Reading a VC Term Sheet: Anti-Dilution, Liquidation Preference, and Board Composition, Explained for Founders

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A term sheet is a letter of intent to invest. The only clauses that are typically legally binding are confidentiality and no-shop (exclusivity). Everything else is, in principle, non-binding. In practice, though, term sheet conditions carry over almost unchanged into the shareholders' agreement. "We'll negotiate that later" is a dangerous assumption to make.

In the Korean startup ecosystem, a term sheet is typically 2–5 pages. It covers the investment amount, valuation, share class, and a list of clauses. The share class is almost always convertible preferred stock. Unlike common stock, it comes attached with liquidation preference, weighted voting rights, and anti-dilution protection. The common stock founders hold and the convertible preferred stock investors hold aren't the same thing just because they're both called "stock."

The moment you receive a term sheet, the key move is running every clause through exit scenarios. You need to simulate in a spreadsheet what the founder actually walks away with if the company is acquired for ₩10B, ₩20B, or ₩50B. Plenty of founders still sign without ever running that calculation.

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An anti-dilution provision is a mechanism that corrects an existing investor's ownership stake when a later round raises money at a lower valuation than the previous round — a down round. There are broadly two correction methods: full ratchet and weighted average.

In the Korean market, broad-based weighted average is effectively the standard. That said, full ratchet sometimes gets slipped in when an early-stage angel or strategic investor (SI) sets the terms. Founders need to confirm not just "there's an anti-dilution clause" but which method it uses.

Let's walk through the numbers on how anti-dilution correction actually plays out in a down round. Say a Series A investor put in ₩100M at ₩10,000 per share, acquiring 10,000 shares. In Series B, a down round drops the price to ₩7,000 per share. Under full ratchet, the existing investor's conversion price resets to ₩7,000, so that same ₩100M investment now converts into 14,285 shares. Those extra shares don't appear out of thin air — they dilute the founder's common stock.

There's also a negotiating lever to soften anti-dilution correction: a pay-to-play clause. Insert one, and any existing investor who doesn't participate in a later funding round loses their anti-dilution protection. That's a founder-favorable term, but pushing for it directly in Korea can make the negotiation tense. Judge it based on the specific situation and relationship.

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Liquidation preference is the right of preferred-stock investors to receive a set amount before common shareholders when the company is sold or liquidated. 1x non-participating liquidation preference is the standard. "1x" means the investor gets their principal back first; "non-participating" means that after recovering their principal, they don't also share in what's left over.

The problem shows up when a "participating" term is attached. With participating liquidation preference, the investor takes their principal first, and then also takes an additional cut of the remaining proceeds based on their ownership percentage. This is called a double dip. Say a VC invests ₩1B for a 25% stake, and the company is later sold for ₩3B. Under 1x participating liquidation preference, the VC takes ₩1B (principal) + ₩500M (25% of the remaining ₩2B) = ₩1.5B. The founder and other shareholders split the remaining ₩1.5B. If it had been non-participating, the VC would take ₩750M (25% of ₩3B) instead of ₩1B, leaving the founder ₩2.25B.

The multiple matters too. Attach a 2x or 3x liquidation preference instead of 1x, and a scenario where the company sells for a modest amount can leave the founder with nothing at all. If you're being asked for anything beyond 1x non-participating in an early Korean funding round, it's worth re-examining that investor's underlying thesis.

Liquidation preference often disappears automatically at IPO, because convertible preferred stock converts into common stock. But for an exit via M&A or a secondary sale — any path other than IPO — the liquidation preference still applies as written. Unless IPO is your only conceivable exit path, this clause isn't one to skim over.

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The board composition clause decides who gets how many board seats. It's a clause founders commonly overlook, but the moment investors hold a board majority, things like removing the CEO, changing business direction, or blocking future fundraising become possible without the founder's consent.

At the seed stage, a common structure is 2 founders, 1 VC, 1 independent director (2:1:1). After Series A, VCs frequently ask for an additional seat. Watch for a pattern where the investor nominates the "independent" director — nominally neutral, but if that seat is functionally aligned with the investor, the founder ends up a minority on a three-person board.

You should also check for veto rights or separate consent requirements on major decisions. Separately from board composition, a term sheet can include a clause requiring majority consent from preferred shareholders on specific matters. The broader that list of matters, the more your real operating autonomy as founder shrinks.

1. Confirm the total number of board seats and how many each party gets to nominate.
2. Confirm who holds the right to nominate the independent director.
3. Ask for a full, itemized list of the decisions that trigger investor veto rights.
4. Check the quorum requirements to see whether resolutions can pass without the VC present.
5. Check whether there's a clause covering the conditions for removing the CEO.
6. Check what board consent is required for raising a later round or discussing an M&A.
7. Examine whether board composition change conditions (e.g., seats returning to the founder upon hitting a certain revenue target) are negotiable.

Negotiating board composition tends to feel less emotionally charged than negotiating the investment amount or valuation, but its real-world impact can be greater. It's worth simulating in advance, in particular, how board composition plays out if the company's situation deteriorates.

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Beyond the three core clauses, a term sheet includes other clauses that directly affect founders. Drag-along, tag-along, and right of first refusal (ROFR) are the main ones.

Drag-along lets a majority of shareholders force minority shareholders to go along once they agree to an M&A. Once a founder ends up holding a minority stake, a VC can push through an M&A on terms they want, regardless of what the founder wants. The trigger conditions for drag-along (the consent threshold, minimum sale price, etc.) need to be nailed down clearly at the term sheet stage.

Tag-along is the right for investors to sell alongside a founder, on the same terms, when the founder sells their own shares. It can feel inconvenient from a founder's perspective, but it's a standard clause with little room to negotiate. Right of first refusal, on the other hand, requires a founder or existing shareholder to offer existing investors the first opportunity to buy before selling shares to a third party. It becomes a constraint on secondary sales or a founder cleaning up their personal stake.

Vesting clauses shouldn't be overlooked either. Korean contracts don't always spell this out explicitly, but building a co-founder share buyback condition for early departure into the term sheet or shareholders' agreement upfront builds investor trust and heads off disputes. Finalize an equity structure without vesting, and an early co-founder departure gets read by investors as a structural risk.

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Q. Is it okay to sign a term sheet before retaining a lawyer?

Not recommended. A term sheet's own legal force is limited, but it becomes the starting point for everything that follows. In particular, the anti-dilution method, the liquidation preference multiple, and board composition all need to be nailed down clearly at the term sheet stage to make the definitive agreement negotiation go smoothly. At minimum, have a lawyer with startup investment experience review it.

Q. If the term sheet terms don't sit well with me, is it better to just decline?

If the terms deviate significantly from standard, negotiate before declining. VCs also treat the term sheet as a starting point for negotiation. Standard negotiating positions include asking for broad-based weighted average on anti-dilution and non-participating on liquidation preference. On board composition, aim to either keep a founder majority or agree on how the independent director gets nominated. Whether to decline is a decision you can still make after negotiating — no need to rush it.

Q. How do Korean VC term sheets differ from overseas ones?

Overseas VC term sheets are often based on the NVCA standard template. The structure of anti-dilution, liquidation preference, and board clauses is similar, but overseas VCs tend to push harder for the option pool (ESOP) to be set on a pre-money basis. Setting ESOP on a pre-money basis dilutes the founder's real stake further. Korean term sheets often leave this clause unclear, so it's essential to confirm it explicitly.