Term Sheet Red Flag Scanner
Know which terms matter and which will haunt you. A term sheet is a 10-page document with 50+ negotiable terms. Most founders miss the ones that actually matter. This scanner highlights 30+ red
Know which terms matter and which will haunt you. A term sheet is a 10-page document with 50+ negotiable terms. Most founders miss the ones that actually matter. This scanner highlights 30+ red flags—which ones are worth fighting about and which are negotiable theater.
How to Use This Scanner
- Print your term sheet (or have it open alongside this guide)
- Read through each red flag section and check if you see that language
- Score severity: 🔴 Critical, 🟡 Warning, 🟢 Common (but watch)
- For each red flag you spot, note the page number
- Consult with your lawyer, but use this to prioritize which issues to negotiate
Remember: No term sheet is perfect. You’re looking for patterns of unfairness, not isolated issues.
SECTION 1: VALUATION RED FLAGS
1.1 🔴 Full Ratchet Anti-Dilution
What it looks like:
"Upon a subsequent preferred stock issuance at a price less than
the Series A price per share, the conversion price shall be
adjusted to equal such lower price (full ratchet anti-dilution)."
Why it’s dangerous: If you raise Series B at a lower price (down round), your Series A investor gets the new price retroactively. Your Series A investor is “made whole” by adjusting their conversion shares downward. This dilutes founders and later-round investors dramatically. Example: Series A paid $1/share. Series B is at $0.50/share. Series A investor now owns twice as many shares at your expense.
What to negotiate instead:
- Weighted average anti-dilution (narrow-based or broad-based)
- Narrow-based: adjustment based only on new shares issued
- Broad-based: adjustment accounts for all outstanding shares
- Best outcome: no anti-dilution (founders take risk)
- Market standard: weighted-average anti-dilution
Severity: 🔴 Critical. This is worth walking away over.
1.2 🔴 Unreasonable Valuation Cap
What it looks like:
"The Company's valuation for purposes of this investment is $15M pre-money,
with a cap table implying $30M post-money."
Why it’s dangerous: A valuation is an opinion, but it sets the cap table forever. At $30M post-money, your Series A check size (e.g., $5M) gives the investor 16.7% ownership. If you could have raised the same money at $40M, the investor would own only 11.1 percent. Every $5M in valuation equals 1 to 2 percent difference in founder ownership loss.
What to negotiate instead:
- Always benchmark against comparables (similar companies, same stage)
- Don’t accept the first number; ask for justification
- If the investor won’t budge, consider finding another investor
- The valuation becomes your floor for Series B (most investors won’t price a down round)
Severity: 🔴 Critical. This affects all your future dilution.
1.3 🟡 Participation Rights (Capped)
What it looks like:
"The Series A Preferred shall have the right to participate,
pro-rata with its ownership, in any future issuance, capped at
3x the original investment amount."
Why it’s dangerous: Pro-rata rights are normal. Uncapped pro-rata means investor can keep buying forever to maintain ownership percent. Capped pro-rata means investor can buy up to 3x their initial check (less dilution to you). Some investors demand uncapped pro-rata rights.
What to negotiate instead:
- Capped pro-rata rights (3x or 5x is standard)
- Broad-based weighted average anti-dilution (less painful in down rounds)
- In exchange for uncapped pro-rata, negotiate other terms down
Severity: 🟡 Warning. Less critical than valuation, but still matters.
1.4 🟢 Dividend Accrual (Non-Cumulative)
What it looks like:
"The Series A Preferred shall be entitled to an annual non-cumulative
dividend of 2% of the original issue price, payable only if the
Company is profitable."
Why it matters: Non-cumulative dividends are fair (only paid if earned). Cumulative dividends accrue whether profitable or not (builds up a hidden liability). 2 percent annual dividend is standard and harmless. This is often negotiating theater—most startups never declare dividends.
What to negotiate instead:
- Keep it non-cumulative (avoid hidden debt)
- Keep it below 2 percent (1 percent is fine)
- Most VCs will accept “no dividend” from startups
Severity: 🟢 Common but watch. Not worth fighting hard over, but prefer non-cumulative.
1.5 🟡 Price-Based Anti-Dilution Adjustment on Down Round
What it looks like:
"If any shares of Common Stock are issued at a price below the
Series A price, the Series A price shall be adjusted downward
(broad-based weighted average)."
Why it’s dangerous: In a down round, this helps Series A investors but dilutes you. The exact mechanics vary (narrow-based vs. broad-based). Broad-based formula hits founders harder than narrow-based. Example: Series A at $2/share (2.5M shares on 10M base = 20 percent ownership). Series B at $1/share on 10M shares. Broad-based anti-dilution reduces Series A price, increasing their shares from 2.5M to 3.3M. Founders now own 58 percent instead of 71 percent.
What to negotiate instead:
- Narrow-based weighted average (only counts new shares, not all outstanding)
- No anti-dilution if you can live with it (founder-friendly)
- Cap the adjustment (e.g., floor at 80 percent of original price)
Severity: 🟡 Warning. Standard in VC term sheets, but worth negotiating.
SECTION 2: CONTROL RED FLAGS
2.1 🔴 Investor Controls Most Board Seats
What it looks like:
"Board of Directors shall consist of 5 seats:
- 2 seats designated by Series A Investor
- 1 seat for Series A Director
- 1 seat for Founder CEO
- 1 seat held by Investor/Founder consensus"
Why it’s dangerous: The investor controls 3 of 5 seats (60 percent plus control). You control only 1 seat as founder. Major decisions (hiring, budget, exit strategy) are made by the board. If you lose the founder seat (fired or left), you have no board representation.
What to negotiate instead:
- Standard: 3-person board (1 founder, 1 investor, 1 neutral)
- Growing: 5-person board (2 founders, 1 investor, 1 investor, 1 independent)
- Push for independent directors as the board grows
- Negotiate founder seat is “Founder CEO” (so you stay if re-elected)
Severity: 🔴 Critical. This is governance, not valuation. Control matters as much as ownership.
2.2 🔴 Veto Rights on Key Decisions
What it looks like:
"The Series A Preferred shall have the right to approve or consent to:
- Annual budget and any material changes
- Hiring or firing executives with >$200K salary
- Capital expenditures >$100K
- Any acquisition, merger, or sale of the Company
- Issuance of new share classes or equity"
Why it’s dangerous: These veto rights paralyze decision-making. You need investor consent to run your own company. $200K salary threshold is low (your VP of Engineering might hit this). $100K capex is easy to hit in an early-stage company.
What to negotiate instead:
- Veto only on truly major items: M&A, liquidation, issuance of senior preferred
- Raise thresholds: $500K salary, $500K capex, $1M plus exits
- Carve-outs for budgeted items (if the expense was in the approved annual budget)
Severity: 🔴 Critical. Veto rights remove your ability to run the company.
2.3 🟡 Registration Rights (Demanding)
What it looks like:
"The Series A Investor shall have the right to require the Company to
register shares for sale at any time, at the Company's expense.
The Company shall bear all costs of registration and ongoing compliance."
Why it’s dangerous: Registration rights are for late-stage companies (Series C plus). Early stage, they’re irrelevant (no public exit in sight). Cost: $200K to $500K plus for a registration statement. Liquidity events trigger them (they can force you to register before you’re ready).
What to negotiate instead:
- Piggyback rights only (they can ride along if you register, but can’t force it)
- For early stage, demand removal entirely
- If included, ask for carve-outs (e.g., not before Series D)
Severity: 🟡 Warning. Unlikely to matter early, but set up the right precedent.
2.4 🟢 Information Rights (Standard)
What it looks like:
"The Company shall provide Investor with quarterly financial statements
within 30 days of quarter-end, annual audited statements, and monthly
cap table reports."
Why it’s standard: Information rights are normal and expected. Quarterly financials are totally reasonable. Monthly cap table is a bit much for early stage, but doable. Reasonable cap: quarterly audited statements, cap table on request.
What to negotiate instead:
- Quarterly financials (not monthly)
- Cap table updates only after financing events, not monthly
- Board meetings count as information sharing
- Reasonable turnaround times (45 days for audited financials is normal)
Severity: 🟢 Common. Not worth a big fight, but set reasonable expectations.
2.5 🔴 Drag-Along Rights (Overly Broad)
What it looks like:
"Holders of a majority of the Series A Preferred may drag along all other
shareholders (including Founders holding Common Stock) into any sale
of the Company, even if that sale is against the will of Founder shareholders."
Why it’s dangerous: Drag-along forces minorities to sell in an exit (even founders). Normal for late-stage deals but aggressive early stage. 50 percent plus 1 threshold means majority can force a sale you don’t want. If you own 30 percent and the investor owns 40 percent, they can force a sale.
What to negotiate instead:
- Drag-along only for qualified investors (Series A and later)
- Threshold: greater than 66 percent or unanimous (consensus required)
- Carve-out: founders can’t be dragged out at a lower price per share than lead investor
- Remove entirely and rely on tag-along instead
Severity: 🔴 Critical. This removes your ability to block an unfavorable exit.
SECTION 3: LIQUIDATION RED FLAGS
3.1 🔴 Participating Preferred (Uncapped)
What it looks like:
"Upon liquidation, the Series A Preferred shall receive its
original investment amount (1x), plus the right to participate
pro-rata in any remaining assets (full participation)."
Why it’s dangerous: Participating preferred means investor gets paid twice. First: 1x preference (get your money back). Second: participate in leftovers like common shareholders. Example: $5M Series A, company sells for $10M. Lead gets $5M back, then $2.5M of remaining $5M (pro-rata). Founders get $2.5M on remaining assets. Lead made 1.5x, founders made 0.5x. This inverts founder ownership impact in a win scenario.
What to negotiate instead:
- Non-participating preferred (get your 1x, then pro-rata with common)
- Capped participation (1x preference plus participate up to 2x total)
- Most founder-friendly: common stock preference (everyone pro-rata, no preference)
Severity: 🔴 Critical. This destroys founder returns in successful exits.
3.2 🔴 Multiple Liquidation Preferences (Series A gets 2x)
What it looks like:
"Upon liquidation, holders of Series A Preferred shall receive
2x their original investment before any other liquidation preference
holders or common shareholders receive anything."
Why it’s dangerous: 2x preference means they get paid twice before you get anything. If company sells for $8M and Series A invested $5M, they get $8M (all proceeds). Founders and later investors get nothing. 1x is normal; 2x is punitive and rare.
What to negotiate instead:
- 1x preference (standard)
- Never accept 2x from Series A
- If they demand it, that’s a signal to find another investor
Severity: 🔴 Critical. This is a deal-killer.
3.3 🟡 Liquidation Preference Accrual (Dividends)
What it looks like:
"The Series A Preferred shall have an annual 3% accruing,
non-participating preference. At liquidation, this preference
accrues compounded annually."
Why it’s dangerous: 3 percent per year compounds fast (3 percent in year 1, 6 percent by year 2, 9 percent by year 3). At liquidation, the preference can exceed the actual investment. If Series A invests $5M at 3 percent annual preference for 5 years, preference equals $5.8M. At an $8M exit, founders get very little.
What to negotiate instead:
- No accruing dividend (flat 1x preference)
- If accruing, cap it (e.g., maximum 1.5x)
- Insist on non-cumulative (only payable if earned)
Severity: 🟡 Warning. Not as critical as participating preferred, but sneaky.
3.4 🟢 Liquidation Definition (Check Scope)
What it looks like:
"Liquidation Event shall include: acquisition of the Company,
sale of substantially all assets, merger, change of control,
or any transaction where >50% of voting power changes hands."
Why it matters: Wide definition triggers in scenarios founders might not expect. Example: Series B fundraising where you hire a new CEO (change of control) could trigger liquidation prefs. Narrow definition: only actual M&A or bankruptcy.
What to negotiate instead:
- Liquidation equals actual sale (M&A) or bankruptcy, not fundraising
- Carve-out: hiring new CEO doesn’t trigger unless founders exit
- Clear definition prevents surprises
Severity: 🟢 Common. Worth reading carefully to understand when prefs kick in.
3.5 🟡 Redemption Rights
What it looks like:
"If the Company has not achieved an IPO or qualifying sale by Year 7,
the Series A Preferred shall have the right to require the Company
to redeem their shares at 1x investment plus accrued dividends."
Why it’s dangerous: Redemption forces the company to buy back investor shares. For a cash-strapped startup, this could force a sale or bankruptcy. Investor pressure to exit when you’re not ready. Rare in early-stage but shows up in later rounds.
What to negotiate instead:
- Remove entirely (most startups won’t have redemption rights)
- Carve-out: not if company is growing greater than 20 percent YoY
- If included, extend timeline to 10 plus years
Severity: 🟡 Warning. Unlikely early stage, but set the precedent to avoid it.
SECTION 4: EMPLOYEE & OPTION POOL RED FLAGS
4.1 🔴 Option Pool Expansion Without Consent
What it looks like:
"The Company shall maintain an option pool equal to 20% of all
outstanding shares immediately after this financing. If the option
pool falls below 20%, it shall be replenished automatically, fully
diluting existing shareholders."
Why it’s dangerous: Option pool expansion dilutes founders without approval. 20 percent option pool is standard, but “automatic replenishment” is not. If you issue options to hire engineers, the pool shrinks. Automatic replenishment means founders get diluted whenever pool hits 19 percent. Founder dilution without a new financing event is sneaky.
What to negotiate instead:
- Option pool set at financing (e.g., 20 percent at Series A)
- Option pool expansion requires board consent (not automatic)
- Replenishment only via new fundraising round
Severity: 🔴 Critical. This is hidden dilution.
4.2 🟡 Acceleration of Vesting on Down Round or Exit
What it looks like:
"Upon a change of control or down round, all unvested founder and
employee options shall immediately fully vest."
Why it’s dangerous: Normal: vesting accelerates on a sale (you earned it, founders should get paid). Dangerous: vesting accelerates on a down round (no exit yet). Down round vesting means employees/founders get their full equity upside even if business is struggling. Investor uses this to push you toward an exit when they want out.
What to negotiate instead:
- Full acceleration only on a change of control (actual exit)
- Single-trigger acceleration: acceptable
- Double-trigger: employee must be terminated post-acquisition (harsher, but normal)
- Remove down-round triggers entirely
Severity: 🟡 Warning. Problematic but less critical than option pool expansion.
4.3 🔴 Founder Vesting Reset on Termination
What it looks like:
"If the Founder is terminated for cause (including performance issues
determined by the Board), vesting stops immediately and all unvested
equity is forfeited."
Why it’s dangerous: Standard vesting: 4-year vest, 1-year cliff. Normal. Termination for cause: if fired, you lose all unvested equity. This is standard. Dangerous version: “for cause” is defined loosely or by board discretion. Investor could push to fire you in year 3 (only 1 year of vesting left on a 4-year plan), then founder loses $500K in equity.
What to negotiate instead:
- Define “for cause” narrowly (felony conviction, gross negligence, material breach)
- Include carve-out: terminated for performance, but give founder time to cure (30 to 60 days notice)
- Single-trigger acceleration on termination without cause (fired equals you’re vested)
Severity: 🔴 Critical. This affects how much equity you actually keep.
4.4 🟢 Option Exercise Window (Standard)
What it looks like:
"Employees have 90 days after termination to exercise vested options,
or the options expire. Extensions not permitted."
Why it matters: 90 days is standard for tax-qualified options (ESPP, ISO). 90-day window is harsh for employees (especially on big options). Standard: no problem. Problematic: 30 days or less.
What to negotiate instead:
- 90 days is fine (standard market)
- Anything less than 90 days: push back
- Extended exercise window for founders if desired (but requires special treatment)
Severity: 🟢 Common. 90 days is standard and fair.
4.5 🟡 Claw-Back on Down Round
What it looks like:
"If a down round occurs, the Board may claw back options issued at
higher prices and re-price them to the new round's price."
Why it’s dangerous: Clawback means your options get repriced downward. You thought you had options at $2/share; down round reprices them to $1/share. This hurts optionholders and makes retention difficult. Investors like clawback; employees hate it.
What to negotiate instead:
- No claw-back (most founder-friendly)
- Claw-back only for unvested options, not vested
- Board discretion required (not automatic)
Severity: 🟡 Warning. Expect this to come up; prepare to fight it.
SECTION 5: INFORMATION & REPORTING RED FLAGS
5.1 🟡 Quarterly Audited Financials (Expensive Requirement)
What it looks like:
"The Company shall provide Investor with quarterly audited financial
statements within 30 days of quarter-end, including balance sheet,
income statement, and cash flow statement."
Why it’s dangerous: Quarterly audits cost $10K to $30K per quarter ($40K to $120K annually). For a pre-revenue or early-revenue startup, this is expensive. Quarterly audits are for late-stage companies, not Series A. Standard: quarterly unaudited financials or monthly management accounts.
What to negotiate instead:
- Quarterly unaudited (company-prepared) financials
- Monthly management accounts (less formal)
- Annual audit, not quarterly
- Cap expense at X (e.g., “any costs exceeding $10K per quarter are founder responsibility”)
Severity: 🟡 Warning. Not a control issue, but a cash drain.
5.2 🟡 Cap Table Audits
What it looks like:
"Investor shall have the right to audit the Company's cap table
annually, at Investor's discretion and at Company expense."
Why it’s dangerous: Cap table audits can cost $5K to $15K. Investors can demand them whenever (at your expense). Assumes your cap table is messy (it isn’t). Theater in most cases.
What to negotiate instead:
- Remove entirely
- Limit to: “upon a financing event, cap table shall be verified by counsel”
- State: “Cap table audits at Investor expense, not Company expense”
Severity: 🟡 Warning. Low probability, but prevents future cost surprises.
5.3 🟡 Right to Inspect Books & Records (Frequency)
What it looks like:
"Investor shall have the right to inspect the Company's books,
records, facilities, and financial systems at any time without notice."
Why it’s dangerous: “At any time” is invasive. Without notice: investors show up unannounced. Distracts from operations. Standard: with notice (e.g., 5 business days).
What to negotiate instead:
- With reasonable notice (5 to 10 business days)
- Only during normal business hours
- Quarterly or less frequently (not continuous)
Severity: 🟡 Warning. Annoying but not control-changing.
5.4 🟢 Annual Financial Audit (Standard)
What it looks like:
"Upon Company's achievement of $10M revenue, the Company shall
provide annual audited financial statements prepared by an independent auditor."
Why it’s standard: Annual audits are normal at growth stage. $10M revenue trigger is reasonable. Founders expect this at this scale.
What to negotiate instead:
- Acceptance of auditor “selected by Company, reasonably approved by Investor”
- Company bears audit costs (normal)
- No additional audits beyond annual (quarterly or special audits are extra)
Severity: 🟢 Common. This is expected and reasonable.
5.5 🟡 Inspection Rights on Data & Customer Contracts
What it looks like:
"Investor shall have the right to review customer contracts,
data security practices, and any proprietary information held by
the Company to verify compliance and customer concentration risk."
Why it’s dangerous: Data security: customers’ private information exposed to investor. Customer contracts: competitors see your terms. Over-broad data review can expose trade secrets. Risk: investor finds information and shares it.
What to negotiate instead:
- Limit to summary information (e.g., “top 5 customers and their contract terms”)
- NDA on investor (protect data before showing anything)
- Third-party audit instead of direct investor review
- Remove entirely if possible
Severity: 🟡 Warning. IP and data security matter.
SECTION 6: EXIT RED FLAGS
6.1 🔴 Tag-Along Rights (Punitive Terms)
What it looks like:
"If Founders sell shares in any secondary transaction, Investor
shall have the right to tag along at the same price and terms,
or the sale is prohibited."
Why it’s dangerous: Tag-along prevents you from selling any secondary shares. You can’t diversify without investor permission. If you want to sell $1M of your equity in a secondary round, investor blocks it. Blocks founder liquidity events. Different from drag-along (drag equals forced sale; tag equals I get to join any sale you make).
What to negotiate instead:
- Tag-along only for “substantial sales” (e.g., greater than $5M or greater than 5 percent of your shares)
- Carve-out: founder secondary transactions up to 10 percent of your equity per year
- Remove entirely (investors usually won’t, but worth asking)
Severity: 🔴 Critical. Blocks your ability to diversify or take profit.
6.2 🔴 Right of First Refusal (Overly Broad)
What it looks like:
"Before any sale, merger, or liquidation, the Company and Investor
shall have the right of first refusal to match any third-party offer.
If either declines, the other can block the transaction."
Why it’s dangerous: Right of first refusal: okay for investors (normal). Blocking right: problematic (prevents good exit). If you have a $100M offer and investor declines to match, investor can block it. Stalls exits.
What to negotiate instead:
- ROFR only for investors (normal)
- Remove blocking right entirely
- If blocking right exists, only if investor matches (not if they decline)
Severity: 🔴 Critical. Blocks strategic exits.
6.3 🔴 Forced Sale (Investor Controls Exit Decision)
What it looks like:
"If there is an offer to acquire the Company for >$20M, the Board
may approve the sale even if Founders object. Majority board vote
controls exit decisions."
Why it’s dangerous: Forces you into an exit you don’t want. Combines with drag-along (you can be forced to sell). Investor wants liquidity; you want to keep building. Classic founder-investor misalignment.
What to negotiate instead:
- Founder veto on exits below a certain threshold
- Supermajority board vote required for exit (not simple majority)
- Co-founder consent required for exits (if co-founders exist)
- Remove forced-sale language entirely
Severity: 🔴 Critical. This removes your ability to control the outcome.
6.4 🟢 Co-Sale Rights (Standard)
What it looks like:
"If Founders sell shares in any exit or secondary transaction,
Investor may co-sell their shares at the same price and terms."
Why it’s standard: Co-sale is normal and expected. Investor protects their investment. Unlike tag-along, co-sale doesn’t block your sale (it just lets investor sell too).
What to negotiate instead:
- Accept this (it’s standard)
- Carve-out: co-sale waived if founder sale is less than 5 percent of ownership
- No co-sale for secondary transactions (only actual exits)
Severity: 🟢 Common. Standard and fair.
6.5 🟡 Deemed Liquidation (Broad Definition)
What it looks like:
"A Deemed Liquidation Event shall include any transaction where
the voting power of the Company changes >50%, including Series B fundraising
where new investors take a board seat."
Why it’s dangerous: Triggering liquidation prefs on a fundraising is aggressive. New Series B investor takes board seat equals 50 percent voting change equals deemed liquidation. Forces payoff of Series A before Series B closes. Blocks future fundraising.
What to negotiate instead:
- Deemed Liquidation equals actual sale or bankruptcy
- Exclude fundraising events
- Clear definition that hiring or board changes don’t count
Severity: 🟡 Warning. Rare, but set the right precedent.
SECTION 7: FOUNDER-SPECIFIC RED FLAGS
7.1 🔴 Non-Compete Clause (Overly Broad)
What it looks like:
"Founder shall not, during employment and for 3 years after,
engage in any competitive business or solicit customers of the Company."
Why it’s dangerous: 3-year non-compete is excessive (1 to 2 year is normal). “Any competitive business” is too broad (what counts as competitive?). Prevents you from starting another company in the same space after exit. Enforceability varies by state, but creates use in dispute.
What to negotiate instead:
- Non-compete: 1 year after exit, not 3
- Define “Competitive Business” narrowly (same target market, not just same tech)
- Include carve-out for non-competitive side projects
- Sunset clause: drops to 6 months after year 2
Severity: 🔴 Critical. This affects what you can do after the company.
7.2 🔴 IP Assignment (Overly Broad)
What it looks like:
"Founder hereby assigns to the Company any intellectual property created
during employment, including work created on Founder's own time using
personal equipment, if the work relates to the Company's business."
Why it’s dangerous: “Relates to the Company’s business” is vague. Everything you work on after hours could count. Can assign side projects to company. Prevents outside entrepreneurship.
What to negotiate instead:
- IP assignment: only work created during business hours with company resources
- Carve-out: personal projects using personal equipment don’t count
- Exclude pre-existing IP (work done before employment)
- Check local law (California doesn’t enforce broad IP assignments)
Severity: 🔴 Critical. This affects your future options.
7.3 🔴 Founder Vesting Reset on Termination for “Cause”
What it looks like:
"If Founder is terminated for cause, all unvested equity is immediately
forfeited. 'Cause' includes material breach of duties, failure to perform,
or board discretion that Founder is not adding value."
Why it’s dangerous: Vague “for cause” definition. “Board discretion” means investor can fire you and you lose equity. Year 3 of a 4-year vest: you lose 1 full year of equity. Creates use over you.
What to negotiate instead:
- Define “for cause” narrowly: felony conviction, gross negligence, material breach
- Notice and cure period (30 to 60 days to fix issue before termination)
- Single-trigger acceleration: if you’re terminated without cause, you’re fully vested
Severity: 🔴 Critical. This is your income.
7.4 🟡 Founder Non-Solicitation (Employee & Customer)
What it looks like:
"Founder shall not, during employment and for 2 years after,
solicit any customers or employees of the Company."
Why it’s dangerous: Non-solicitation of employees: prevents you from hiring your old team if you start a new company. Non-solicitation of customers: prevents you from going after the same market. 2 years is aggressive (1 year is standard). Could prevent legitimate business activities.
What to negotiate instead:
- Non-solicitation of employees: 1 year post-exit, not 2
- Customer non-solicitation: narrow to “direct customers at time of exit” only
- Carve-out: passive customer relationships okay, active solicitation prohibited
Severity: 🟡 Warning. Limits future options, but less critical than non-compete.
7.5 🟡 Confidentiality (Overly Long or Broad)
What it looks like:
"All Company information shall remain confidential in perpetuity,
including strategy, customer lists, pricing, technology, and any
information not publicly available."
Why it’s dangerous: “In perpetuity” is a long time. Overly broad definition (pricing is competitive, not confidential long-term). Prevents founder from discussing experience at future jobs.
What to negotiate instead:
- Confidentiality: 3 to 5 years, not forever
- Carve-outs: publicly available information, information founder independently knew
- Exception for disclosures in legal proceedings or to legal counsel
- Standard: customer lists and trade secrets remain confidential, but strategy becomes public over time
Severity: 🟡 Warning. Expected but negotiate scope.
7.6 🟡 Founder Indemnification (Liability)
What it looks like:
"Founder shall indemnify and hold harmless the Company, its shareholders,
and the Board from any claims, liabilities, or damages arising from
Founder's negligence, breach of contract, or violation of law."
Why it’s dangerous: Personal indemnification is risky. You’re legally liable for company decisions made as CEO. D&O insurance covers the company; indemnification covers you personally. Can be used to sue you after exit.
What to negotiate instead:
- Company carries D&O insurance (standard)
- Indemnification only for gross negligence or intentional misconduct
- Carve-out: no indemnification for actions taken in good faith as CEO
- Insurance covers indemnification costs (Company pays, not you)
Severity: 🟡 Warning. Get insurance to cover this.
7.7 🟢 Founder Lockup (Standard for Exit)
What it looks like:
"Founder agrees not to sell any shares for 180 days after a public
offering or acquisition (lockup period)."
Why it’s standard: Lockup is expected after an exit (prevents founder dumps). 180 days is standard (6 months). Applies to all shareholders, not just founders. Actually good: prevents stock crashes after exit.
What to negotiate instead:
- Accept this (it’s standard)
- Negotiate for early release if hitting milestones
- Carve-out: can sell for “hardship” reasons
Severity: 🟢 Common. This is normal and expected.
SECTION 8: DECISION TREE—Which Red Flags to Fight
Use this to prioritize which flags matter:
Is this a 🔴 RED FLAG?
YES → Is this about founder ownership/control?
YES → FIGHT HARD. This affects your equity and ability to run the company.
NO → NEGOTIATE. Try to improve, but be willing to compromise.
NO → Continue to yellow flags.
Is this a 🟡 YELLOW FLAG?
YES → Is this a financial cost to the Company?
YES → NEGOTIATE. Can you lower the threshold or remove it?
NO → ACCEPT OR NEGOTIATE. Not worth blocking the deal.
NO → This is 🟢 COMMON. ACCEPT unless unusual circumstances.
ULTIMATE RULE: You can give on 3 🟡 yellow flags to win on 1 🔴 red flag.
This is the art of negotiation.
Common Trade-Offs (What to Concede, What to Fight)
You can probably give on:
- Quarterly unaudited financials (information rights)
- Co-sale rights (standard)
- Some board observation rights for other investors
- Annual audit requirement (if company grows)
You should NOT give on:
- Broad drag-along rights
- Participating preferred (unless capped)
- Full ratchet anti-dilution
- Overly broad IP assignment
- Vesting resets on termination
These are negotiable theater:
- Registration rights (won’t matter for early-stage)
- Dividend rates (most companies never pay)
- Detailed cap table audit rights (rarely used)
Red Flag Summary Checklist
Use this to score your term sheet:
🔴 CRITICAL RED FLAGS (Don’t sign if you disagree):
- Full ratchet anti-dilution
- Investor controls most board seats
- Broad veto rights on daily operations
- Participating preferred (uncapped)
- Founder vesting reset on termination
- Broad non-compete or IP assignment
- Drag-along rights without founder protections
🟡 WARNING FLAGS (Negotiate, but not deal-breakers):
- Weighted-average anti-dilution (instead of no anti-dilution)
- Expensive reporting requirements (quarterly audits)
- Down-round vesting triggers
- Tag-along rights without carve-outs
- ROFR that blocks exits
🟢 COMMON FLAGS (Accept unless unusual):
- Non-participating preferred at 1x
- Quarterly unaudited financials
- Co-sale rights
- Annual audit requirement (at scale)
- Board observation rights for other investors
Final Thought
A term sheet is a negotiation, not a final contract. Everything is negotiable. The red flags that matter most are about control and founder ownership, not valuation or reporting requirements.
Use this scanner to spot trouble, then hire a startup lawyer to negotiate. The legal fees ($5K to $15K) are the cheapest insurance you can buy. A bad term sheet can cost you millions in dilution or lost control.
Next in this series: The Investor CRM helps you manage outreach to avoid ending up with a bad term sheet in the first place.