UK term sheet standards explained: the number is just the start for founders

UK Venture Capital Term Sheet Guide: What Founders Need to Know

Receiving your first venture capital term sheet is a significant milestone. While the headline valuation can feel like a validation of your hard work, it is essential to understand that the number is just the start. A UK venture capital term sheet is a complex document where seemingly small clauses can have a significant impact on your ownership, control, and future wealth. Misunderstanding UK-specific conventions for valuation or the layers of investor protections can lead to unexpected founder dilution and a loss of leverage.

This UK venture capital term sheet guide is designed for founders of pre-seed to Series B companies. We will decode the key terms, highlight critical differences between UK and US standards, and provide a practical framework for negotiating a deal that sets your company up for long-term success. For a broader overview, see the Term Sheet Understanding hub.

Decoding UK Startup Valuation: The Headline Number Isn't the Whole Story

When a UK investor offers £1 million on a £4 million valuation, the immediate assumption is they are buying 25% of the company. This is broadly correct, but the calculation contains a crucial UK-specific nuance. The foundational point is that UK valuations are typically discussed on a 'post-money' basis. This means the £4 million figure represents the company's value after the investor's £1 million has been injected. The pre-money valuation is therefore £3 million. This post-money standard simplifies the maths (£1 million is 25% of £4 million) and is partly influenced by the requirements of government-backed investment schemes, as the post-money valuation standard in the UK is partly influenced by SEIS/EIS investment structures.

However, the real dilution for founders often comes from the employee option pool. Investors almost always require a post-money employee option pool to be created before their investment. The typical employee option pool size is 10-15%. This pool is designed to attract and retain future key hires. The critical point is that this pool is created from the existing equity, meaning it dilutes the founders, not the new investor. This effectively reduces the price the founders are receiving for their shares.

Let’s illustrate this with a simple cap table calculation.

Scenario:

• Investment: £1,000,000
• Post-Money Valuation: £4,000,000
• Required Option Pool: 10% (of the post-money valuation)

1. Investor's Stake: The investor owns £1M / £4M = 25%.
2. Option Pool Sizing: The option pool needs to be 10% of the company, valued at £400,000.
3. The Dilution: The pre-money valuation is £3,000,000. But this £3M value must now account for both the founders' equity and the new £400,000 option pool. This means the founders' equity is now valued at only £2,600,000, not the full £3M.
4. Final Cap Table: The ownership is now split three ways:
   • Investor: 25.0%
   • Option Pool: 10.0%
   • Founders: 65.0%

Without the option pool, the founders would have retained 75%. The creation of the pool has cost them 10% of the company. This dilution happens before the investor’s money arrives.

Investor Protections: Standard Venture Capital Deal Terms in the UK

Beyond the valuation, a term sheet contains several clauses designed to protect the investor’s capital. While some are standard, others can significantly erode founder returns and control. A scenario we repeatedly see is founders focusing solely on the headline number while ignoring these crucial underlying terms, which define key investor rights in UK startups.

Liquidation Preference

This clause determines the payout order in an exit event, like a sale or merger. In short, investors get their money back first. The UK standard for liquidation preference is 1x non-participating. This means in an exit, an investor can choose between two options: receive their original investment back (the '1x'), or convert their shares and receive their percentage ownership of the exit proceeds. They will choose whichever option gives them a higher return.

This becomes problematic if the term is 'participating'. Participating preference allows an investor to get their money back and also share in the remaining proceeds. This 'double-dipping' can drastically reduce founder returns in modest exits.

Example: The Impact of Participating Preference

• Scenario: An investor puts in £1M for a 20% stake. The company is later sold for £10M.
• With 1x Non-Participating (Standard): The investor can take £1M back or 20% of £10M (£2M). They will choose the £2M. The remaining £8M goes to the founders and employees.
• With 1x Participating (Red Flag): The investor first gets their £1M back. Then, they get 20% of the remaining £9M (£1.8M). Their total return is £2.8M. The founders and employees are left with only £7.2M.

Anti-Dilution Protection

This protects investors from dilution if the company raises a subsequent funding round at a lower valuation, known as a 'down round'. The UK standard for anti-dilution protection is Broad-Based Weighted Average. This is a fair, blended approach that adjusts the investor's conversion price based on the size and price of the new round, taking into account all outstanding shares. It protects the investor without excessively punishing the founders. The red flag to watch for is a 'Full Ratchet' anti-dilution, which is a highly aggressive term and rare in the UK. A full ratchet would re-price the investor's entire original investment at the new, lower price, causing massive dilution to everyone else.

Board Composition and Veto Rights

Control is another key area of negotiation. For early-stage deals, founders should expect to retain board control. A typical seed round board composition is three people, often two founders and one investor. As the company grows, this may change. A typical Series A board might expand to five people, such as two founders, one investor, one independent director, and a chair.

Investors will also require 'protective provisions' or veto rights over major decisions. This is normal, but the scope should be limited to fundamental strategic actions. These typically include selling the company, changing the articles of association, or taking on significant debt, not day-to-day operational matters.

Key Differences Between UK and US Term Sheets

Much of the startup advice available online originates from the US, which can create confusion when you receive a UK term sheet. While the core concepts are similar, the market standards for certain legal clauses differ significantly. Understanding these differences between UK and US term sheets is key to avoiding costly legal debates and negotiating from a position of strength.

Founder Warranties

A major divergence appears in founder warranties. To bridge the gap between extensive due diligence and the pragmatic realities of an early-stage business, UK term sheets often involve more extensive founder warranties compared to US deals. This means founders are asked to personally guarantee a long list of statements about the company are true. These cover everything from intellectual property ownership and employee contracts to the accuracy of your accounts. A breach of these warranties can have serious personal financial consequences, so their scope should be carefully reviewed and limited by legal counsel.

Good Leaver / Bad Leaver Provisions

Another UK-specific feature is the detail and prevalence of leaver provisions. 'Good Leaver / Bad Leaver' provisions are standard and more detailed in the UK. These clauses dictate what happens to a founder’s shares if they leave the business. A 'Good Leaver' (e.g., due to death or disability) is typically allowed to keep their vested shares. A 'Bad Leaver' (e.g., resigning to join a competitor or gross misconduct) is often forced to sell their shares, both vested and unvested, back to the company at a steep discount. The definitions of what constitutes a 'good' or 'bad' leaver are a key point of negotiation.

Governing Law

Finally, a simple but crucial point: the governing law and jurisdiction for UK deals should be England & Wales. US term sheets will almost always cite Delaware law. For a UK company with UK investors, there is no reason to adopt a foreign legal framework. This is a non-negotiable point and a standard clause that should not be contested.

Your Negotiation Playbook: Practical UK Investment Negotiation Tips

Navigating a term sheet is not about winning every point. It is about achieving a fair deal that aligns incentives and builds a strong foundation for a long-term partnership with your investor. Here is a practical playbook for your negotiation.

1. Anchor on a Neutral Standard
2. Your negotiation starting point should be based on established market practice. Fortunately, The British Private Equity & Venture Capital Association (BVCA) provides model documents that serve as a credible, neutral baseline for UK term sheets. Before you speak to a lawyer, familiarise yourself with the BVCA's model term sheet. If an investor's term deviates significantly from this standard, you can reasonably ask them to justify why their deal requires an off-market term.
3. Model the Economics
4. Do not rely on the headline valuation alone. Model the economics in a simple spreadsheet. Create different exit scenarios, such as a low exit (£5M), a medium exit (£25M), and a great exit (£100M). Calculate the actual cash return to founders, investors, and the option pool under the proposed terms. This exercise will make the real-world impact of terms like liquidation preferences and option pools crystal clear. Every founder should undertake this critical exercise.
5. Prioritise Your Negotiation PointsYou cannot and should not fight every clause. Focus on what truly moves the needle on economics and control. Group your 'asks' into three categories:
   • Must-Haves: These are the red flag terms. Push back firmly on anything beyond a 1x non-participating liquidation preference, any form of full-ratchet anti-dilution, or an investor-controlled board at the seed stage.
   • Important to Negotiate: These are areas for reasonable discussion. This includes the size of the option pool (is 15% necessary when 10% would suffice?), the precise definitions in the 'Good Leaver / Bad Leaver' clause, and the scope of founder warranties.
   • Accept as Standard: Do not waste negotiation capital on market-standard terms. This includes a 1x non-participating preference, broad-based weighted average anti-dilution, and the governing law of England & Wales.
6. Hire an Experienced UK VC Lawyer
7. Do not try to save money by using a generalist commercial lawyer. An experienced UK venture capital lawyer has seen hundreds of term sheets. They will immediately spot off-market terms and know which points are worth fighting for. Their expertise is an investment that will pay for itself many times over by protecting your equity and control.

Conclusion

A term sheet is more than a financial document; it is the blueprint for your relationship with your new investors. The headline valuation is the hook, but the substance lies in the details of dilution, investor protections, and control. By understanding UK-specific standards, modelling the potential outcomes, and focusing your negotiation on the terms that matter most, you can secure a deal that is not just good on paper, but fair in practice. A good term sheet aligns interests, preparing you and your investors for the challenges ahead. Continue at the Term Sheet Understanding hub.

Frequently Asked Questions

Q: What is the difference between a term sheet and a shareholders' agreement?
A: A term sheet is a non-binding summary of the proposed investment terms. Once signed, lawyers use it to draft the full, legally binding documents, including the Shareholders' Agreement and Articles of Association. The term sheet sets the commercial foundation, while the final documents contain the full legal detail.

Q: How long does it take to negotiate a UK term sheet?
A: For an early-stage deal with standard terms, negotiation can be quick, perhaps a week or two. If the terms are complex or non-standard, it can take several weeks of discussion between founders, investors, and their respective lawyers to reach an agreement before moving to final legal drafting.

Q: Is a 10% option pool always required?
A: A 10-15% option pool is a common investor request, but its size is negotiable. You can argue for a smaller pool if you can demonstrate it is sufficient to cover your hiring plan for the next 18-24 months. The key is to justify your number with a credible hiring forecast.