One of the most important parts of negotiating a sale or investment is establishing the term sheet. Although often only 2-3 pages long, with typically 20 terms spelled out in it, the term sheets contain summaries of all the critical aspects of a deal, and once they’re agreed, the remainder of the process can be significantly more automated.
There may be only a few terms that really matter in the end. We should make sure our lawyer is comfortable with all the terms, however focus on the terms that matter and only really fight for those.
Valuation and the type of security offered are critical. We need to be prepared to sacrifice valuation for a clean security. Everyone always thinks that price/valuation is the most important thing to maximize in a deal. However, the structure of the security can be much more important in the long run, as can other terms relating to things like dilution protection, hard floors, decision control rights etc.
Whether the VCs buy 33% of our company or 30% of our company is much less important than having a capital structure that’s easy for an outsider to understand and want to join (e.g., investment banker or later-stage VC)
Always have a Plan B.
The quality of your VC isn’t more important than the quality of your product or your team, but it’s right up there. But – and this is an important but – you should expect to “pay” for quality in the form of slightly weaker terms (whether valuation or type of security). This is where having a BATNA really comes in handy. (More on what a BATNA is in the link).
Ask for references. Don’t be shy – prospective VCs are checking up on you…you have every right to do the same with them. Ask them for references of CEOs they’ve worked with. Ask them for a CEO they’ve had to fire as a reference. The good ones will give you the full roster of everyone they’ve ever funded and tell you to call anyone. The bad ones will give you two names and ask for time to prep them ahead of time.
Don’t let the VC get away with negotiating a point by saying “we always do it this way.” That’s just not true. VCs may have a preferred way of doing deals or handling a specific term, but every deal they’ve ever done is different, and they know it. If there’s a compelling reason for them to insist on a particular term, you have the right to hear it (if it’s important to you).
If you have multiple investors in the syndicate, insist on a single investor counsel and a lead investor. This is essential to (a) protect your sanity, and (b) prevent you from paying zillions of dollars in legal fees. You have to make the VCs stick to it, though – they can’t come back and re-trade the deal after it’s been negotiated. This is also helpful in getting a syndicate cooperating with each other and aligning the members’ interests, particularly if it has investors who have participated in different rounds of the company’s financing. Do expect to play moderator constantly throughout the process, however, to ensure that it goes smoothly.
Try do deal in advance with follow-on financings. When an investor doesn’t participate in a follow-on financing, it creates a total nightmare for you. Other investors will want to punish their wayward colleague and can create massive collateral damage in the process to common shareholders and management. Just as VCs will insist on something called “pre-emptive rights” (the right to invest in future financings if they want), you and your lawyer should insist on some protection in the event that one of your investors abandons you when you are raising more capital.
Handle the term sheet negotiation carefully. Whether it’s an initial round or a follow-on round, how you handle yourself in this negotiation sets the tone for the next stage of your relationship with the VC. The financing is the line of demarcation between you and the VC courting each other, and the VC joining your board and effectively becoming your boss.
Finally don’t forget to say thank you at the end of the process. Whether you send a formal email, a handwritten note, or a token gift, be sure to thank your VCs after a financing. They’re putting their butt on the line for your company, they’re investing in YOU, and they’re making it possible for you to pursue your dream. That deserves a thoughtful thanks in my book.
Once a Term Sheet has been approved by all parties, the deal team moves to complete due diligence, resolve any outstanding issues and to formally write up an investment proposal to present the investment case. Depending on the circumstances, relevant third party due diligence items such as an intellectual property review, accounting and legal review, or human capital review will be commenced.
So there you have it – your Term Sheet – a generally non-binding agreement that identifies basic terms and conditions under which an investment will be made. The Term Sheet provides the basis for development of more detailed legal documents.
A term sheet might include hundreds of requirements. To keep it manageable, list detailed requirements in separate term sheets and group those details under one requirement heading on your master term sheet. This process should not bog down on too many “how’s” – keep it moving and FOCUS on the issues that are important.
Now, that BATNA – here’s a good article on what it is and why it’s important. http://www.beyondintractability.org/bi-essay/batna
Maven Partners 
Leave a comment