Raising VC money: how to negotiate a term sheet

This is the sixth post in a Friday series on “raising VC money”.  For the list of topics we are covering, click here.  In this post, we’ll focus on “how to negotiate a VC term sheet.”

Let’s say that after interacting with a VC, you’re at last invited to the all-critical partners’ meeting (more here) to pitch the group.  After you leave the conference room, the VCs will huddle together to share feedback and decide on a course of action.  If the answer is “yes,” your VC Point Person will contact you very soon to begin the term sheet process.

A term sheet sounds complex but really isn’t.  Many blogs have touched on the various terms in the document, and so, I won’t cover those here.  Instead, I’ll focus on the overall dynamic of this negotiation and how an entrepreneur may handle it.

Advice #1: retain a lawyer who knows well VC financings.  A common mistake I see entrepreneurs make is when they hire an attorney that is very capable, but whose expertise is elsewhere.  VC terms and norms are very specific.  An attorney who covers real estate, general corporate law or leveraged buy-outs will not be calibrated.

In the same way physicians specialize, attorneys do the same.  So, make sure you’re not only getting advice but well-calibrated advice.

For example, a friend of mine wanted to leave a hedge fund and start a new one.  I introduced him to an attorney who specializes in helping people leave hedge funds and start their own.  To save money, my friend instead went to a different attorney, who was not a specialist.  The exit negotiation was a disaster, unfortunately.

Advice #2: own the negotiation.  You should use your attorney as a sounding board, but you should negotiate the financing.  You can call time outs as necessary to call your attorney, but this is your chance to begin a new phase in your relationship with the VC.  You’ll likely have some difficult topics to discuss on the Board down the road, and the ability to have open, honest and direct conversations is critical.

Advice #3: stack rank the open issues.  The VC will propose terms and you will likely have amendments.  Realize that you may not get everything you want, nor will he.  So, if you both can clearly communicate what you really need as opposed to what you want, the discussion will be positive and quick.  This is the “win-win” approach.

It’s also important because you then can inform your attorney what you really want.  Some younger attorneys are very aggressive about showing their value to you and will fight for a particular term to show how they’re helping you.  I think that’s all fine and good if it’s a term you actually care about.

Advice #4: qualify the VC’s interest level.  I would say 90% of term sheets being offered are genuine.  The VC has done his homework and wants to invest.  However, realize that most term sheets have a “no shop” clause, meaning that you cannot speak to another VC.  So, it would be terrible if you signed a term sheet, stopped your fundraising, only to have the VC drop out later.  If a VC has not yet done his homework, do not sign a term sheet.

Advice #5: do not engage in term sheet wars.  I’ve seen negotiations get out of control when the entrepreneur’s attorney makes massive edits to the VC’s term sheet.  The VC’s attorney then responds with an equally onerous draft.  More drafts ensue.  The legal bills pile up.

Rather than telling your attorney to hack the document, call the VC directly and work out the issues.  Have a handshake agreement on a revised set of terms and then inform your attorney of the changes.

Advice #6: always, always remain calm.  A bit ago, we were negotiating a term sheet with an entrepreneur.  He was a very effective presenter and had great ideas.  However, his personality changed during the term sheet negotiation.  He became very emotional, erratic and made bad decisions.  We then caught him telling half-truths.  So, we withdrew our term sheet.  We learned during this process that he couldn’t handle pressure.

We think people’s true selves come out during times of stress, and we weren’t comfortable with what we saw.

Advice #7: be honest.  One time I negotiated terms with an entrepreneur with a great idea.  After we agreed to terms, he tried to re-open the negotiation.  He had changed his mind and was hoping I’d understand.  A few days later, he did the same thing on some other terms.  I drew the line in the sand and we closed on the financing.

A few years later, this entrepreneur left the company and joined a public competitor.   The executives he had recruited to his company were flabbergasted.  I know people need to make a living, but I do wonder whether the vacillation I saw earlier was a sign of a major character flaw.

So, now 10 years later, if I sense dis-honesty, I’m done.  The entrepreneur, by the way, should do the same thing if he senses a lack of integrity in the VC.  The average time to exit for a start-up is now nine years.  Don’t partner with a VC unless your instincts give it a resounding yes.

So, I hope this is helpful.  Next issue, we’ll cover “how to negotiate the legal documents.”

936 views

Leave a Reply