Term Sheet Posts

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.

“Having information that the other side doesn’t have gives [VCs] an advantage… they take advantage of entrepreneurs who haven’t been through this before… they were totally willing to take advantage of us.”

Mitch Kapor, Founders at Work

“Knowledge is Power.”

Sir Francis Bacon

In this series of articles, we’re going to explain how to negotiate a great deal with your Series A investors. We’re calling this series Term Sheet Hacks.

The VCs know more than you do.

You, the entrepreneur, negotiate a term sheet once every few years. You negotiate your most important term sheet (the Series A) when you have the least experience. You negotiate against a VC firm that issues two to three term sheets per month. You negotiate against a “standard” term sheet that encapsulates decades of combined knowledge from hundreds of venture firms.

Like a good chess player, your prospective investors know what the game looks like many moves from now:

  • Their term sheet foresees the Series B, possibly terminating you, selling the company, and more.
  • Their term sheet anticipates those events and includes terms like ‘protective provisions’ and ‘election of directors’ that create the best future outcome for their firm.
  • They employ a full-time CFO or general counsel who ensures their firm is cutting good deals. And his shelf is filled with books on the hilarious topic of term sheets.

On the other hand, you probably have a basic understanding of a few simple terms like ‘valuation’ and ‘vesting schedules’. You barely know what the game looks like right now, let alone at the Series C.

Your investors can take their time – they have years to invest their money – but you’re under pressure from your employees and co-founders to deliver the money that will keep your company alive. The clock is ticking…

Good companies get bad deals all the time.

Many of the successful companies that we all read about in the news didn’t negotiate good deals simply because they didn’t get good advice. Consider Jim Clark‘s (founder of SGI and Netscape) account in The New New Thing:

“At [SGI] board meetings… Jim’s face would get red and he’d start shouting that [an investor and board member] had cheated him and his engineers.”

Or ask a friend who has taken money from investors.

Whether these stories are true is irrelevant. Like any negotiator, your prospective investors are not in the business of giving you a good deal. They are in the business of making money for themselves and their investors (their limited partners).

Isn’t this what my lawyers are for?

In principle: yes. In practice: no.

With few exceptions, most law firms advise their clients to accept “standard” terms.

Most law firms do a lot more business with VCs than they are likely to do with you. VCs refer new clients to the law firms, hire the law firms regularly, and know the attorneys socially. Where do you think the law firms’ loyalty lies?

The basic incentives between you, your law firm, and your prospective investors are not in your favor. Your lawyers make money by executing transactions and your investors simply bring more transactions to your lawyers than you do.

You can’t hack a term sheet without leverage.

Don’t bother trying to apply any of these term sheet hacks if you don’t have leverage. You can’t negotiate at all without leverage. Roughly speaking, leverage is power.

Alternatives are the most basic type of leverage in any negotiation. Fancy negotiators call their best alternative a BATNA (Best Alternative To a Negotiated Agreement). If you’re negotiating a term sheet with the famous Blue Shirt Capital, your BATNA may be an independent term sheet from the renegade Herd Mentality Management.

A BATNA is just one type of leverage and it is possible to negotiate effectively without a good BATNA. Hostage negotiators do it all the time. But if you’re not in the mood for a hostage negotiation, get multiple offers before you apply any of these hacks. Don’t let anyone tell you that creating competition to invest in your business is a bad thing.

Let’s get this party started.

Our goal here is to give you the knowledge to effectively negotiate against the experts. We don’t have all the answers but we’ve negotiated enough term sheets, started enough companies, and learned from enough entrepreneurs, lawyers, and VCs to understand how this game can play out. Term Sheet Hacks is a work in progress and we’re looking forward to learning more from your comments and emails.

These articles assume that you either have a term sheet in-hand or are anticipating one. If you need a basic understanding of term sheets, read Brad Feld’s term sheet series and hire a lawyer.

Before you go on, please read our disclaimer:

This site provides information. Use it at your own risk.

Information is not the same as legal advice – the application of information to an individual’s specific circumstances. This site does not provide legal services or legal advice.

Although we try to make our information accurate and useful, you should consult a lawyer to interpret and apply this information to your particular situation.

We are not lawyers and we do not take any responsibility for rashes, financial ruin, or anything else that follows from applying this information.

Our first two hacks show you how to create a board that reflects the ownership of the company and why you should make a new board seat for a new CEO. We also maintain a list of all the term sheet hacks. Please do read on…