The Term Sheet Clause That Cost a Founder 12% of Her Company

She had a strong company, a signed seed round behind her, and a Series A term sheet on the table. By every visible measure, things were going well. What she did not know was that a single paragraph in her seed documents — signed eighteen months earlier, in a hurry, on her lawyer's reassurance that it was "pretty standard" — had quietly repriced her entire outcome.

The clause was participating preferred.

What participating preferred actually does

A liquidation preference determines who gets paid first when the company is sold, and how much. With a standard non-participating preference, an investor chooses at exit: take their money back, or convert and take their ownership percentage. One or the other.

Participating preferred removes the "or." The investor takes their money back first — and then also takes their ownership percentage of everything that remains. They are paid twice from the same exit. Founders and employees absorb the difference.

At a large exit, the effect is diluted and nobody complains. But most exits are not large. At a realistic mid-range exit — the kind most good companies actually have — participating preferred routinely shifts ten or more points of effective ownership from the founder to the investor. Not on the cap table anyone looks at. In the waterfall nobody models.

How we found it — and what it took to fix

When we audited her cap table ahead of the Series A, we modeled the liquidation waterfall at five exit scenarios. That is when the clause surfaced: at her most likely exit range, her effective ownership was twelve percentage points lower than her cap table suggested.

The repair was possible only because we caught it before the next round. The Series A became the renegotiation lever: we reviewed the new term sheet clause by clause, and negotiated the removal of participation as part of the round's terms. She closed on founder-favorable terms — and recovered those twelve points at exit.

The questions that would have caught it 18 months earlier

Before signing any term sheet, you should be able to answer these — with numbers, not impressions:

• Is the preference participating or non-participating? Is there a cap on participation?
• What do I personally receive at a $10M exit? At $50M? At $100M? (If nobody has modeled this, that is the red flag.)
• What does this clause become at the next round, when new investors demand at least the same terms?

"Pretty standard" is not an answer. Every clause is standard for someone — the question is who it is standard for.

"I did not know what I had signed until Marina showed me."

Raising soon? Have your cap table modeled first →  Get the 10-clause red flag guide