Term Sheet Red Flags: 20 Clauses That Should Make You Walk Away

A term sheet is supposed to be the beginning of a partnership. In too many Indian fundraises, it is the beginning of a slow-motion disaster that founders only recognise three years later, when the company is worth more on paper but the founders have less real control over it than they did when they owned 100%.

Most of the time, this is not because the investor was malicious. It is because the founder, under time pressure and competing term sheets, signed language they did not fully understand. Preparation closes that gap.

This guide walks through 20 term sheet clauses that are either structurally bad, or acceptable in moderation and dangerous at extreme ranges. Each one is explained in plain language, with the specific ask and the specific number or phrasing that should make a founder push back or walk away.

How to Read This List

Each red flag below follows the same format: what the clause looks like, why it is dangerous, what the market standard is, and what the specific negotiation ask should be.

The goal is not to refuse every aggressive clause. Some aggressive-looking clauses are tolerable in exchange for others. The goal is to recognise them and to trade deliberately.

Economic Red Flags

1. Full-Ratchet Anti-Dilution

What it says: If the company issues shares in a future round at a price below the current round, the investor's share price is retroactively re-set to the lower price.

Why it is dangerous: In a down round, full-ratchet converts into massive additional share issuance to the existing investor, wiping out founder and employee equity disproportionately.

Market standard: Broad-based weighted-average anti-dilution. This adjusts the price modestly in a down round, proportionate to the size and dilution of the new round.

Negotiation ask: "We will accept broad-based weighted-average anti-dilution. Full-ratchet is a deal-breaker for us."

2. Participating Liquidation Preference with Multiple Above 1x

What it says: On exit, the investor first gets 2x or 3x their money back, and then also participates in the remaining proceeds on a pro-rata basis alongside common shareholders.

Why it is dangerous: A 3x participating preference on a ₹20 crore investment means the investor takes ₹60 crore off the top on any exit, and then participates in the remaining distribution. On a ₹100 crore sale, founders may see almost nothing.

Market standard: 1x non-participating preference — investor receives the higher of their money back OR their pro-rata share on exit, not both.

Negotiation ask: "1x non-participating is our ceiling."

3. Participating Preferred Without Cap

What it says: Investor gets 1x money back plus participation in remaining proceeds on a pro-rata basis, with no ceiling.

Why it is dangerous: Sometimes framed as "only 1x" and slipped past founders, but the participation right is the hidden cost.

Market standard: Either non-participating, or participating with a reasonable cap (e.g., 2x total return).

Negotiation ask: "If participation is required, cap total return at 2x."

4. Cumulative Dividends

What it says: Preference shares accrue a fixed dividend (e.g., 8% annually) that compounds and must be paid on exit or conversion.

Why it is dangerous: In an Indian unlisted startup context, this is rarely about dividend yield — it is a mechanism to accrue an additional return above 1x preference that compounds silently.

Market standard: Non-cumulative or zero dividend. Indian CCPS structures typically carry a nominal ₹0.01 or 0.0001% dividend for statutory compliance only.

Negotiation ask: "Non-cumulative dividend, rate at 0.0001% or the minimum required by law."

5. Liquidation Preference Triggered by Non-Exit Events

What it says: Preference is paid not only on acquisition or liquidation but also on "deemed liquidation" events including, for example, a material asset sale, change in business, or failure to achieve milestones.

Why it is dangerous: Broad deemed-liquidation triggers mean the investor can demand their preference back in situations where the company is still operating.

Market standard: Deemed liquidation events limited to acquisition, merger, and sale of substantially all assets.

Negotiation ask: "Deemed liquidation limited to change-of-control events, and requires shareholder special resolution to trigger."

Governance Red Flags

6. Disproportionate Board Composition

What it says: Investor appoints 2 of 5 board seats in a Series A round.

Why it is dangerous: With 2 investor directors, 2 founder directors, and 1 independent (nominated by investors), the founder lacks board control despite holding 60%+ economic ownership.

Market standard at Series A: Founders appoint 2 directors, investor appoints 1 director, 1 independent appointed by mutual agreement. Founders retain board majority until Series B or C.

Negotiation ask: "Founder-controlled board at Series A. Independent director requires mutual approval, not investor veto."

7. Onerous Reserved Matters / Veto Rights

What it says: A long list of decisions require investor consent — often 30-50 items covering operational matters like hiring any employee above a salary threshold, signing any contract above ₹50 lakh, or opening a new office.

Why it is dangerous: A reserved-matter list that is too long converts the investor into a de facto co-CEO. Every operational decision requires a call.

Market standard: Reserved matters limited to genuinely strategic decisions — amendment of charter documents, new funding rounds, acquisitions, disposals of more than 20% of assets, voluntary liquidation, change in business, related-party transactions above a threshold.

Negotiation ask: "Reserved matters list capped at 12–15 items, all strategic in nature, with clear quantitative thresholds."

8. Individual Investor Veto at Low Threshold

What it says: Any single investor holding 2% or more of the company can veto reserved matters.

Why it is dangerous: Later rounds add more investors. A 2% veto holder that is no longer strategically aligned can hold the company hostage.

Market standard: Reserved matter consent requires holders of majority or 2/3 of preference shares voting as a class, not individual vetoes.

Negotiation ask: "Reserved matter consent by majority of preference shares as a class. No individual veto rights."

9. Founder-Specific Veto Rights Expiring on Termination

What it says: Specific founder rights (consent on certain matters) automatically lapse if the founder ceases to be employed.

Why it is dangerous: Creates an asymmetric incentive. A board that wants to dilute founder power can engineer a termination that also eliminates founder veto rights.

Market standard: Founder rights tied to equity ownership, not employment. A founder who is pushed out but retains >10% equity should retain core rights.

Negotiation ask: "Founder rights tied to equity ownership threshold, not employment."

Drag and Tag Red Flags

10. Drag-Along at Less Than 75% Threshold

What it says: A majority of preferred shareholders can force all other shareholders to sell their shares in an acquisition.

Why it is dangerous: A drag-along with a low threshold (e.g., 51%) means a single investor with 51% of the preferred class can force a sale at a price that is disastrous for founders.

Market standard: Drag-along triggered at 75% of preference shares AND a majority of common shares, with a minimum sale price or other floor conditions.

Negotiation ask: "Drag threshold 75% of preference plus majority of common. Floor price linked to preference preference amount or a hurdle rate."

11. Drag-Along That Forces Founders to Sign Restrictive Covenants

What it says: On a drag, founders must sign non-compete and non-solicit covenants as part of the transaction.

Why it is dangerous: Founders can be dragged into signing two-year non-competes in an acquisition they did not want and for which they receive nothing above pro-rata proceeds.

Market standard: Drag obligations limited to customary reps and warranties. Restrictive covenants on founders require founder-specific consent or additional consideration.

Negotiation ask: "Drag obligations for founders limited to standard reps. Any non-compete requires separate founder consent and consideration."

12. One-Way Tag-Along

What it says: Investors can tag along when founders sell but founders cannot tag along when investors sell.

Why it is dangerous: Creates an asymmetric exit path. Investors get early liquidity; founders cannot.

Market standard: Tag-along rights for all shareholders (or, if limited, symmetric between classes).

Negotiation ask: "Tag-along rights extend to founders and employee option holders, symmetric with investor tag rights."

Rights of First Refusal and Pre-emption

13. ROFR on Every Founder Share Transfer

What it says: Investors have a right of first refusal on any transfer of founder shares, including transfers to family, trusts, or estate planning vehicles.

Why it is dangerous: Blocks legitimate estate planning, intra-family transfers, and minor secondary sales.

Market standard: ROFR excludes transfers to permitted transferees (immediate family, trusts for family benefit), subject to the transferee signing an adherence agreement.

Negotiation ask: "ROFR carve-out for transfers to family members, family trusts, and estate planning vehicles."

14. Pro-Rata Rights That Extend Beyond Maintenance

What it says: Investor has the right to purchase more than their pro-rata share in future rounds (super pro-rata).

Why it is dangerous: Lets the investor increase ownership disproportionately in subsequent rounds, crowding out new investors and diluting founders further.

Market standard: Pro-rata rights limited to maintenance of existing ownership percentage.

Negotiation ask: "Pro-rata rights capped at the investor's current ownership percentage."

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Process and Timing Red Flags

15. Exclusivity Longer Than 45 Days

What it says: The founder cannot speak to other investors or entertain alternative term sheets for a specified period — often 90 or 180 days.

Why it is dangerous: Long exclusivity periods eliminate leverage. If diligence drags on and the investor renegotiates, the founder has no alternative ready.

Market standard: 30–45 days exclusivity for Series A, automatically extending only if diligence is substantively progressing.

Negotiation ask: "Exclusivity 30 days, extending to 45 days only by mutual agreement and conditioned on diligence progress."

16. NDA That Contains Non-Compete or Non-Solicit Covenants on Founders

What it says: The "NDA" signed at the start of discussions includes covenants preventing the founder from building a competing business or soliciting employees of the investor's portfolio companies.

Why it is dangerous: Founders sign NDAs casually; the non-compete language in an NDA can be legally material. Under Section 27 of the Indian Contract Act, 1872, post-contractual non-competes are void, but during-engagement restrictions can be enforced.

Market standard: NDA restricted to confidentiality. No substantive non-compete or non-solicit on founders at NDA stage.

Negotiation ask: "NDA confined to information confidentiality. Any restrictive covenants on founders addressed only at term sheet or definitive agreement stage."

17. No-Shop With Break-Up Fee

What it says: If the founder signs the term sheet and subsequently takes another deal (even one offering materially better terms), a break-up fee is payable to the investor.

Why it is dangerous: Break-up fees at the term sheet stage create artificial lock-in. Term sheets are typically non-binding except on confidentiality and exclusivity.

Market standard: Term sheet is non-binding except for confidentiality, exclusivity, and expense reimbursement. No break-up fee.

Negotiation ask: "Term sheet binding only on confidentiality and exclusivity. No break-up fee."

Founder-Facing Red Flags

18. Non-Compete Covenants on Founders

What it says: Founders agree not to engage in any competing business for 2–5 years after termination of employment.

Why it is dangerous: Beyond the legal enforceability issues (Section 27 ICA), broad non-competes lock founders out of their own industry for years if they exit the company. Indian courts have been restrictive on post-termination non-competes, but the mere existence of the covenant creates settlement leverage in disputes.

Market standard: Non-solicitation of employees and customers for 12–24 months post-employment is common and enforceable. Non-compete is typically limited to the period of employment.

Negotiation ask: "Non-compete during employment. Post-employment restrictions limited to non-solicitation for 12 months."

19. Founder Vesting Re-start

What it says: On closing of the round, founder shares are re-subjected to a fresh vesting schedule — often 4 years from the round closing.

Why it is dangerous: A founder who has already been working for 3 years loses the vesting credit from those years.

Market standard: Credit for time already worked. Typical structure: total vesting period is 4 years from original start date, with the cliff already deemed met.

Negotiation ask: "Vesting credit for time already worked. Unvested shares vest over remaining period to original 4-year milestone from founder start date."

20. "Bad Leaver" Provisions with Overbroad Triggers

What it says: If a founder ceases to be an employee for reasons the investor considers to constitute "bad leaver" conduct (e.g., "material underperformance," "loss of investor confidence"), unvested shares and a portion of vested shares are forfeited or bought back at par value.

Why it is dangerous: Vague bad-leaver triggers give investors unilateral power to convert a founder into a bad leaver via a terminations-and-consequences chain.

Market standard: Bad-leaver limited to clear misconduct — conviction of a crime, fraud, material breach of confidentiality, material breach of non-solicit. Buyback at fair market value, not par.

Negotiation ask: "Bad-leaver definition limited to conviction of fraud or willful material breach. Unvested shares forfeit on bad-leaver; vested shares subject to company buyback at fair market value, not par."

The Negotiation Sequence

For most Indian founders, the right order of engagement with a term sheet is:

1. Read it line by line. Do not rely on summaries. The devil lives in subclauses.
2. Check the 20 red flags above. Create a table: current position | market standard | our ask.
3. Prioritise. Pick 4–6 issues that are genuinely non-negotiable. Do not fight on 15 things; investors read this as inexperience.
4. Triangulate. Compare against at least one other recent term sheet in your stage and sector (ask a peer founder or advisor).
5. Engage counsel before signing. Even a short 2-hour review by an experienced venture lawyer can surface issues.
6. Negotiate in a single batched response. Not clause-by-clause over days.
7. Be prepared to walk. If there is no BATNA (Best Alternative To a Negotiated Agreement), the founder has no leverage. Walking away from a deal is sometimes the negotiation.

What "Acceptable" Looks Like

A clean, founder-friendly Indian Series A term sheet typically includes:

• 1x non-participating preference, non-cumulative.
• Broad-based weighted-average anti-dilution.
• Founder-controlled board (2 founders, 1 investor, 1 independent).
• Reserved matters limited to 12–15 strategic items, by class vote.
• Drag-along at 75% plus majority of common, with reasonable floor.
• Mutual tag-along rights.
• Pro-rata rights capped at maintenance.
• Exclusivity 30–45 days.
• Non-compete limited to employment term; non-solicit 12 months.
• Vesting: credit for time worked; double-trigger acceleration.
• Bad leaver limited to fraud / wilful misconduct; vested shares bought at FMV, not par.

A term sheet substantially in this shape can be signed with confidence. A term sheet far from it requires sustained negotiation or walking away.

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Frequently Asked Questions

Is a term sheet legally binding in India?▾

Most provisions of a term sheet are non-binding by design. A typical Indian term sheet explicitly states that all commercial terms are indicative and subject to execution of definitive documents (Share Subscription Agreement and Shareholders' Agreement). However, specific provisions — usually exclusivity, confidentiality, and expense reimbursement — are expressly marked as binding and are enforceable under the Indian Contract Act, 1872. Founders should read the binding/non-binding carve-out carefully. A break-up fee provision, if included and marked binding, is also enforceable if properly drafted.

How long does a typical Indian Series A term sheet take to convert into definitive documents?▾

Conversion from signed term sheet to closed round typically takes 60–90 days for Series A in India. The components: 3–4 weeks of legal, financial and commercial diligence; 3–4 weeks of drafting and negotiating the Share Subscription Agreement and Shareholders' Agreement; 1–2 weeks for statutory compliances (ROC filings, stamp duty, FEMA compliance if the investor is foreign). Complex rounds with multiple co-investors or foreign direct investment considerations can stretch to 120 days or more. An exclusivity period shorter than the realistic closing timeline creates dangerous pressure on founders.

What is the difference between participating and non-participating liquidation preference?▾

Non-participating preference gives the investor a choice on an exit: either take back their invested amount (1x preference) or convert to common shares and take their pro-rata share, whichever is higher. Participating preference gives the investor both: 1x their money back plus pro-rata participation in the remaining proceeds. Participating preference is materially more founder-unfriendly. Indian market standard is 1x non-participating preference. Participating preference, if accepted, should be capped at a total return of 2x (meaning investor cannot take more than 2x their money including the participation). Full participating with no cap is almost never appropriate for Series A in India.

Are non-compete covenants on founders enforceable in India?▾

Post-termination non-compete covenants are generally unenforceable in India under Section 27 of the Indian Contract Act, 1872, which voids any agreement that restrains a person from exercising a lawful profession, trade, or business. Indian courts have consistently held that post-termination non-competes cannot be enforced. Non-competes during the term of employment are enforceable to a reasonable extent. Non-solicitation covenants — preventing the founder from soliciting employees or customers of the company — are more enforceable, particularly for durations of 12–24 months post-termination. Founders should negotiate to replace non-competes with non-solicits wherever possible.

What is a 'drag-along' clause and at what threshold should it be set?▾

A drag-along clause allows a specified majority of shareholders to force all other shareholders to participate in a sale of the company. It ensures that a small minority cannot block an acquisition approved by the majority. Market-standard drag thresholds in Indian Series A term sheets are 75% of preference shares voting as a class PLUS a majority of common shares, with a minimum sale price or other floor conditions. Lower thresholds (e.g., 51% of preference alone) are founder-unfriendly and should be pushed back against. Drag provisions should also include carve-outs — for example, the obligations imposed on dragged shareholders should be limited to customary reps and warranties, not unlimited indemnities or restrictive covenants.

Can I negotiate a term sheet without engaging a lawyer?▾

You can, but you should not. A term sheet negotiation is one of the highest-leverage legal exercises a founder ever undertakes, and the cost of expert review (₹50,000–₹3,00,000 at Series A) is trivial compared to the impact of an adverse clause over 5–10 years. Engage a venture lawyer with recent experience in Indian VC deals. For pre-seed angel rounds, lighter-touch review may be sufficient, but at seed and Series A, professional review is a minimum cost of doing business. Many Indian boutique firms offer flat-fee term sheet reviews at ₹50,000–₹1,50,000 for standard rounds.

What are the most commonly missed red flags in Indian term sheets?▾

Three clauses are most commonly overlooked: (1) broad deemed-liquidation triggers that allow investors to trigger preference payment without an actual exit event; (2) drag-along thresholds set below 75% or missing price floors; (3) founder-specific covenants buried in the Shareholders' Agreement draft that were not flagged in the term sheet. A fourth, specific to Indian deals, is the stamping implications of the term sheet and definitive documents — inadequate stamping under the applicable state Stamp Act can render documents inadmissible in evidence, a detail that surprises founders when disputes arise years later.