Series B Term Sheet: ESOP Top-Up, Liquidation Preference and Founder Dilution
Khetify, an agri-tech platform, is raising ₹200 crore in Series B at a pre-money valuation of ₹800 crore. Before the round the cap table is: founders 58%, Series A investor 26%, angels 8%, ESOP pool 8%. The incoming investor has offered two term sheets on identical price and has insisted, in both, that the post-money ESOP pool be 12% of the fully diluted capital. Term Sheet X gives a 1x non-participating liquidation preference. Term Sheet Y gives a 1x participating preference with a 2x cap, and adds a broad-based weighted-average anti-dilution clause. The founders' base case is a ₹1,200 crore exit in four years; the bull case is ₹3,000 crore and a stress case is ₹700 crore. The lead investor argues that Y is 'standard for Series B' and that the founders should focus on the valuation, not the fine print.
1. Compute the post-round cap table under a 12% post-money ESOP pool and quantify the founders' true dilution versus the naive 20% figure.
Read the worked answer
Post-money valuation = 800 + 200 = ₹1,000 crore; the investor's ₹200 crore buys 20%.
If the ESOP pool must be 12% of post-money fully diluted, the existing holders (founders, Series A, angels) collectively hold 100 − 20 − 12 = 68%, and they split it in the ratio 58:26:8 (total 92).
| Holder | Pre-round | Post-round | Change |
|---|---|---|---|
| Founders | 58.0% | 42.87% | −15.13 pp |
| Series A | 26.0% | 19.22% | −6.78 pp |
| Angels | 8.0% | 5.91% | −2.09 pp |
| ESOP pool | 8.0% | 12.00% | +4.00 pp |
| New investor | - | 20.00% | +20.00 pp |
The naive calculation says founders keep 58 × 0.80 = 46.4%, a 11.6 pp dilution. The correct figure is 42.87%, a 15.13 pp dilution - 3.53 pp worse, because the pool top-up from 8% to 12% is funded entirely by existing holders.
In value terms. Founders' pre-money value = 58% × 800 = ₹464 crore. Post-money = 42.87% × 1,000 = ₹428.7 crore. The pool top-up costs them ₹35.3 crore, being 58/92 of the ₹56 crore increase in pool value. The 12% pool is not 'free' because it is 'for employees'; it is a transfer from founders to future hires, and it is being priced at the post-money valuation rather than the pre-money.
Negotiation point. If the pool is expanded before the round at the pre-money valuation, existing holders bear the dilution but at ₹800 crore rather than ₹1,000 crore, saving roughly ₹7 crore of founder value. Small, but the principle - who bears the pool, and at what price - is worth ₹35 crore here.
2. Model the liquidation waterfall under both term sheets at exit values of ₹700 crore, ₹1,200 crore and ₹3,000 crore.
Read the worked answer
Investor has invested ₹200 crore for 20%. Founders hold 42.87 of the 80 non-investor points, i.e. 53.6% of whatever is left after the investor is paid.
Term Sheet X - 1x non-participating: investor receives max(200, 20% of exit). Term Sheet Y - 1x participating with 2x cap: investor receives min(200 + 20% × (exit − 200), 400).
| Exit (₹ crore) | X – investor | X – founders | Y – investor | Y – founders |
|---|---|---|---|---|
| 700 | 200 | 268 | 300 | 214 |
| 1,200 | 240 | 515 | 400 | 429 |
| 3,000 | 600 | 1,286 | 400 | 1,393 |
Crossover. X equals Y when 0.20E = 200 + 0.20(E − 200), which never holds below the cap - Y is ₹160 crore better for the investor up to a ₹2,000 crore exit. Above ₹2,000 crore the 2x cap binds at ₹400 crore and X dominates. The founders' ₹1,200 crore base case sits squarely in the zone where Y costs them ₹86 crore; the ₹3,000 crore bull case is where Y is worth ₹107 crore to them. The stress case is worse still: at ₹700 crore, Y takes 42.9% of proceeds versus 28.6%, and the founders receive less than their pre-money value.
Judgement. Y is not 'standard' - it is a bet on the downside, paid for out of the base case. A 2x cap is a meaningful concession (many Series B sheets carry uncapped participation), but the cap only helps above ₹2,000 crore, which is not the planning case. Non-participating with a 1x preference is the aligned structure: the investor wins only if the equity is worth more, which is precisely the incentive the founders want in their lead.
3. Should the founders accept Y in exchange for a higher pre-money valuation of ₹900 crore? Evaluate and state the negotiating priorities.
Read the worked answer
Test the trade. At ₹900 crore pre-money, post-money is ₹1,100 crore and the investor's 20% costs ₹220 crore - an extra ₹100 crore of headline valuation in exchange for accepting participation. Recompute founders' stake: existing holders get 68% of 1,100, founders = 58/92 × 68% × 1,100 = ₹470.9 crore.
At the ₹1,200 crore base-case exit under Y: investor takes min(220 + 0.2 × 980, 440) = ₹416 crore; remaining ₹784 crore × 53.6% = ₹420 crore to founders. Under X at ₹800 crore pre-money, founders received ₹515 crore. The higher headline valuation makes the founders ₹95 crore worse off at the base-case exit. The valuation gain is illusory; the preference structure is doing the work.
Sensitivity. Under Y at ₹900 crore, founders only beat the ₹800 crore X outcome when the exit exceeds roughly ₹2,200 crore. Probability-weight the three cases: if base case is 60% likely, stress 25% and bull 15%, Y at ₹900 crore gives 0.6 × 420 + 0.25 × (founders' ₹700 crore share, roughly ₹220) + 0.15 × ~₹1,450 ≈ ₹500 crore, versus ₹515 crore under X at ₹800 crore. X wins on expected value despite the lower headline number.
Negotiating priorities, in order. (1) ESOP pool at 12% but struck at pre-money, or sized at 10% post-money - worth ₹35 crore to founders. (2) Non-participating preference, or participating with a 1x cap. (3) Anti-dilution as broad-based weighted average (acceptable) rather than full ratchet (reject outright). (4) Board composition and reserved matters - a 3-of-5 board with a founder chair. (5) Drag-along threshold at 75% rather than simple majority, so the founders cannot be forced out by the investor plus angels alone. The headline valuation is the least important number on the term sheet, and the lead investor's framing of the discussion is itself a signal.