There are all sorts of protocols in the VC world. Most of them make sense upon further examination, but if you’re a first time entrepreneur, they aren’t obvious, and it’s very easy to mess them up. Here’s one of them.
From VC’s perspective, one of the most annoying things an entrepreneur can do is “shop” a term sheet. That means after they’ve offered you a term sheet in writing you take it to other investors to try to get a better deal. Most VCs I know won’t even send anything in writing until you have verbally agreed on all essential terms precisely to avoid this possibility.
Why are investors so sensitive to this? First of all, no investor wants to think they are “just money” – the idea that you want to get an explicit auction going suggests that.
More importantly, what often happens is that once a VC has offered you a term sheet – especially if that VC is well respected – other VCs suddenly become interested. It is pretty much guaranteed that if Sequoia offered you $4M pre, there are many other investors who, simply because of Sequoia’s offer, would offer you a higher price. So if Sequoia allowed their term sheets to be shopped they’d never get deals done.
Some entrepreneurs think they are being savvy by shopping a term sheet but I would strongly caution against it. The VC/startup community is extremely small and this will usually come back to bite you.
Note that I am not saying an entrepreneur shouldn’t get a competitive process going and try to get the best deal with the highest quality investors. You just need to do it in the right way. Discuss things verbally and only accept a term sheet when you have agreed on all significant terms. At that point, assuming the term sheet agrees with what you said, you should sign it and return it within a day or two. (Don’t say you need to wait for you lawyer to review it – if you want to be an startup CEO you need to learn how to review and evaluate term sheets. Have your lawyer teach you about term sheets before you receive them.).
Also, don’t shop a verbal offer. You can’t go to, say, Greylock and tell them Accel offered you 4 pre. First of all they might collude. Secondly it’s very likely to get back to Accel (they all know each other) and you might lose both deals. What you can say is “I’m planning to wrap things up by X day and I have a lot of interest” and see what Greylock does.
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i like this approach as well. very good advice.
this is how we like to operate at spark and in the vast majority of cases we didn't send out a term sheet until there was a verbal agreement.
there have been exceptions of course but this is how we like to do it.
I think it's the only way VCs can operate. Otherwise you just end up “negotiating against yourself” every time. Took me a long time to understand this dynamic.
after reading your post again, the only thing i would disagree with is the legal review part.
I think it's perfectly fine if the founder/entrepreneur reviews the document with a lawyer before signing it. i actually recommend it.
Hi Chris. I only mentioned the atty thing on my blog, but I tend to disagree on basically all your points. Unless you've got some sort of long-term unusually intimate relationship with a particular VC, you won't get a good deal unless you get two sheets. There's certainly a finessed etiquette to making that work, but if you don't do it, you _won't_ make money as a founder.
Hey there. I'm not saying you shouldn't have someone with legal expertise read the term sheet – I'm just saying entrepreneurs should become experts on terms sheets. There are really only a few documents we need to master as entrepreneurs and this is one of them.
I might have gone overboard the way I stated that.
How about – become an expert yourself and have your lawyer review it. The problem if you don't understand term sheets well yourself is you won't know when the lawyer is being nit picky and when they talking about important stuff.
Thanks Bijan. As I admit to Rafer above, I might have overstated that. Have your lawyer review it. My main point is entrepreneurs need to understand all the terms in the term sheet themselves as well.
There are ways to get a competitive process going without getting multiple term sheets. That's part of the art of raising money.
I agree with you – get educated before you receive a term sheet. Since the actual physical paper is typically the very last step in a financing negotiation/dance, it's hard to negotiate intelligently unless you know all of the variables in play before the term sheet memorializes it. The simplest variable of price (pre-money) is typically the one that everyone understands but in my experience it can often be a less important variable to negotiate. If you've got a good thing going, the price will be high from basically all potential investors but it's the other terms that may differ meaningfully. Not knowing how those terms work is a bit like wanting to use email but not knowing how to type – you can't really excel unless you are educated about the tools.
I'm sure this is good advice in today's VC market.
As a health indicator of the VC market though one could see this as a problem. It is pretty clear that all else equal this protocol strengthens the hand of the VC and weakens the hand of the entrepreneur. Indeed, a VC is not “just money” but one could argue that the entrepreneur should get to decide how to trade off the various aspects of the value that the VC brings without artificial constraints on information flow. This is the age of the Internet after all.
Great post as usual, Chris,
I think what you're saying is there is a big difference between getting multiple term sheeets (verbal or written) and shopping them. Shopping them is the rub – if you're sharing details and offering your equity up like an auction process – it insults the value-add being offered by the investor and violates a confidentiality that is at least implied and probably in the terms. In the process you get at least a bit muddy.
I woder what the other investors think – 'opportunity to trump a competitor' or 'this isnt someone I want run with'…
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chris, this is the VC side of you overwhelming your otherwise excellent common sensivcal advice
entrepreneurs and other human beings:
1. always always always always always have an attorney review a term sheet before skigning or even responding
2. never never never never sign any legal document (or quasi legal document) with an attorneys counsel
sorry typo – for 2. i meant never sign WITHOUT an attorneys counsel
steve – I just really think entrepreneurs need to become experts on term sheets. They can't outsource this to lawyers. I'm not saying entrepreneurs shouldn't have expert advice on term sheets – I'm saying the entrepreneur should be that expert. (!)
Well said. Agree completely.
That's exactly my position.
@davidshore shopping them never includes sharing details or even who issued them. “I have a sheet with a more attractive X than yours” is the limit of it. if you make that up, they'll figure it out a few months later and you'll never get another sheet again. @cdixon is right about information flow, though it isn't quite as rapid on average (in NorCal anyway) as he suggests.
@cdixon like it or not, most of the people who read your blog are much earlier in their career than you are. starting “a competitive process going without getting multiple term sheets” is a very advanced maneuver. most of the folks consuming your (generally awesome) advice need tactics they can actually employ. it's cool to bring up Master Class tactics, but please consider putting a Don't Try This at Home or Professional Driver on a Closed Course warning on them when you do.
rafer – fair enough. i'll try to make the advice more generally applicable.
Thanks for the advice Chris. My personal tendency is to do exactly what you advise against, and you just opened my eyes.
Here's another question I'd love to hear your advice on:
Say you got two term sheets, and would like to see both parties invest. What's the best approach on facilitating that?
How would a first time entrepreneur become an expert? Partner with a seasoned entrepreneur? These seem like shark infested waters.
Um, as I wrote above, by working with attorneys!
Duh. Sorry. I'm an idiot.
Duh. Sorry. I'm an idiot.
Hey Chris – Great post (as always). I stumbled upon your blog a couple of weeks ago, and I am quite impressed with the strong, practical advice that you are providing to entrepreneurs. As a corporate lawyer for 15+ years, I just wanted to make two quick points:
1) There is nothing that will give an entrepreneur more leverage in connection with any deal negotiation than a competitive environment (or the perception of same). Indeed, every investment banker worth his salt understands this simple proposition. Not only does competition validate the other parties' interest, but also it appeals to the human nature of the individuals involved. Competitors can be played-off of each other and, as a result, the entrepreneur will be able to strike the best possible deal. As you point out, however, this strategy must be played very carefully and is better-handled by someone with strong experience.
2) As noted in the comments, an entrepreneur should NEVER sign a term sheet (or indeed any piece of paper) prior to its review by an experienced attorney. Yes, it is imperative that entrepreneurs understand all of the terms and provisions of the term sheet (and become an “expert”); however, the term sheet still must be vetted by an experienced attorney to ensure that the entrepreneur is protected (and hasn’t missed anything). This may sound a bit self-serving — but entrepreneurs trying to play lawyer (particularly with all the forms on the web) is probably the number mistake that I see on regular basis.
Thank you – and keep up the good work. (Btw, I’m launching a new site and a blog next week to help entrepreneurs from the legal side.)
Scott Edward Walker
Walker Corporate Law Group, PLLC
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Margaret
http://businesseshome.net
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