Part 2 Valuations & Preferences: Show Me the Money
In Part 2 of this 5 Part Series, we explore what a valuation is how to protect your upside and avoid getting crushed at exit.
Read valuation terms, protect your upside, and avoid getting crushed at exit.
You've built something real, gained traction, and now an investor is ready to write a cheque.
You feel the pressure — and the excitement. Then, the term sheet arrives. You scan it for the significant number: the valuation. Maybe you even breathe a little easier when it's higher than expected.
But here's the trap:
It's not just about how much your company is worth — it's about what you get when the money flows back.
Valuation is just one lever in the broader economics of a deal. To understand whether the term sheet is founder-friendly, you must go deeper — into liquidation preferences, participation rights, and investor protections.
Because of that high valuation? It doesn't mean much if the structure is stacked against you.
Valuation: Pre-Money, Post-Money, and the Real Math
The term "valuation" gets thrown around like it's absolute truth. But in reality, there are two types — and the difference between them can cost you millions.
Pre-money valuation: Your company's value before the new money goes in.
Post-money valuation: Your company's value after the new money is added.
Why it matters: An investor offers $2M on a $10M pre-money valuation. That means the post-money valuation is $12M — and the investor now owns 16.7%, not 20%.
Founder tip: Always confirm whether the valuation listed is pre- or post-money — and ask for a fully diluted cap table to show ownership percentages after the round.
Liquidation Preferences: Who Gets Paid First (and How Much)
This is where deals can get dangerous for founders — especially if things don't go as planned.
A liquidation preference defines who gets paid back first in the event of a sale, acquisition, or wind-down — and how much they get.
The most common structure:
1x non-participating preferred: Investor gets their original investment back first. Whatever's left is split based on ownership. This is standard and founder-friendly.
1x participating preferred: Investor gets their investment plus a share of the remaining proceeds — a double dip.
But it gets worse: some term sheets include 2x or 3x preferences, meaning the investor receives 2–3x their investment before anyone else gets a cent.
Example:
You sell your company for $10M.
The investor put in $2M with a 2x participating preference.
They get $4M first, then 20% of the remaining $6M ($1.2M).
You and your team split the remaining $4.8M and left with less than expected.
Founder tip: Push for 1x non-participating preferred shares — especially at Seed and Series A. Participating preferences are rare in competitive early-stage deals.
Anti-Dilution: Protecting Investors (Sometimes at Your Expense)
Anti-dilution clauses protect investors if you raise a future round at a lower valuation — a "down round."
There are two main types:
Full ratchet: Investor's original price per share is adjusted to the new lower price. This is very aggressive and can crush founder equity.
Weighted average: A more balanced formula that accounts for the size of the down round relative to the previous capital raised.
Founder perspective
Down rounds happen. However, full ratchet clauses disproportionately punish founders, making raising future capital harder.
Founder tip: Always ask for weighted average anti-dilution, and model its impact on your cap table in worst-case scenarios.
Dividends, Redemption Rights, and the Rest of the Money Stuff
Not all investors will ask for these — but you should know what they mean.
Dividends: Usually accrue but aren't paid unless there's an exit. But if they're cumulative and compounding, they stack up fast.
Redemption rights: Allow investors to "cash out" and get their money back after a fixed period (e.g., 5 years). This can add pressure to sell or raise again.
Founder tip:
Try to remove dividends entirely at an early stage.
Avoid redemption rights unless they kick in very late (e.g., 7–10 years).
What the Data Says
The HSBC Innovation Banking 2025 Term Sheet Guide reveals some helpful benchmarks from actual market activity:
Over 75% of term sheets issued were Seed or Series A, where founder-friendly terms (1x non-participating prefs) remain the norm.
In Series A, 12% of deals had pre-money valuations above £50M, up from 8% the year prior — showing investor optimism returning.
In hot sectors like AI, 95% of term sheets were non-participating, and founders saw better vesting terms due to investor competition.
If you're in a hot market, You have leverage. Use it.
Final Thought: Valuation Isn't Value
A flashy headline valuation is meaningless if the rest of the terms erode your economics.
As a founder, your job is to look beyond the number and ask:
What do I actually own after this round?
How will this play out at the exit?
Are incentives aligned between me and my investors?
Ultimately, a fair structure matters more than a big number—especially if you want to build a lasting company.
Next Up
Part 3 — Control Terms: Who Really Runs the Company?
We'll break down board rights, voting dynamics, founder vesting, and how to keep your seat at the table.
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