An early stage founders guide to working with VCs — from Term Sheet to Signed Deal

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An early stage founders guide to working with VCs:


The 2 min TL;DR

Now that VCs have explicitly shown interest in investing in your company, the time has come to agree with them on the specific terms and conditions of the deal. This phase is of course very “technical,” and you’ll be working closely with your lawyer to structure the deal so that both the VCs and you are aligned and happy with it.

Before signing the final agreement, you’ll progress through different steps from negotiating the Term Sheet to going through a due diligence and the negotiation of the terms of the final contract. The length of the overall process depends on each case and how “complex” the deal is.

Term sheet

After the assessment phase, if a VC wants to invest in your company he will first send you a Term Sheet.

Term Sheet Negotiation

In this post, I won’t tell you how to read or negotiate a Term Sheet. Since it’s a very “technical” topic the best way not to fuck up is to do it together with a trusted and experienced lawyer. You should also request the help of other founders who have been through this experience.

For those who don’t know, a term sheet is a “non-binding document meant to record two or more parties’ intentions to enter into a future agreement based on specified (but incomplete or preliminary) terms”. It’s the document which lays the foundations of the future terms and conditions that’ll you negotiate with the VCs for the final contract. You’ll generally find in it the amount the VC wants to invest, the valuation of your company for this round and the types of shares they will get.

The crucial aspect to keep in mind is that a term sheet is a non-binding agreement and if, for various reasons, you or the VC decides that he’s not willing to invest anymore, the deal won’t be concluded. Be aware that it happens that VCs cancel an investment for no good reason even after they’ve issued a Term Sheet. It’s clearly a bad behavior and you should avoid this kind of investors. That being said, there are also some good reasons for an investor not to pursue a deal after they’ve sent a TS. For example when they discover some legal issues during the due diligence phase which were not shared by the founders initially.

VC Due Diligence

Remember when in “Part 2: preparation & introduction” I explained that you should do some reference checks on the VCs you’ve shortlisted?

Well, now that you are so close to spending many years with an investor, you should clear the last questions marks:

  • If there’s an aspect that the VC promotes heavily and which is important for you — like being a “VC platform” — it’s a good time to ask more details about it. Don’t hesitate to ask for concrete examples of companies that have benefited from their value adds.
  • Don’t hesitate to do more reference checks and to discuss with the founders of their portfolio. You can ask them introductions to the ones you want to talk to.
  • Ask yourself whether you trust the person you’ve been interacting with during the overall process. Having affinities and trust in the investor who’ll be in charge of you is extremely important. Even if the fund is great, but you don’t get along with this person, it’s better to be open about it and to change.
  • Ask the VCs what they do when a portfolio company doesn’t do well.

Once you’ve chosen the investors you want to work with and have negotiated + signed their TS, it’s time to move to the next phase: deal finalization.

Deal Finalization

Startup Due Diligence

## Some investors prefer to conduct the legal & business due diligences before emitting a Term Sheet. ##

A due diligence is simply the process of checking in details some particular aspects of a deal. Let’s say that the success of your company depends heavily on a unique technology that you have patented. Before making the investment and transferring their money to your bank account, the investor needs to check if everything was done properly on the IP side and if you are the real owner of this patent.

The due diligence process can cover many aspects from “legal” ones, how your legal entity is structured and if there are risks, to technology or HR ones, which are assessed by external agencies or the VC in-house team. That being said, at early stage the due diligence process should be light and “heavy” due diligences are an exception.

Contract Agreement

As usual before signing any contract, you should be sure to understand it well and to negotiate any term that you don’t feel comfortable with. It has to be done with a lawyer who has experience with this kind of work.

How long does it take to go from Term Sheet to signed contract?

It can vary greatly. From a couple of weeks if the deal is simple and if all parties are quickly aligned, to months for a complex deal: a heavy due diligence is needed, a legal restructuration is required, you have plenty of investors that you need to align, your cap table is messed up etc.