Closing Posts

Thanks to Walker Corporate Law Group, a boutique law firm specializing in the representation of entrepreneurs, for supporting Venture Hacks this month. This post is by Scott Edward Walker, the firm’s founder and CEO. If you like it, check out Scott’s blog and tweets @ScottEdWalker. – Nivi

It’s a new year — which means it’s time to make resolutions. Rather than write about my resolutions, I decided to put on my lawyer hat and advise entrepreneurs on what I think their New Year’s resolutions should be. During my 15-year career as a corporate lawyer (including nearly eight years at two major law firms in New York City), I have seen entrepreneurs make certain fundamental mistakes over and over again. So what better way to welcome in the new decade than to recommend the following resolutions to entrepreneurs…

Resolution 1: “I will create a competitive environment when I’m doing deals”

There is nothing that will give an entrepreneur more leverage in a negotiation than a competitive environment (or the perception of one). Every investment banker worth his salt understands this simple proposition. Not only does competition validate a firm’s interest, but also it appeals to the human nature of the individuals involved. Competitors can be played off each other and, as a result, the entrepreneur will be able to strike the best possible deal.

I learned this important lesson as a young corporate associate in New York City. As I discuss in my video post, Lessons Learned in the Trenches of Two Big NYC Law Firms, I recall having two M&A transactions on my plate: one was a divestiture — i.e., the sale of a division of a multinational corporation being auctioned by an investment bank; and the other was the sale of a private company to a competitor (with no i-bankers involved). In both deals, my firm was representing the sellers but, as we worked our way through the negotiation process of each deal, we ended-up with two completely different acquisition agreements with respect to the material terms.

In the auctioned deal, because the i-banker was able to play the prospective buyers off each other and create a competitive environment, the final agreement was extremely seller friendly and included broad materiality qualifications, a huge basket/deductible and a cap on seller’s liability of 10% of the purchase price. In the private-company transaction, however, there was only one prospective buyer — and the buyer’s principals knew that the seller was anxious to sell and thus were playing hardball. The deal terms ended-up being extremely buyer-friendly and included a large portion of the purchase price being escrowed and a cap on the seller’s liability equal to 100% of the purchase price.

The lesson learned is that you must create a competitive environment (or the perception of one) in order to have strong negotiating leverage. There is, however, one important caveat that entrepreneurs should keep in mind: this game must be played carefully and is better handled by someone with experience. The last thing an entrepreneur wants is to end up with is no deal at all.

Resolution 2: “I will leave my heart at home”

You have to think with your head, not with your heart — particularly when you’re doing deals. The best deal guys are masters at taking their emotions out of transactions and being extremely disciplined. They will just walk from a deal if they get out of their comfort zone (e.g., with respect to the price, risk profile, etc.), regardless of how much time and money they have spent.

On the other hand, most entrepreneurs become emotionally wedded to a particular transaction and are unable to maintain their objectivity as they move further along the deal process. They get all excited as soon as someone waves some money at them and allow themselves to get drawn into the money guy’s web. It is critical that entrepreneurs understand this dynamic. Entrepreneurs will generally be negotiating with guys on the other side of the table who are far more deal savvy than they are – venture capitalists, private equity guys, etc. – guys who are masters at playing on their emotions.

This is why it is so important for entrepreneurs to establish a game plan (i.e., dealbreakers) before the negotiating process begins and to have the discipline to stick to the plan and be willing to walk, if necessary. If an entrepreneur is seeking venture capital financing, he should sit down with his transaction team before reaching out to the VC’s to establish his dealbreakers with respect to key terms, such as valuation, the liquidation preference, board composition, etc. The same approach should be followed if he’s interested in selling his company: What’s the lowest purchase price you’ll accept? What’s the highest cap on liability you’ll agree to? Will you agree to escrow part of the purchase price? If so, how much and for how long? Once you establish the dealbreakers early on, you can take your heart out of the equation and think with your head.

Resolution 3: “I will work my balls off”

This is the advice a senior partner gave me when I was a young corporate associate at a major New York City law firm: “If you want to be a great lawyer, you have to work your balls off and make practicing the law the number one priority in your life.” He explained that this means everything else in your life has to be pushed aside, and you need to “work, work, work.” And when you’re not working, he added, you need to be reading treatises and articles discussing the deals you’re working on to get a deeper understanding of the significant issues. When I explained to him that, after three months, I had been working nearly every weekend and that my girlfriend was ready to leave me, he told me that I need to get a new girlfriend.

I received similar advice from Harry Hopman, my old tennis coach (and the winningest coach in Davis Cup history), when I was playing tennis in the minor leagues after college. He preached to me that: “It all comes down to one word — desire. How badly do you want it? How much are you willing to sacrifice?” And he was right. When I was traveling and playing tournaments in Europe and South America, I noticed that the best tennis players were generally the hardest working; the qualifiers were the ones going out drinking every night, not the top seeds. Sure there were exceptions — like John McEnroe — but the exceptions were rare.

I have seen this same pattern during my legal career: the most successful clients tend to be the hardest working. The private equity guys and hedge fund guys I represented in New York City were animals; working around the clock and cranking out deal after deal. I attribute a lot of their success to just plain hard work. In 2005, I moved out here to California to help entrepreneurs, and it’s been a mixed bag in terms of the work habits that I’ve seen. Some of my clients are intense and put in the long hours; others, however, are just dreamers — and they are the ones who struggle. In short, there are no shortcuts to success.

Resolution 4: “I will not let my investors screw me”

Here’s the advice I give all my clients to avoid getting screwed by their investors: do your due diligence prior to accepting any money. The number one mistake I have seen entrepreneurs make in any deal is the failure to investigate the guys on the other side of the table. Remember, you will, in effect, be married to your investors for a number of years. Accordingly, entrepreneurs must do what any bride or groom does prior to tying the knot — date for a while and, of course, meet the family.

What does this mean in practical terms? It means surfing the web and learning everything you can about the particular firm making the investment and, more importantly, the particular individuals with whom you are dealing (and who, presumably, will be sitting on your board for a number of years); it means breaking bread and having a couple of beers with the potential investors; and it means getting references and talking to other entrepreneurs and founders who have done deals with them. Issues to address include: How have they treated their other portfolio companies? Are they good guys or jerks? Can they be counted-on and trusted? Do they share your vision for the venture? Will they add significant value (e.g., through contacts, domain expertise, etc.)?

There is an outstanding video discussion on between Brandon Watson, a smart entrepreneur (currently at Microsoft), and Andrew Warner, the founder of Mixergy, as to what could happen if you don’t adequately diligence your investors. Brandon is extremely candid and discusses how he got “bullied” by his board. Moreover, he expressly notes in the comments to that post that, “the diligence factor was that I knew them, but had never taken money from them. It’s hard to know how people are going to react when they are at risk of losing money because of something you are directly responsible for until you are actually at that point.”

Resolution 5: “I will retain a strong, experienced lawyer to watch my back”

This is obviously a bit self-serving, but every entrepreneur needs a strong, experienced lawyer to watch his back. There is just too much at stake for entrepreneurs to be (1) using sites like LegalZoom, (2) pulling forms off the web and trying to play lawyer, or (3) retaining the cheapest lawyer to save money. And as the Madoff affair and other recent high-profile cases demonstrate, there are a lot of unscrupulous characters out there trying to take advantage of unsophisticated entrepreneurs.

There are also more subtle potential problems entrepreneurs need to be protected from, including the inherent conflict of interest that certain service providers have. For example, entrepreneurs need to be careful with investment bankers, who generally only get paid if a particular deal closes. Indeed, a middle-market i-banker’s entire year can be made or broken based on whether or not he can close one or two deals.

Unfortunately, I experienced this issue first-hand shortly after moving to California when I got pulled onto an M&A deal in which an i-banker stuck his finger in my chest and warned, “We’re going to get this deal done despite you fucking lawyers.” He then later complained to the managing partner (who had the client relationship) that I was blowing up the deal because I had retained special environmental counsel from my old NYC law firm and we were pushing too hard on the environmental indemnity. Good work by the i-banker (and cheers to my former managing partner) for getting the deal closed by watering down the environmental indemnity: less than six months later our client’s company was indicted for environmental problems that it inherited as part of the acquisition.

The bottom line is that a strong, experienced corporate lawyer will sober the entrepreneur and lay out all of the significant legal risks in a particular transaction; he will then push hard to negotiate reasonable protections. If the deal sours and lawsuits are filed, well-drafted documents with appropriate protections become a kind of insurance policy to the entrepreneur.

If you like this post, check out Scott’s blog and tweets @ScottEdWalker. If you want an intro to Scott, send me an email. I’ll put you in touch if there’s a fit. Finally, contact me if you’re interested in supporting Venture Hacks. Thanks. – Nivi

How do you quickly turn a signed term sheet into cash in the bank? I’ve seen entrepreneurs do it in one week and I’ve seen them do it in four weeks.

How do you do it as quickly as possible?

  1. Complete all business diligence before you sign a term sheet.
  2. Set a firm closing date for your lawyers and justify it with something like, “I’m leaving the country on that date.”
  3. Have a strong BATNA that keeps the other side moving quickly.

Listen to our podcast below for the details.

Audio: How to close a term sheet quickly (mp3)


Nivi: I was talking to a couple of entrepreneurs today about how to expedite the closing process. Closing is when you go from a signed term sheet to money in the bank.

You are taking the signed term sheet, which is really just a letter of intent; it is for the most part non-binding, except for some confidentiality and no shop clauses, and turning it into a set of closing documents and money in the bank.

Closing can take anywhere from one week, to four weeks, to six weeks, depending on the complexity of the closing. There are some things that you just can’t speed up. There may be legal diligence that needs to be done that just can’t be expedited. It takes time to get it done.

Other than those issues that you can’t really speed up any faster than they are going, it is really up to the entrepreneur to set the timetable for closing. You can set things up so it gets done in a week and you can set things so it gets done in four weeks.

My preference is to get it done quickly for a few reasons. One: It just reduces the risk of not closing. Two: The faster you get it done the quicker you can get back to building your business. Three: It is just good experience and practice to move things forward during negotiations with your lawyers, with the other side’s lawyers, and with the other side.

There are three parts to closing quickly. One: What you do before you sign the term sheet. Two: After you sign a term sheet, what you do on your end to make sure things are moving quickly. Three: After you sign a term sheet what you do to make sure the other side is moving quickly. Lets cover each of those parts.

Before you sign the term sheet

First lets talk about what you do before you sign a term sheet. Number one, most term sheets have a clause or term in there that indicates what the expected closing date is so your lawyers, the other side’s lawyers, and the other side can all work together towards that date.

My next suggestion is to conduct all your business diligence before you sign the term sheet so there is no business diligence left to do once you have signed the term sheet, during the closing process.

A lot of startups, I think, make the mistake of signing a term sheet too quickly before the investors have made the decision to really invest in the company. And they are just locking the company up with the term sheet, taking the company off the market so they can do their real diligence.

I would prefer to get all the business diligence done before I sign the term sheet. And we have a blog post on this, look it up. It is called, Complete business diligence before you sign a term sheet. We have also got another blog post called, Discuss your plans before signing a term sheet.

You also want to complete as much legal diligence as makes sense and is possible before you sign a term sheet as well. Why leave some legal risks? Why take yourself off the market and expose yourself to the risks that there is some legal issue that is going to trip up the financing. You want to get as much of that done before you sign the term sheet as well. You can find more info on that in the blog post. For most seed stage investment there is not a lot of complexity in your legal documents, whether it is IP or existing contracts, or what have you.

And top tier investors aren’t going to try to push business diligence to after a signed term sheet, in general. And if they do they are pretty up front about it and there is usually a good reason why. If you are working with a good firm you will get the business diligence done before you sign a term sheet anyway. And if you are a seed stage startup without a lot of complexity the legal work is pretty turnkey, which means that you can get it done quickly. And it is really up to you to determine how long it is going to take. These financing closings take as long as you let them take.

How do you expedite the closing process? There are two parts to this. The first part is making sure your lawyers move quickly. The second part is making sure the other side moves quickly. The other side consists of the fund and their lawyers.

Moving quickly on your end

First lets talk about making sure your side moves quickly. You should understand that you are in a very high leverage position with respect to your lawyers. Your lawyers have taken the risk of working with you while you were an unfunded, seed state startup with a lot of risk that you would go out of business.

They perhaps deferred fees, or gave you reduced rates. And they took on the risks of working with you with the hopes that you would be come a venture backed startup and grow on to great success and do a lot of business with them. Which is exactly what is starting to happen to you at this point in time, you are getting venture backed. You have a signed term sheet.

Your lawyers are in a pretty precarious position. They have taken a lot of risks and that risk is starting to bear fruit. But they are in a position where they are not locked-in in any way. You are not locked-in with them so you can terminate them at any point in time still. If you terminate them they have taken a bunch of risks, worked for reduced rates, deferred fees, and they weren’t interested in working with you while you were a seed stage company. They just did that to build the relationship so that you could work with them when you were a venture back startup spending lots of money on legal fees. If you terminate them, they won’t be able to reap what they sowed. So they’re in a precarious position. You have a lot of leverage over them.

The first thing to do to expedite the closing process is talk to my lawyers and tell them — if you haven’t already, which hopefully you’ve done — is tell them you’re going to measure them in four ways. High quality advice, one. Two, the speed at which they get things done for you. Three, the number of errors in the work product. Four, cost.

Next, you tell your lawyers that you want to have an extremely firm date for the closing process. You can take the Steve Blank approach there, if you like, and tell them that prior to that date, if they need help you are available to help them out, but when that date comes you don’t want any excuses. Right? If they come at you with excuses by that date, it’s really a fireable offense.

The best way to justify an extremely firm date is with a justification. People like to have reasons for why you want them to do things. So come up with a reason why the closing needs to happen by such and such date. For example, “I’m going on vacation on that date, I’m having a baby, I’m leaving to go to a business meeting in a foreign country, we need the money to make a payment, we need the money to hire somebody.” Just get with your team, brainstorm a solid reason why it absolutely has to be closed by that date.

That’s the end of the story of making your side move quickly. Ultimately, it’s really in the interests of your lawyers to actually get it done quickly. We’ve seen too many law firms get fired after a closing because the closing wasn’t done quickly enough, there were too many errors and the entrepreneurs were not happy with it. I think it’s important and good for the law firm for you to communicate what your metrics for success are. Finally, your lawyers are not computers, right? They’re humans. So don’t take the tone of the discussion here too literally. You want to treat them with grace and humility and make them excited to work with you.

Making the other side move quickly

The other piece of the puzzle is getting the other side to move quickly on the closing and getting the other side’s lawyers to move quickly on the closing. In general, if you’re closing with a good firm, a good fund, they also want to close quickly. They don’t have any interest in a slow closing process. It’s just a question of getting their lawyer’s bandwidth.

The best advice I have to get the venture fund, or investors and their lawyers to move quickly, is to have a great BATNA. That’s really the only advice I have for you there. Preferably you’re in a situation where your BATNA has said something like, “If the other side blinks during the closing process, call me.” You want to have a BATNA that’s still chomping at the bit to invest in your company.

I’m not suggesting that you break any no shop clauses or anything like that, or confidentiality agreements that you have in your term sheet. What I am suggesting is prior to signing a term sheet, you want to have a BATNA that is chomping at the bit and will be interested in investing in your company even if the term sheet blows up after it’s signed. They’re chomping at the bit, like I said, they’ve said something like, “If the other side blinks during closing, call me.”

If they haven’t said something like that, you can say something like that. When you call the investors that you’re not going to take money from and tell them that you’re going to sign a term sheet with someone else, you can tell them, “If there’s any problem during the closing process you are going to be my first call. I’m not expecting any problems during the closing process, but in the odd case that there is a problem during closing and we decide to pull the plug, you are going to be my first call.”

So you’re setting things up to have a great alternative if things blow up during closing, and you’re providing yourself with an excuse. You’re saying, if things do blow up it’s not going to be them pulling the plug, it’s going to be me pulling the plug.

Take it away Kazumi.

In Be Careful Who You Deal With, Matt McCall, a Managing Director at DFJ Portage, has great advice for entrepreneurs who are dealing with “slimy bottom sucker” investors:

“As these markets continue their chaotic path downward, people’s true colors come out. Some people show increasing amounts of fairness and consideration. Others will self-optimize and use every bit of leverage that they can get their hands on.

“Two entrepreneur friends of mine recently had a very negative experience with an investor who has a reputation for being Machiavellian and it really, really has incensed me. These slimy bottom suckers use the changing market conditions to test how low they can retrade an existing deal. Here is the standard game plan for these kinds of assholes. When they sense a dramatic change in the market, they pull away their term sheet siting “policy” changes. However, instead of walking away from the deal, they mention in passing that they might reconsider under “different terms”. If the entrepreneur bites, they know that they have leverage and they proceed to throw down absolutely egregious terms (multiple liquidation preference, half the original price, etc). If the entrepreneur bites on this, they know they really have them and continue to ratchet down the terms until things break and they back off.”

Read the rest of Matt’s post to learn how you can counter this investor’s game with your own game theory.

Machiavellian investors will try this trick in good markets too (I’ve seen it happen). Once you sign a term sheet, the investor will try to retrade terms. By then, you’ve told other prospective investors that you’ve signed a term sheet. It’s hard to go back to them and explain what’s happening. And if you walk away from the signed term sheet, it’s hard to talk to new investors with a blown-up term sheet on your hands.

Of course, Machiavellian entrepreneurs exist too. And VCs have enough “institutional knowledge” to know that. Unfortunately, most entrepreneurs don’t have commensurate knowledge about their counterparts.

(Via Ask the VC.)

Yesterday, I was brainstorming a list of things-to-do with an entrepreneur who is getting ready to sign a term sheet.

After searching through the Venture Hacks archives, I realized one of our posts already covers it: How much diligence should we do before signing a term sheet? I think that post mostly stands the test of time—problem solved.

I revised the post to include this question for prospective investors:

“Do you agree with our plan for the next two/three/four quarters?”

Discussing this before you sign a term sheet has a few benefits:

  1. You learn what it’s like to work with the investor—before you marry him for the life of the company. If you don’t like working with him, he may not be the right husband-for-life.
  2. You discover if your investor agrees with your plan. If he doesn’t agree with your plan or you don’t agree with his revisions, why do you want him to join the company? Are you really going to put someone on the board who doesn’t agree with what your plans?
  3. Getting agreement on the plan before the financing is normative leverage. If your investor wants to change the plan in the future, you can ask him to justify the change: “We agreed on a plan, how have the circumstances changed since we agreed on a plan, and why does that require us to change the plan?”

Completely unrelated (or is it?):


“Once the term sheet is signed, the power shifts away from the startup to the purchaser. The typical term sheet will give the purchaser the discretion to step away from the deal if due diligence is unsatisfactory, or if the necessary internal approvals are not obtained.”

Suzanne Dingwall Williams, on M&A

“… there is a wide range of behavior among VCs—the group that doesn’t put a term sheet down until they are committed are at one end of the spectrum; the group that puts down a term sheet to try to lock up a deal while they think about whether or not they want to do it is at the other.”

Brad Feld

Summary: Complete business diligence and prepare for legal diligence before you sign a term sheet. Signing a term sheet early is a recipe for a hostage negotiation.

A reader asks:

“Our term sheet says ‘any obligation on the part of the investors is subject to satisfactory completion of due diligence by the prospective investors.’ How much diligence should we do before signing the term sheet?”

Whether or not your term sheet includes this term, complete business diligence and prepare for legal diligence before you sign a term sheet.

Signing a term sheet early is dangerous.

Signing a term sheet, with or without a no-shop agreement, while an investor is still conducting business diligence, is a recipe for a hostage negotiation:

You sign a term sheet, let other investors know, and go off the market while your prospective investors do diligence. After 2-4 weeks, your prospective investors say, “Uh, yeah, the results of diligence weren’t so good, we’ll still do the deal but with these (worse) terms instead.”

While you’ve been off the market, your prospective investors have been creating alternatives by looking at other companies. Every company that is raising money, not just your competitors in the marketplace, is competing for your prospective investor’s time and money. Meanwhile, the market your created before signing a term sheet has dissipated.

Even if you turn down these worse terms and approach new investors, you will have to explain why you walked away from a signed term sheet. So, before you sign a term sheet, complete business diligence and prepare for legal diligence.

Complete business diligence.

Business diligence is whatever your investor needs to make his investment decision. Some firms complete business diligence before they offer a term sheet. Other firms offer term sheets before they complete business diligence because they want to lock out the competition while they evaluate the company.

Determine whether business diligence is complete by asking:

  • Has this investment been approved by the entire partnership? Are any other approvals required?
  • Why do you want to invest?
  • Have you done your references? (And have we done our references?)
  • Are there any other steps besides legal diligence once we sign the term sheet?
  • When was the last time you or your partnership signed a term sheet that didn’t close? Why? How many times have you not closed a term sheet in the last five years? Why?
  • Do you agree with our plan for the next two/three/four quarters?
  • How quickly can we close? Under what assumptions are we coming up with this date?

Prepare for legal diligence.

After you sign a term sheet, investors conduct legal diligence, looking for reasons to not invest or reasons to revise the terms.

Legal diligence,

  1. Confirms whether your claims are actually true, e.g. your annual revenue actually is $10M.
  2. Uncovers important facts you didn’t mention, e.g. you’re being sued.
  3. Completes tasks you should have done earlier, e.g. all employees sign NDAs.

Before you sign a term sheet, help your prospective investor eliminate most reasons to not invest by,

  1. Telling the truth. (Duh.)
  2. Disclosing everything.
  3. Working with your lawyer to sign the agreements you need to sign. (If you can afford it.)
  4. Asking your prospective investor, “What diligence remains once we sign the term sheet? Which items can we complete before we sign the term sheet?” Document these items in an email to your investor. This email is normative leverage in case the list suddenly gets bigger during closing.

Desperation is no reason to rush into a term sheet.

You: “It must be great to complete diligence before signing a term sheet—but we’re desperate for money right now.”

Venture Hacks Shift Manager: That’s the worst reason to rush into a term sheet. Signing a term sheet before completing business diligence makes you more desperate, not less. A term sheet with or without a no-shop takes you off the market, dissipates your market, and places you at the mercy of your prospective investor.


Image Source: McDonald’s.