You’ve been talking to a capital partner for months. The term sheet lands in your inbox. The headline valuation is better than you expected, and for the first few minutes that’s the only number you read. Whether you arrived here through growth equity, a minority recap, or a search for non-bank financing, this document could define your next five years.
Then you scroll down. There are four more pages of terms you’ve never seen before. The partner at the private equity firm has already been helpful, has the right references, and says everything in the document is standard. But you want to read them closely before you agree to anything.
The valuation is the first number you look at and the one that matters least a year later.
The seven clauses further down the term sheet decide whether your capital partnership feels like a tailwind or a leash. Whether the next five years feel streamlined, or you spend them on the phone with your investor about things you used to decide in thirty seconds.
If you run a service business in the $5 million to $30 million revenue range and you’re in a conversation with an operator-friendly private-equity firm, this piece is a field guide to those seven clauses. Plain English for each one. What a traditional private-equity firm usually asks for. What an aligned partner looks like. And how to tell which one you’re reading before you sign.
Read ahead if you’re interested in:
- Why valuation is often the least important number on a term sheet a year later.
- The seven clauses that actually decide how your partnership runs and how it ends.
- The specific language to look for that distinguishes aligned capital from traditional private equity.
- How to read a term sheet yourself on a first pass, the way you’d read a long customer contract.
The Clauses That Actually Run Your Business
Meet Alex Kim. Alex runs Northvale Electrical, a commercial and light-industrial electrical contractor with 32 trucks, a shop in Burlington, Ontario, and $18 million a year in revenue at 13% EBITDA. Twenty-two years ago it was Alex and a second-hand van. Today there are three long-tenure foremen, a senior estimator, a dispatcher, and a bookkeeper who’s been with the firm since year four. Alex has been talking to a mid-market private-equity firm for about six months about a minority recapitalization: they take 35%, Alex keeps 65% and keeps running the shop, and $5 million comes off the table into Alex’s personal account. The firm wins a growth partner for a sector it wants to be in; Alex wins a second bite of the apple down the road without walking away from the business today.
The valuation in the term sheet is $14.5 million for the 35%. That implies an enterprise value around $41 million on $2.3 million of EBITDA, roughly eighteen times. It’s a very high number, far better than Alex’s accountant expected when they modelled it six months ago. Alex reads it three times and then keeps scrolling.
Think about a term sheet the way you’d think about the long-term service contract you wrote with your biggest commercial customer. On the first page is the headline rate. That number got everyone’s attention in the first meeting. But what actually determines whether that contract is a good one, whether you make money on it, whether you sleep at night, whether you still want to work with them in year three, lives in the scope section, the change-order language, the termination terms, and the dispute-resolution clauses. Most owners know this in their own contracts. You argue them for hours. You walk away from prospective customers who won’t budge on the termination language, even when the rate is right.
A term sheet is the same document, viewed from the other side of the table. The rate card is the valuation. And the scope, change-order, and termination language is after the first page.
The problem is that most owner-operators see a term sheet about once in a career. The partner across the table has usually seen hundreds. Without a framework, it’s hard to sign with a clear sense of what you just agreed to.
So what’s actually in those other pages, and which parts decide whether you still like this partnership in year three?
Seven clauses do most of the work. They fall into three groups.
- Two clauses decide how the money comes out: the liquidation preference and the participation right.
- Two more decide who runs the business between now and exit: the board and its voting mechanics, and the list of matters reserved for investor consent.
- The last three decide what the rest of your life looks like after the cheque clears: what happens to your equity if you leave, whether the investor can force a redemption on their schedule rather than yours, and what happens when the business is sold.
We’ll walk through each in the same pattern: the plain-English version, what traditional private equity usually asks for, what an aligned partner looks like, and what it would mean for (our hypothetical business leader) Alex and Northvale.
The Waterfall: How Money Gets Paid Out
Two clauses on the first page of the term sheet decide who gets paid what when the business eventually sells. They sound technical. They’re actually a formulation of who owns what, priced in the language of a future sale. Get these wrong and the valuation on page one can quietly become less than it looks.
1. Liquidation Preference
Plain English. A liquidation preference is the order and multiple in which cash gets paid out when the business is sold. Using Alex’s offer:
- A “1x non-participating preference” would mean the investor gets their $14.5 million back before any other money moves, once.
- A “2x preference” would mean they get $29 million back first.
A preference often earns an annual dividend on top. The range is 6% to 10%. At 8% compounded, the preference balance grows by 47% after five years, 71% after seven.
Two ways the dividend can work.
In most deals the investor picks the bigger of two payouts at exit: the preference balance with the dividend added, or their ownership percentage of the sale price. On a small sale, the preference wins and the dividend comes off the top. On a big sale, the ownership percentage wins and the dividend doesn’t matter. The investor is choosing the other path. That’s the normal version.
The aggressive version adds the dividend to both paths, or uses unpaid dividends to give the investor more shares when they convert. That’s a much bigger ask.
What traditional private equity usually asks for. Often a 1x preference, and sometimes a 2x or 1.5x in a stressed situation. Unpaid dividends are added to the conversion to give the investor more shares.
What an aligned partner looks like. A 1x non-participating preference is the honest middle ground in a minority recap of a profitable Canadian service business. It protects the investor’s downside without rewriting the economics at exit. If the investor takes the ownership-percentage payout, the dividends effectively go away. A single-digit dividend on a clean 1x is normal. If it’s still live, or if it turns into extra shares, it’s not.
What it means at Northvale. Imagine Northvale has a harder couple of years and eventually sells for $20 million. A 1x non-participating preference means the investor picks the greater of their $14.5 million preference or their 35% pro-rata share of the sale ($7 million). They take the $14.5 million; Alex takes the remaining $5.5 million. A 2x preference (so $29 million, more than the whole sale price) means the investor takes everything and Alex walks out with zero. The headline ownership is the same in both cases. The cash at exit is dramatically different, and the preference multiple is what decides it when the sale price is modest.
2. Participation
Plain English. Participation decides whether the investor, after taking their preference, also participates in the remaining equity as if they were a common shareholder (a regular owner, which is what you are).
- “Non-participating” means they pick one pile of money or the other, whichever is higher.
- “Participating” means they get both.
Participation is often the quiet lever that turns a minority position into a majority of the cash at exit without ever changing the ownership percentage on paper.
What traditional private equity usually asks for. Full participation, occasionally with a cap at 2x or 3x the original investment.
What an aligned partner looks like. Non-participating is the honest version in a minority recap. The investor’s upside comes from owning 35% of a bigger business, not from taking their money back and then also taking 35% of what’s left.
What it means at Northvale. Imagine Northvale grows over the partnership’s holding period and eventually sells for $50 million. With a 1x non-participating preference, the investor takes the greater of their $14.5 million back or their 35% pro-rata share ($17.5 million). They pick the 35%. Alex keeps $32.5 million. With a 1x participating preference, the investor takes $14.5 million and 35% of the remaining $35.5 million ($26.9 million total). Alex keeps $23.1 million. The valuation on page one was the same number. The exit math is a $9.4 million difference in the owner’s pocket.
The Control: Who Decides What
So the waterfall decides who gets paid at the end. What about in between, when the business is running fine and a real decision has to be made about a hire, a truck order, a new contract, a change in compensation? Who actually decides, and whose permission do you need?
Two clauses do most of the work here. They’re the ones most likely to change what it feels like to run your business the months after closing.
3. Board Composition and Voting Mechanics
Plain English. The term sheet sets the size of the board and who appoints each seat. A five-person board with two investor seats, two owner-operator seats, and one independent is a different company from a five-person board with three investor seats and two owner-operator seats. Voting control at the board level flows from this clause.
What traditional private equity usually asks for. A full control structure where the investor dictates all major decisions. That can look like the investor appointing the chair outright, or like language that lets the investor veto the owner-operator’s candidates for the independent seat without the owner-operator having the same right in reverse. The result is a board where contested calls go one direction (the investor’s) by default.
What an aligned partner looks like. A board where neither side controls the tiebreaker alone. The most common aligned structure in a minority recap is 2+2+1: two investor-appointed directors, two owner-operator-appointed directors, and one genuinely independent director mutually agreed. Smaller boards also work (1+1+1, or an investor observer seat without a vote on smaller positions). What makes “mutually agreed” real is the selection process: a short list both sides contribute to, candidates with no prior business relationship to either the firm or the owner-operator, and a fallback mechanism for what happens if no name gets both sides’ sign-off.
What it means at Northvale. Alex’s instinct was that the board was a formality. In reality, major decisions in the business can be made unilaterally without his consent. Contested calls go to the investor’s board members. The board can cause the company to take on debt, terminate employees, expand geographically and close down business lines, regardless of what he thinks about it.
4. Reserved Matters
The previous section is about what can happen without your permission. This one is about what you can do without asking for it.
Plain English. Reserved matters (sometimes called “protective provisions” or “consent rights”) are the list of decisions you can’t make without the investor’s written consent. This is the change-order clause of the term sheet. If reserved matters read like a normal supplier scope, you have a partnership. If they read like the investor has signed off on every variation before it happens, you have a new boss.
What traditional private equity usually asks for. A long list of consent items with thresholds that don’t track how the business actually operates, and no carve-out for items already approved in the annual operating budget. Capex that catches routine fleet replacement. Hiring thresholds that catch a senior foreman’s salary. Every material contract above a modest floor, regardless of whether it was already planned for. Each item on its own is defensible. The list, taken together, means decisions you used to make in a morning start requiring an email and a week.
What an aligned partner looks like. Three structural features do most of the work. First, a short list tied to real downside for the investor: acquisitions, material new debt, a sale of the company, a change in the business’s core line of work. Second, thresholds calibrated to the size and rhythm of the business, so routine operating decisions stay operating decisions. Third, and this is the one that most often gets skipped, a budget carve-out: anything already provided for in the annual operating budget the board has approved doesn’t re-trigger consent. The goal is an informed partner, not a second layer of approval on calls you’ve been making for two decades.
Thresholds are named dollar amounts, written into the agreement at signing. Budget carve-outs apply consistently across every dollar-denominated item on the list. Catch-all language (“any material transaction,” “any agreement outside the ordinary course”) is resisted. The list is finite and the finite list is the contract. If something didn’t make the list, the operator gets to run it.
What it means at Northvale. Alex’s current practice is that a $90,000 truck order is a same-day decision, pulling off an annual fleet-renewal budget the team has already reviewed. Reserved matters that miss a budget carve-out, so that same truck order becomes a board email because it crosses a generic threshold, change the texture of the business on day one. Not because the investor is acting in bad faith, but because a document that doesn’t contemplate the rhythm of the business will end up sitting in front of the board more than either side really wants.
Life After the Investment
So far we’ve walked through the waterfall and the control clauses, four of the seven. The last three describe what happens after the investor’s money is in. What happens to the equity you’re keeping if you leave. Whether and when the investor can force the company to buy their shares back. And how the eventual sale of the business actually gets run.
These three clauses look administrative. They decide how much of your rollover equity actually ends up yours, whether a calendar date can trigger a forced cash payout to the investor, and who gets to shape the eventual sale.
5. What Happens to Owner-Operator Equity on Departure
Plain English. Every owner-operator deal needs a mechanism for what happens to the operator’s equity if they leave. Voluntarily, involuntarily, on death or incapacity, or by mutual agreement. There are two families of mechanism, and the right one depends on the partnership.
Vesting with acceleration is the right frame when new equity is being granted to the operator at closing: a management-option pool, a top-up grant, or a sign-on equity package. The operator earns the equity over time and can lose it if they leave before it’s earned. Acceleration on a sale (single- or double-trigger) ensures the operator doesn’t leave money on the table when the business is sold.
Triggering Events with good-leaver / bad-leaver treatment is the right frame when the operator is rolling existing equity into the deal, already earned over years of ownership, not being granted fresh. Instead of vesting schedules, the shares are subject to defined events such as death, incapacity, termination with or without cause, voluntary departure or the breach of the agreement.
What traditional private equity usually asks for. A four- or five-year vesting schedule on the operator’s rollover equity, combined with double-trigger acceleration only and a “good leaver / bad leaver” provision where the board decides, without a standard defined in the document, whether your departure qualifies for any vesting at all. On a Triggering-Events structure, the equivalent move is a broad common-law definition of “cause” and a forced-sale price pegged well below fair value on anything that isn’t death or incapacity. The issue isn’t the mechanism; it’s the open-ended discretion on what counts as a good leaver.
What an aligned partner looks like. Four principles apply across both families of mechanism.
First, good-leaver events are treated at fair value. Death, incapacity, and termination without cause should not result in an equity haircut.
Second, bad-leaver events trigger a defined discount to fair value. The discount should be specified, not left to post-hoc negotiation. Distinct tiers for distinct fact patterns (for instance, a smaller haircut for a wilful breach of the shareholders agreement than for a termination for cause) give the document an internal logic that a court can read and enforce.
Third, “cause” should be defined narrowly and tied to the underlying employment or advisory agreement. Broad common-law definitions of cause (“conduct injurious to the corporation”) give the board a tool to extract equity; narrow definitions (“wilful misconduct, with written notice and a reasonable opportunity to cure”) don’t.
Fourth, if a court later disagrees with a for-cause determination, the termination should convert to without-cause by operation of the agreement. Without this provision, an operator who wins a wrongful-dismissal claim still forfeits the bad-leaver discount, because the forfeiture happened on the day of termination, not on the day of the ruling. With it, the equity snaps back to the good-leaver treatment automatically.
What it means at Northvale. Alex’s rollover equity is worth $26.9 million on paper (65% of a $41.4 million post-money). This equity was earned over twenty-two years rather than granted fresh at closing, but it’s framed as vesting and re-opens decades of ownership. As a result, it looks more like a clawback tool for the investors instead of simply a way of aligning his continued contributions with the partnership.
6. Redemption Rights
Plain English. A redemption right lets the preferred holder force the company to buy back their shares. Unlike most of the other clauses in the term sheet, a redemption right does its work when nothing else is happening. It doesn’t require a sale, a bad actor, or a dispute. It just requires a calendar date to pass.
The questions that matter (assuming the right exists at all):
- What’s the trigger date, and is the runway measured from closing, from an agreed target exit date, or on some other clock?
- Is there a cash-on-hand test, a solvency carve-out, or a financing-out that protects the company from being forced to redeem when doing so would be destabilizing?
- Is redemption mandatory, automatic on a date, or at the holder’s election?
- How is the redemption price calculated, and do accrued dividends stack on top?
What traditional private equity usually asks for. A redemption right exercisable five years after closing at original issue price plus accrued dividends, at the holder’s election, with limited or no cash-flow test. The right is often framed as a “backstop” for the investor in case no other liquidity event materializes. In practice, it’s the clause that converts a minority investment into a fixed-term loan with equity upside. Payable in cash, on the investor’s schedule, regardless of whether the business can afford it on that date.
What an aligned partner looks like. Default position in owner-operator partnerships is not to take a redemption right at all. Where one exists, look for a long runway (6+ years) and a cash-flow test that protects the company from having to redeem when doing so would be destabilizing. That combination turns the redemption right into a backstop against indefinite illiquidity, not a tool for forcing exits on the investor’s schedule.
What it means at Northvale. Alex’s term sheet is silent on redemption. He should check. Silence often means the boilerplate elsewhere in the agreement fills the gap in the investor’s favour. If the clause is in there, the three questions to ask before signing are: when does it trigger, does it have a cash-flow test, and does that test look anything like Northvale’s actual cash flow in the year before the trigger.
7. Drag-Along, Tag-Along, and Exit Approval
Plain English. Three mechanisms govern how a sale of the business actually happens, and each one decides something different.
- Drag-along decides when one side can force the other to sell. It’s the clause that answers the question “can the investor sell the business out from under me, or do I have to agree?”
- Tag-along decides when one side can ride along with the other’s sale. It’s the clause that answers the question “if the investor finds a buyer for their shares, can I force that buyer to take mine too?”
- Joint sale-process approval decides how the sale actually runs: who picks the banker, who signs the letter of intent, who negotiates the purchase agreement, and what happens to the operator’s role after close.
What traditional private equity usually asks for. Drag-along rights triggered at a simple majority, often held by the investor class alone. Sale-process control vested in the investor after a holding period, with banker selection, deal terms, and closing mechanics all resting on the investor’s side. Sometimes a “no-shop” clause that prevents the owner-operator from independently exploring alternatives.
What an aligned partner looks like. Drag-along triggered above a threshold that neither side can reach alone. Sale-process approval joint, with the final terms all subject to both-sides consent. For owner-operators interested in a second bite or a rollover into the next phase, this clause is where that intent either gets protected or quietly written out.
What it means at Northvale. Alex’s plan is a year-six-or-seven sale to a strategic acquirer, possibly with a rollover into a combined business. Whether that plan survives the term sheet depends on three numbers. The drag threshold: if it’s set above any single party’s holdings, Alex and the investor have to agree before anyone can be forced to sell. The board-approval threshold for M&A: if a sale is a reserved matter requiring at least one operator-director vote, the same answer holds by a different route. The tag-along scope: if it’s symmetric, Alex can bring his equity along if the investor exits to someone Alex would rather partner with than sell to. These three together are the exit. The “joint approval” language everyone quotes is the outcome, not the mechanism.
How to Read a Term Sheet on a First Pass
You’re not going to negotiate all seven clauses. You don’t need to. What you need on a first read is a framework for triage: which clauses do most of the damage when they go wrong, and which ones are roughly standard across the market.
If you can only ask yourself three questions on that first read, ask these:
What is the liquidation preference, and is it participating or non-participating? The answer decides how much of the valuation on page one is real at exit. A 1x non-participating preference is the honest starting point; a cumulative dividend on top of it is normal and doesn’t by itself indicate misalignment. What you’re watching for is the base multiplier and the word “participating.”
What are the reserved matters, and is there a budget carve-out? Read the list against the actual rhythm of the business, and look for language that says items already approved in the annual operating budget don’t re-trigger consent. Without that carve-out, the list turns routine operating decisions into board emails.
Does a redemption right exist, and what’s the cash-flow test? Most term sheets either have one or they don’t. If it’s there, the trigger date and the cash-flow test decide whether it’s a backstop or a loan-with-upside.
Those three answers, taken together, tell you most of what you need to know about whether the partnership runs like a tailwind or a leash. The other four clauses matter too, but they’re second-order: they tune the partnership rather than set it.
Two patterns are worth watching for on a first read, separately from the clauses themselves. The first is how the partner across the table responds when you ask about a specific clause. A genuinely aligned partner explains what the clause does, why it’s in the document, and what they’d be willing to change. The second is whether the term sheet has been tuned to the size of your business. Reserved-matters thresholds that don’t contemplate routine operating decisions, or that don’t carve out items already approved in the budget, tell you the document wasn’t built around your business.
Six months from now, you’ll pick up another term sheet. Another investor, another conversation that started at a trade dinner or a referral. The headline valuation will be roughly the same. This time you won’t start there. You’ll go straight to the liquidation preference and the accruing dividend, the reserved-matter thresholds and budget carve-outs, the equity-on-departure structure, and the redemption trigger. By the time you circle back to the valuation number on page one, you’ll know whether it’s the right number or just the number that’s printed first. Sometimes you’ll sign. Sometimes you’ll walk away at the term-sheet stage instead of at the last minute, and that walk-away will feel like the healthiest decision you made all year. Either way, when you show up to work the week after closing, the deal will feel the way you wanted it to, because you understood what you were signing.
If you’re an owner-operator of a Canadian service business and you’re looking at your first private-equity term sheet, or want a second set of eyes on one you’ve already been handed, let’s have a straightforward conversation. No pitch decks, no pressure. Just a plain-English read of what you’re looking at and what to ask before you sign.