Startup term sheets can hide investor veto rights and liquidation preferences

The headline valuation is only part of the deal

A term sheet sketches the terms on which an investor may fund a startup. Its headline valuation can draw attention, but the details help determine what the investment means when the company is sold or wants to make a major move. Two clauses to examine are the liquidation preference and investor veto rights. Term sheets are often preliminary; the negotiated terms are typically spelled out in the final investment documents.

Who gets paid first

A liquidation preference sets the order for distributing sale proceeds. With a common 1× preference, an investor may be entitled to receive the amount they invested before common shareholders—often including founders and employees—receive sale proceeds. If little money is left after that payment, common shareholders may receive little or nothing.

The exact result depends on the clause. A nonparticipating preference generally gives the investor a choice: take the preference or convert the investment into common shares and receive a share of the proceeds that way. A participating preference can let the investor take the preference first and then share in what remains. The distinction matters most when a sale price is modest relative to the investment and the company’s ownership structure.

Who can block a decision

Veto rights, often written as approval requirements for specified actions, give investors a say over decisions such as selling the company, taking on certain debt, or changing the rights attached to shares. They do not necessarily give an investor control over everyday operations. But if approval is required, a founder cannot simply proceed alone, even when the decision seems commercially sensible.

These rights can also matter collectively: if approval is required from a defined group of preferred shareholders, the identity and voting threshold of that group affect who can block a proposal. Founders therefore need to read past the valuation and ask what happens in a sale—and which future decisions require someone else’s consent.