Negotiating a Term Sheet | Key Takeaways

Kindly brought to you by Goodwin Law.

 

Whether you are a founder or a VC, ensuring you get the best terms when negotiating a fundraising term sheet is key!

GBx members heard from:

• Serena Dayal, Partner at Softbank Vision Fund
• John Casnocha, Partner at Goodwin Law
• Amber Atherton, Partner at Patron VC and GBx Exec Director

 

Setting the Scene

• More structure being seen in term sheets than say in the boom of 2021, given the uncertain macro.
• The good news is that early stage cheques are still going on. Series A – C has slowed and the valuations have come down, but the terms are relatively similar.
• Whilst company valuations on a term sheet may be lower due to the present macro downturn, it is better to exceed expectations than for those who raised at inflated valuations and now have underwater options.

 

How can a start-up best prepare for negotiations?

• From a legal perspective: set up your data room and get your documentation ready. You can no longer grant equity after the term sheet written so ensure you have board approval and have sorted this.
• If you have an old term sheet – from your present company or a previous one – refamiliarize yourself with it.
• Consider what is important to you beyond valuation – because you should have a decent amount of wiggle room on that. Eg. Increasing the increasing option pool because you’ll have to hire a CFO; Or ensuring you have room for an independent board director for strategic advice.

 

Common sticking points that arise during the negotiation of a term sheet?

• Investors focus on economics and control rights (the latter is what you’re most often negotiating, particularly the board)
• Early stage you set a precedent for future investors – they often want the same terms
• Have an open dialogue with investors – why do they want it – why might this not be a good idea
• Remember when negotiating term sheets – founders and investors often get het up on certain points – which in the next fundraising round, a new term sheet may render pointless.

 

Advice on term sheets

• Founders often under-estimate the top-up of the option pool. New hires at c-suite or exec level are often made between fundraises, so consider how many options you will need. This helps you stay on good terms with your board members and they have often seen this dismissed at negotiation stage and then haunting founders afterwards.
• Try to keep early stage term sheets as clean as possible
• Be thoughtful about board composition
• Have a conversation with these VCs – they will be your partner, on your board, and financially aligned with you. If you can’t have a transparent conversation now, it bodes badly for the inevitable growing pains.

 

Difference between European funds and US funds with negotiating term sheets.

• In Europe there is less consistency among terms – therefore often negotiations take a bit longer and EU investors often want more control over hiring, budget, taking out debt.
• In the US, term sheets are more customary under NBCA forms.
• If you are raising in Europe you should therefore have a more detailed term sheet.

 

Are there any key clauses that founders should not compromise on?

• Be cautious of rights of first refusal regarding acquisitions. Strategic investors wanting right of first refusal chills the possibility of doing an M&A deal with anyone else.
• Senior liquidation preference in early term sheets sets a precedent for all future investors to want the same deal.
• Giving out 5-6 Board seats early leaves less room for later joining board members.

 

A cautionary note on SAFEs

• At present, SAFEs are highly dilutive to founders’ equity. Terms are pretty standard but you have the economics to consider. If you raise $5m on a $25m valuation, that investor has locked ownership. If you go on to raise another $5m, that initial investor will still have 20% ownership.

 

Words by Chiara Benn