That said, with a lot more capital being available, startups with high investor demand are raising a lot more money at an earlier stage with much higher valuations. This direction was also showcased this week at the Y Combinator Demo Day:

ilan abehassera on Twitter

Most of the YC startups I am seeing from this batch (W19) are super super early, with much later stage valuations. I wish they were raising less money with valuation < 10M post. Raising at a $15/20M valuation at this stage is, most of the time, going to kill them, Thoughts?

But all is good when things are pointing in the right direction. Lead investors are pushing term sheets left and right to try and get into the best deals. But what happens when the market turns? Capital will start to dry up, making it harder for founders to raise new rounds to fund their companies. Financing and exit dynamics will shift and the following terms in term sheets will increase in importance for founders and VCs.

Let’s take a brief look at terms that every founder needs to understand to protect themselves in case of market downturn:

Drag-Along

This term gives the right to the preferred investors to drag-along all other investors and the founders into a sale of the company, regardless of others desires. Investors might even push for a sale that are at or below the liquidation preferences, which might leave the entrepreneurs empty-handed.

This term matters most when things are falling apart. To make things more favourable from a founder perspective, ask the venture fund during the term sheet negotiations to have the drag-along rights to pertain to following the majority of common shareholders instead of preferred. In this situation, the founder, who own common stock, are dragged along only when a majority of the common shareholders agree to a sale/merger.

Pay-to-Play

Basically, in a pay-to-play provision, investors of previous rounds must keep participating in future financing to not have their preferred stock converted into common stock in the company. Under this term, the investor has to support the company during its life cycle or have his shares converted to common. This protects founders whenever the investor does not want to commit to their pro-rata rights during an economic meltdown. It also sets the table for the rules of engagement for future financing rounds from the very beginning of the relationships between the company and its investors.

Unfortunately, this provision may not be suitable for early-stage seed funds as they often do not participate in follow on rounds. This term would ultimately penalize them for backing you early on when no one else would.

Both terms become important when markets come crashing down like they did in 2001 and 2008. It additionally helps protect the founders from unknowingly committing and accepting the first term sheet that hits their desk.

Which other terms should be included in the list?