Founders raising a first or second round are negotiating some of the most important documents in the life of their company against investors who handle investments and term sheets every day. A startup lawyer has to know not only the legal structure of an investment but the commercial reality of funding: which terms are ordinary market practice, which can be negotiated and which create real risk for the founder. The difference matters. A founder may accept an unfavourable term not because the investor would not have agreed to something else, but because they did not know the term was negotiable. The startup lawyer's role is to identify those points early and deal with them before the negotiation hardens.
Decisions taken at the start of a startup can create problems when the next round arrives. An untidy share split between founders with no proper vesting schedule, an external contributor who never signed an IP assignment, or a cap table that was not updated after a SAFE converted can all look secondary when the company is three people with no revenue. They become significant once an investor's due diligence begins. At that point, putting earlier omissions right can take time, additional agreements and negotiation, at a moment when the company is already under pressure. Getting the corporate structure, the founders' agreements and the IP assignment right early limits that risk before the next round.
A term sheet has standard terms and it has red flags — they are not all equally important to the founder.
The anatomy of a term sheet matters as much as the headline valuation. Liquidation preferences can materially affect what is left for founders and early employees on an exit. Anti-dilution clauses determine how the risk of a future down round is allocated. Board composition and board rights affect governance and control of the company after the investment. These points have to be assessed while the term sheet is being negotiated, because they are far harder to change once they have been agreed and carried into the final investment documents. The same is true of the ESOP. A properly designed option plan can be a real tool for attracting and retaining people. The size of the pool, how it is allocated, the vesting schedule and the exercise terms all have to be considered against the funding and the future development of the company. The startup lawyer's job is not simply to review the term sheet. It is to help the founder understand what its terms mean for the company, for their control and for their economic position at the next funding and on exit.
The first week counts
Early decisions create problems at the next round
Untidy share allocations between founders, the absence of vesting schedules and gaps in the corporate documents can look immaterial in the early stages. They become significant once Series A due diligence begins — and putting them right at that point can be difficult and expensive.
Know what is negotiable
Term sheets have standard terms and red flags
Liquidation preferences, anti-dilution and board composition are all settled at term sheet stage — knowing what is an ordinary market term and what can be negotiated can materially change the outcome of the deal.
Easy to overlook
IP assignment from external contributors is not automatic
Unlike employees, external contributors and freelancers do not automatically assign the intellectual property they create. The absence of a proper written assignment is one of the issues that can surface during an investor's due diligence.
Design it properly
An ESOP is a tool for attracting and retaining people
A share incentive plan that is properly sized, with a proper vesting schedule, is one of the strongest tools a startup has for hiring and keeping talent in a competitive market.