Term Sheet Red Flags Founders Miss

A term sheet is read twice. Once by the founder at signing, quickly, with the valuation number filling most of the field of vision. Once by lawyers at exit, slowly, when every clause is worth exactly what it says. The gap between those two readings is where founders lose money. This briefing, current as of July 2026, walks through the clauses that most often pass the first reading and dominate the second — and puts a price on each. It assumes a Pakistani private company raising a priced or convertible round; where a clause interacts with Pakistani statute, we say how.

One framing point first. Most of a term sheet is expressly non-binding, but the parts that bind — exclusivity, confidentiality, costs — bind fully under the Contract Act, 1872, and the non-binding parts set the anchor for the long-form documents. Founders almost never claw back at the shareholders' agreement stage a term they conceded at the term sheet stage. Negotiate the term sheet as if it were the deal, because commercially it is. This is the stage at which advice is cheapest and most effective — see our fundraising and investment practice.

The checklist

Clause	The red flag	What it costs at exit
Liquidation preference	Anything above 1x, or "participating"	Investor takes their money back and then shares the rest; in a modest sale, founders can walk away with a small fraction of what the headline split suggested
Anti-dilution	Full ratchet rather than broad-based weighted average	One down round reprices the investor's entire position at the new low price; founders absorb the whole adjustment
Redemption or put right	Investor may demand repayment after a period	Converts equity risk back into debt at the investor's option; can force a distressed sale to fund the redemption
Drag-along	No minimum price, no time threshold, low approval trigger	Founders can be forced to sell at a price that clears the investor's preference and little else
Founder vesting	Reverse vesting restarted on the full stake, no acceleration	A founder pushed out before exit forfeits equity earned over years; on acquisition, unvested shares may die with the deal
Founder warranties	Personal, uncapped, unlimited in time	Sale proceeds remain exposed to claims long after closing; personal assets stand behind company statements
Reserved matters	Veto list covering ordinary operations	Every later round, ESOP grant, and senior hire needs investor sign-off; slows the company and hands hold-up power at exit
Exclusivity	No end date, or triggered by soft conditions	The one binding clause; locks you out of the market while the investor takes their time
Costs	Company pays investor legal costs, uncapped	The round shrinks by the other side's legal bill, whatever it turns out to be
ESOP top-up	Pool created or refreshed pre-money	The dilution for the pool comes entirely out of founders and existing holders, not the new investor
Non-compete	Broad restraint on founders post-exit	Under section 27 of the Contract Act, 1872, agreements in restraint of trade are void subject to narrow exceptions — a clause the investor may know is fragile here but will price as if enforceable [SCOPE OF EXCEPTIONS AND CURRENT CASE LAW — TO BE VERIFIED BY REVIEWING LAWYER]

The economics clauses: preference and participation

The liquidation preference is the clause that most reliably surprises founders at exit, because it does nothing until then. A 1x non-participating preference is the fair market standard: the investor chooses either their money back or their percentage, not both. "Participating" changes the arithmetic — money back first, then a share of the remainder — and a multiple above 1x compounds it. In a strong exit the difference is tolerable; in the modest exits that are common outcomes, the preference stack can consume most of the consideration before ordinary shares see anything.

Under Pakistani law the preference must also be made real, not just promised. The Companies Act, 2017 permits a company to have different kinds and classes of share capital, but the rights attach through the memorandum and articles and the conditions the Act and its regulations impose — a preference described only in a shareholders' agreement, never written into the articles, is a weaker thing when tested [CONDITIONS FOR CLASSES OF SHARES AND VARIATION OF CLASS RIGHTS — TO BE VERIFIED BY REVIEWING LAWYER]. Founders should also treat a redemption right with particular caution: redeemable preference shares are permitted under the Companies Act, 2017 only within statutory conditions as to the source of redemption money, and an investor holding a contractual put against the company has effectively converted equity back into debt [REDEMPTION CONDITIONS — TO BE VERIFIED BY REVIEWING LAWYER].

The control clauses: vetoes, boards, drag-along

Reserved matters are where a minority investor becomes a controlling one. Some vetoes are legitimate — new share issues, changes to the articles, winding up. The red flag is a list that reaches into operations: hiring above a salary line, budgets, contracts above a modest threshold. Each item is defensible alone; together they mean the founder runs the company on licence. At exit, an over-broad veto list is hold-up power: a party whose consent is needed for everything can extract value for anything.

Drag-along deserves the closest reading of all. In principle it is healthy — it prevents a small holder blocking a sale everyone else wants. The red flags are structural: a drag exercisable by the investor alone rather than by a genuine majority, no floor price, and no minimum holding period. Combine a low drag threshold with a participating preference and the investor can force a sale at a price at which only the preference is paid. Remember too that in Pakistan a drag must actually be performed through the transfer machinery of the Companies Act, 2017 — instruments of transfer, board registration of transfers, and articles drafted so the obligation is enforceable against a refusing shareholder rather than merely actionable in damages under the Contract Act, 1872 [ENFORCEMENT MECHANICS AND POWER-OF-ATTORNEY STRUCTURES — TO BE VERIFIED BY REVIEWING LAWYER].

The founder clauses: vesting, warranties, restraints

Reverse vesting on founder shares is now standard and is not itself a red flag; a founder who leaves in year one should not keep a third of the company. The red flags are the parameters. Vesting restarted from zero on the whole stake ignores the years already served. No acceleration on acquisition means an acquirer can let unvested founder equity lapse. And "leaver" definitions that make almost any departure a bad-leaver event — forfeiting even vested shares — put a founder's entire position at the mercy of a board they may no longer control.

Warranties are the other personal exposure. In the long-form documents, someone will stand behind statements about the company. The red flag at term sheet stage is language pointing at founders personally, uncapped and unlimited in time. The market answer is caps tied to proceeds actually received, time limits, and disclosure against a data room. Founders should also know their own law: a penalty framed as liquidated damages for warranty breach is cut back to reasonable compensation under section 74 of the Contract Act, 1872, but nobody wants to litigate their exit proceeds to find out what "reasonable" means.

The quiet clauses: exclusivity and costs

Exclusivity is usually the only clause in the term sheet that binds immediately, and it binds under the Contract Act, 1872 like any other promise. Cap it in time — measured in weeks, not months — and tie its start to something objective. An open-ended exclusivity signed in a weak fundraising market is a slow squeeze: every week that passes, your alternatives decay and the investor's leverage over final terms grows. Costs clauses are smaller money but pure signal: agree a cap, payable only on completion.

What this means for you

Read the term sheet the way it will be read at exit, and price each clause in that light. Insist on 1x non-participating preference and broad-based weighted-average anti-dilution as your defaults, and treat departures as valuation reductions to be negotiated, not boilerplate to be accepted. Keep the reserved-matters list to genuinely structural events. Put a floor and a threshold under any drag-along, and check it can actually be performed under the Companies Act, 2017 transfer machinery. Cap exclusivity, cap costs, cap warranties. And take advice before signing, not after — the term sheet is legally light but commercially decisive, and every clause above is easiest to fix while it is still one line on two pages.