Three term-sheet traps the lawyer's redline misses

A founder I work with sent me a term sheet on a Tuesday afternoon. He was signing on Thursday. The fund was a known name, the lead partner was someone he liked, and his lawyer had reviewed the redline and pronounced it clean.

I read it that night and called him on Wednesday. The redline was tidy. The lawyer was right that there was nothing legally wrong with any clause. There were three clauses that, on the morning the company exited at twenty-eight million dollars in seven years, would mean the founders would receive about thirty percent less than they thought they would.

The clauses were not legal traps. They were business traps wearing legal clothing. The lawyer, doing exactly the work she had been retained to do, had not been asked to model the exit. She had been asked to redline the legals.

Below are the three traps that most often pass the redline because they are not legal mistakes. Each one is decidable in an afternoon of modelling. None of them require a lawyer who specialises in venture; all of them require the founder to know what to look for.

Trap 1: Liquidation preference dressed as 1x

Almost every modern term sheet shows a 1x non-participating liquidation preference. The number reads cleanly. It says: in a sale, the investor gets their money back first, then converts to common stock and shares the rest with the founders pro-rata. This is the market default and is, by itself, fine.

The trap is not in the 1x. The trap is in the participation. "1x participating" means the investor gets their money back first AND then shares the rest pro-rata. On a $5M check at a $25M valuation, with a $28M exit, 1x non-participating returns the investor $5M and converts to ~17% of common; the founders share the rest. 1x participating returns the investor $5M off the top AND ~17% of the remaining $23M. The founders' share drops by about a million dollars on a $28M outcome, more on smaller exits.

The redline reads "1x participating." The lawyer correctly notes it is participating. The founder, reading the term sheet for the first time, sees the 1x and the cap on participation (sometimes 2x or 3x) and assumes the cap is generous. It is not. The cap is the worst-case for the investor; the median outcome the cap permits is much worse for the founder.

What to model: build the cap table under the realistic exit scenarios you are willing to commit to in an investor update. At each exit valuation, calculate the founder share under non-participating and under participating. The delta is the cost of the trap. Take the term sheet to the partner with the model attached and ask for non-participating. The partner who refuses is signalling the deal terms more clearly than the partner who agrees.

Trap 2: Anti-dilution that triggers on paper events

Weighted-average anti-dilution is standard. It protects the investor from dilution if the next round prices below this round. The math is straightforward and the protection is reasonable. The trap is in two clauses that ride alongside it.

The first is a definition of "price" that includes paper events. SAFEs converted at a discount, options pool top-ups in advance of the next round, secondary purchases at a low strike — any of these can be defined to count as a "new round at a lower price" and trigger the anti-dilution adjustment. A founder who issues a SAFE in good faith to a key advisor at a 20% discount can accidentally retrigger the lead investor's anti-dilution protection, transferring shares from the founders to the lead without a single dollar of new capital arriving.

The second is a definition of the option pool top-up that requires it before the next round, not as part of it. This is the famous "option pool shuffle" — the next round's pool comes out of the founders' shares, not the post-money cap table. Combined with the first clause, the option pool shuffle triggers the anti-dilution adjustment, and the founders pay twice for the same dilution.

What to model: take the term sheet's definitions of "price," "new financing," and "option pool" to your existing cap table. Run the next two plausible rounds against them. The shape of the founder column over those two rounds is the test. If the founder column drops faster under these definitions than under the standard ones, you have found a trap that is not visible in the redline because the redline does not run the cap table forward.

Trap 3: Board control by composition

Most term sheets specify board composition in plain language. Three seats: one founder, one investor, one independent. The founder reads it and thinks the investor has one vote. The trap is not in the vote. The trap is in who the independent is.

If the independent is appointed by mutual agreement, the practical effect is that the founder and the investor each have a veto over the third seat. In a deadlock, the seat stays empty, the board cannot vote, and the founder loses the protection a friendly independent would have provided. The lawyer correctly notes that the language is balanced. The fund correctly notes that they always agree on the independent. Three years later, when the fund and the founder disagree about a strategic direction, the lawyer's note about balanced language is no longer the relevant fact.

The variation to watch for is the "observer seat" with extended observer rights. An observer with information rights and the right to attend executive sessions is, in practice, a fourth board member without a vote, and the meeting changes shape around them. Founders who think they have given up only "observer" rights are routinely surprised at how observed observer status feels in a difficult quarter.

What to model: make a list of the three hardest decisions you might face in the next two years (a pivot, a dismissal of a senior hire, a strategic pivot away from the lead's thesis). Sketch how the board would vote on each under the proposed composition. If the answer is "it depends on the independent," decide now whether you are comfortable with that answer; the board is being designed for the cases where it depends, not for the cases where it does not.

How to read every term sheet from now on

• Build the cap table forward two rounds before signing. Most traps are visible in the second round, not the first.
• Model the exit at three valuations: the realistic one, the soft one ($30-50M), and the moonshot. Founder share under each tells you what you are actually selling.
• Treat the lawyer as a redliner, not a strategist. The strategy is on you. The lawyer makes sure the contract says what it says; you make sure what it says is what you want.
• Talk to one founder who has signed with this fund and exited. Their forty-five-minute story tells you more than the partner conversation does.

The companion habit

The decision-log template on the resources page is the artefact that captures the modelling work behind a term-sheet decision. Date, decision, alternatives considered, why this one, expected outcome, review date. The log is what you read three years later when you are wondering whether the call was right; without it, you only have the outcome and not the reasoning that produced it.

A clean redline is a useful artefact. It is not the same artefact as a clean deal. The deal is decided in the model the redline never sees.