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How to Negotiate Term Sheets with a VC

June 8, 2021
Company Building

If you are awaiting a discussion on terms with your VC…Congratulations! You are only a few meetings away from securing vital growth capital. Growth capital that could transform the future of your business.

Once you have found the right investor, who is interested in your business, and you have agreed on a valuation for your business, conversations progress towards formalising the investment. Typically at this stage the VC will send over a term sheet to you. Simply put, a term sheet is a non-binding agreement that shows the basic terms and conditions of an investment. The term sheet serves as a template and basis for more detailed, legally binding documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is drawn up.

So, this is crunch time. Be smart when you negotiate your term sheet. Prepare well, negotiate with purpose & make informed decisions. Follow these 5 simple steps & you’ll reach alignment quicker & achieve closure faster, ensuring that the money arrives in your bank account sooner.

Keep in mind these 5 points which will help you reach a quick closure and alignment with your VCs on the term sheets and faster money in the bank. But before, if you want to learn more about term sheets, we found this excellent article.

1.Know the market standards:

Prepare for finalising the round before the term sheet actually comes in. Talk to other founders & other friendly VCs who might not be involved in the round to get a sense of market standards. Remember that standard terms can vary depending on the stage, the industry & the market so make sure you get a balanced picture from those with the appropriate experience.

2. Find founders you can rely on for advice:

Surround yourself with people a year or more further down the track. Founders you have successfully navigated complex negotiations & can alert you to the red flags you need to watch out for. They will also give invaluable insight into how you maintain business momentum during the negotiations & get straight back into driving growth once they are concluded.

3. Do a reference check on your investors:

The terms you receive now should always be seen in the context of the longer-term relationship you are building with the investors. Therefore it is important that you gather an understanding of the investor, the experience of other founders who have raised capital from them, and the ongoing contribution they make.

4. Discuss the deal construct & broad terms in advance:

Align on the broad terms with your VC before the term sheet arrives. Hopefully you are not a million miles apart & both parties are better prepared for the next steps. On the other hand if it becomes clear that one party can never meet the other’s expectations, it is better to call it a day now & part on good terms rather than sour a relationship that could come good in future rounds.

5. Keep it Simple:

Term sheets in early-stage business should be simple. The terms should be simple as well. Simple term sheets will ensure that the 2–3 terms which are important to the deal are the ones that get discussed, as opposed to too many complicated terms which may lead to complications along the way.

The Liquidation Preference & Process/Timelines Exclusivity are important but should follow market standards. Therefore your greatest concerns should be the conversations around valuation, dilution & decision making.

Valuation or Dilution: If you are confident in the market standards & have had the right conversations in advance, the valuation & dilution conversation is simple. Identify a fair range that is acceptable to every investor involved in the round & build from there.

Decision Matters or Veto Matters: This might depend on the board construct or the shareholding construct of your company. You shouldn’t enter into a relationship with an overly controlling investor but at the same time you want to be confident that they will support you in establishing the highest levels of corporate governing standards.

Liquidation Preference- This is a binary concept — an investor either gets a liquidation preference or they don’t and the purpose of the provision is to protect investors if a company exits at a value lower than what was initially expected. A liquidation preference means that preferred shareholders (the investors) receive their money back before any of the common shareholders (employees and founders). Typically this too ends up following market standards

Watch the full video here

Follow these steps & you stand a great chance of walking away with not only the growth capital you need but also a group of highly motivated investors who are fully aligned with your strategic goals.

Good luck!

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