movable — participation, the size of the option pool, a full ratchet, an above-1x multiple — and on the board.

The usual cautions apply with force here. These documents are drafted by counsel, every blank is a negotiation, and this lesson is not legal advice. Its job is to make sure you know which blanks matter before you sit down.