Term Sheets, SAFEs and Convertible Notes

This explains the vocabulary; it is not legal advice. Have the actual document read by a lawyer who has done venture rounds before — not your family lawyer. Their education on your deal is expensive in your time.

Three instruments and the difference

• A priced equity round. You agree a valuation, the investor buys shares, it is registered. You know exactly what you have left. It is the most expensive in legal fees and the slowest.
• A convertible note. The investor lends money that converts into equity at the next round, normally with a discount and a valuation cap. If conversion never happens, it is debt with a maturity date and interest.
• A SAFE. Simple Agreement for Future Equity — behaves like a convertible note but is not debt: no maturity, no interest. It grew out of US practice, and outside that jurisdiction its use needs checking with a local lawyer; in much of Europe you will more often see a convertible loan.

Convertibles exist to postpone the hardest question — what is the company worth — until there is more data to answer it with. That is both their advantage and their risk.

Cap and discount: what they really do

These two parameters determine how much the investor gets at conversion.

The discount is a reduction against the next round's price. At a 20% discount the investor converts at 80% of what new investors pay — the reward for arriving earlier and carrying more risk.

The cap is a ceiling on the valuation at which conversion happens. If an investor has a €4M cap and the next round prices at €10M, they convert as if the company were worth €4M — which gives them a materially larger stake than a 20% discount would.

When both appear, whichever is better for the investor normally applies. That is standard and not unfair — you just have to be able to do the arithmetic in advance.

What happens when you stack them. The most common mistake I see: a company signs four convertibles in a row, each with a different cap, and nobody models it. At the next round they all convert at once and the founders discover they gave away far more than they thought. Keep a table of every outstanding instrument and update it on every signature.

The term sheet: read this before the price

A term sheet is a non-binding summary. Most founders read the valuation and stop. These items will affect your outcome more:

• Liquidation preference. Who gets paid first on a sale. "1× non-participating" is the standard: the investor takes either their money back or their pro-rata share, whichever is larger. Participating means both, and at a modest exit it can leave founders with dramatically less.
• Anti-dilution. Protects the investor if a later round prices lower. "Broad-based weighted average" is common and tolerable; "full ratchet" is harsh and has no place at early stage.
• Board composition. How many seats the investor takes, how many the founders keep, whether there is an independent. This decides who decides.
• Protective provisions. The list of things you cannot do without investor consent — sell the company, raise again, change the articles, take on debt above a threshold. The longer the list, the less you run your own company.
• Founder vesting. If you do not have it, expect it. Four years with a one-year cliff is standard, often with credit for time already served.
• Drag-along and tag-along. Who can force whom to sell, and who can join a sale.

The option pool and where it sits

This is where founders lose the most without noticing.

The investor will want an option pool for future hires, typically 10–15%. The question is not whether there is a pool, but whether it is created before or after the round.

Created pre-money — the usual ask — it dilutes only the existing shareholders, meaning you. Created post-money, it dilutes everyone including the new investor. The difference to your stake is often several percentage points, more than you would win by fighting hard on the valuation.

The second half of this: justify the pool size with a hiring plan. If the investor asks for 15% and you plan four hires before the next round, work out what you would actually grant them and show it. Pools can be agreed at a number that matches the plan rather than a round percentage.

What is negotiable and what is not

At pre-seed and seed you have less leverage than you would like, but not none. These genuinely move:

• Option pool size and placement. The best effort-to-outcome ratio on the page.
• The cap on convertibles. Real room here, especially with more than one interested party.
• The scope of protective provisions. The list can usually be trimmed to what genuinely matters.
• Participating preference. At early stage this can normally be refused; if an investor insists, that tells you something about how they think.

Conversely, arguing over 1× non-participating preference, standard vesting and ordinary anti-dilution is usually not worth it — these are market standards, and pushing on them spends credibility you will need elsewhere.

Above all: the only real leverage is competition. One term sheet means you are accepting terms. Two means you are discussing them. That is why the process is run in parallel — more in the fundraising overview, and on how the price gets set at all in startup valuation.