Entrepreneurs see just a few term sheets while building their startups. This is especially true for first time entrepreneurs.
Since investors work with many companies, they see many more term sheets.
As a result of this discrepancy, entrepreneurs often come across term sheet terms that they don’t understand, find clear, see the purpose of, or find fair.
When this happens, one of these three scenarios plays out.
1. The entrepreneur doesn’t ask about the term with the goal of trying to understand it. This is the worst possible scenario because what you don’t understand or find clear often comes back to haunt you in the future.
2. The entrepreneur asks about the term and digs in until he really understands and accepts the reasoning behind it. If it’s a red line he absolutely doesn’t want to cross, he refuses the term.
3. The entrepreneur asks about the term, is told that it’s a standard term, and accepts this. This is just as bad as not asking about the term because it results in the same lack of understanding. There is no such thing as a standard term. Even if a term is indeed found on most term sheets, it’s there because it addresses a possible future scenario where there may be a divergence between the objectives of the entrepreneur and those of the investor. With the benefit of having seen many term sheets in the past, it’s the investor’s responsibility to explain the reasoning behind each term that the entrepreneur seeks to understand. If the investor says that it’s just a standard term, they either don’t understand it or don’t want to share the reason for it. Both are red flags.
Originally published at Thoughts of a VC.