Series A term sheet - is 25% dilution normal or am I getting screwed?

We just got our first Series A term sheet and I'm trying to figure out if the terms are standard or if we're being taken advantage of.

Background: B2B SaaS company, $2.1M ARR, grew from $400K last year. Profitable on a contribution margin basis but burning about $50K/month on growth initiatives. Three cofounders currently own 75% (I have 35%, other two have 20% each). Early angel investors and advisors own the remaining 25%.

The term sheet:

• $8M investment at a $32M pre-money valuation
• 20% of post-money ($40M post)
• But they're asking for a 15% option pool increase BEFORE the investment
• Full ratchet anti-dilution protection
• 2x liquidation preference, participating preferred
• Lead gets a board seat + observer rights for another partner

When I do the math with the new option pool, my ownership drops from 35% to like 26%. That's a 25% dilution which seems really high for a first institutional round?

Also not sure about the "participating preferred" thing. My lawyer mentioned it's aggressive but I don't fully understand the implications. Can someone explain in plain English?

That participating preferred is a huge red flag. Let me explain what it means:

Normal preferred stock: Investors choose between getting their money back (liquidation preference) OR their percentage ownership in an exit. They pick whichever is higher.

Participating preferred: They get their money back FIRST, THEN they also get their percentage of what's left. They get paid twice.

Example: If you sell for $50M with 2x participating preferred on $8M:

• They get $16M off the top (2x their $8M)
• Then they get 20% of the remaining $34M = $6.8M more
• Total to investors: $22.8M out of $50M sale (45% of proceeds on 20% ownership)

You getting absolutely crushed on modest exits. This structure was common in 2009 but is mostly dead now except for struggling companies.

The full ratchet anti-dilution is also really aggressive. Most term sheets use weighted average anti-dilution which is way more founder-friendly.

Full ratchet means if you ever raise money at a lower valuation (down round), their shares get repriced to the new lower price. Basically transferring ownership from founders to early investors.

At your metrics ($2M ARR, profitable unit economics, good growth), you should be getting much better terms. Are you talking to multiple VCs or is this your only option?

We have two other firms interested but they're both earlier stage investors (late seed/pre-A) and couldn't write the full $8M check. This is the only term sheet we have in hand right now.

Our lawyer said the participating preferred is "non-market" and we should push back hard. But I'm worried about offending them and losing the deal. We have about 4 months of runway left and really need this capital.

The full ratchet thing - is that something I can negotiate away? What's the standard protection VCs get?

Startup attorney here. Your lawyer is correct - this term sheet has multiple non-market terms for a healthy Series A. Let me break down what's standard vs. aggressive:

Market terms for your stage:

• 1x liquidation preference, non-participating (standard for 95% of deals)
• Broad-based weighted average anti-dilution (not full ratchet)
• Pro rata rights for future rounds
• One board seat for the lead investor
• Standard protective provisions (approval rights on major decisions)

Aggressive terms in your sheet:

• 2x participating preferred (extremely aggressive, usually only seen in distressed financings)
• Full ratchet anti-dilution (punitive, non-standard)
• 15% option pool increase (depends on your hiring plans, but forcing it pre-money increases their ownership at your expense)

The 25% dilution itself isn't crazy for a Series A, but the structure underneath is problematic. You should absolutely negotiate these terms.

I accepted similar terms in 2019 when I was desperate for capital. Biggest mistake of my fundraising career.

We sold the company 2 years later for $45M (which I thought was amazing). After the participating preferred math, investors got $28M and founders/employees split $17M. I personally walked away with $4.2M on a $45M exit after working 5 years and owning 22% of the company.

If it had been standard 1x non-participating preferred, I would have made $9.9M instead. The participating preferred cost me $5.7M.

Don't make my mistake. Counter-propose aggressively or walk away if you can.

Wow, that's sobering. Thank you for sharing that.

I'm going to push back on the participating preferred and full ratchet. What should I counter with specifically? Just "1x non-participating and broad-based weighted average"?

Also, if they refuse to budge on these terms, is that a sign they're a bad partner? Or is it normal negotiation and I should just accept it to get the deal done?

Here's how I'd approach the negotiation:

Hard no's (non-negotiable):

1. Change participating preferred to non-participating. This is the most important point. If they won't budge here, seriously consider walking away.
2. Change full ratchet to broad-based weighted average. Explain you need downside protection flexibility for future rounds.

Negotiable items:

1. Liquidation preference: Offer to keep 2x if they make it non-participating. Or push for 1.5x as a compromise. But never accept 2x AND participating.
2. Option pool: Show them your actual hiring plan. If you don't need 15% for hires in the next 18 months, negotiate it down to 10% or make it post-money.

If they refuse to move on the participating preferred, that's a massive red flag about the partnership. Good VCs understand founder alignment matters for long-term success.

VC here (though not one of your potential investors). Chiming in because this is frustrating to see.

At $2.1M ARR with strong growth and profitability, you should be getting clean, founder-friendly terms. The terms you described are what we'd offer to a struggling company with 6 months of runway and no other options.

Some questions to consider:

• Have you run a proper process with 8-10 VCs? Or did you just talk to a few?
• What's your monthly burn and true runway?
• Could you become default-alive (profitable) if you had to?

If you have negotiating leverage, use it. If you don't, creating it (even through getting profitable for 6 months) is worth delaying the round.

This has been incredibly helpful. I talked to my cofounders and our lawyer over the weekend. Here's our plan:

1. We're going to reach out to 5 more VCs this week to create competition and potentially get another term sheet
2. We're submitting a counter-proposal to the existing VC: 1x non-participating preferred, broad-based weighted average anti-dilution, 12% option pool (we can justify this with our hiring plan)
3. If they refuse to move on participating preferred, we're going to walk away and either raise a smaller round from the other interested investors or cut burn to get profitable

Turns out if we cut our growth spending, we can actually be cash-flow positive at current revenue levels. We'd grow slower (maybe 50% instead of 100% this year) but we'd have leverage in negotiations.

Lesson learned: Don't raise from a position of desperation. Thanks everyone for the reality check.

Smart approach. Getting to profitability (or near-profitability) completely changes the negotiating dynamic. You go from "need money to survive" to "want money to accelerate growth."

One more thing to add to your counter: ask them to explain their rationale for the participating preferred. Sometimes investors will back down just from having to justify aggressive terms out loud.

Good luck with the process. Feel free to DM me if you need a second set of eyes on the revised terms once you get them.