Negotiate Your Term Sheet Like a Pro
By Michelle Dervan, Lisa Shu, Helen Adeosun
Term sheet negotiation can be stress-inducing for founders and investors alike. Our combined experiences as investor, founder, and negotiations professor have helped us distill the following lessons to help others smoothly navigate the process, and ultimately create and capture the most value from their deals.
H.A: Preparing for the Process
Do your homework. As a founder, you may come to the relationship with your investors at an information disadvantage. Having now gone through two rounds of equity financing at Care Academy, I highly recommend that founders do their homework by reading the most recent thought leadership (ex. AVC, First Round, CooleyGo, NVCA), the book Venture Deals by Brad Feld and James Mendelson, and by speaking with founders who have raised in the same segment and at the same stage no more than 6 months prior. You’ll receive timely feedback on what is ‘market’ and this can help you to look beyond valuation as the only place to maximize value.
The right lawyer is key. Partnering with a lawyer who sees a high volume of venture deals is really helpful. They will be another valuable source of information on what is ‘market’ and can advise on the levers that will be most salient given your company’s stage, industry, geography, and other context. When selecting a lawyer, ask how many venture deals they personally have done recently and at which stages (Series Seed, A, B, etc.).
Time is the enemy of deals. Once a deal is in play, remember that every delay diminishes the probability of it closing. For investors, this means acting swiftly when submitting and explaining terms, carrying out diligence and reference calls, and managing the legal team through setting concrete deadlines. On the Founder side, this means quick feedback on terms, submission of materials, and active management of the legal team towards a deadline. Know that the number of legal pages that culminate for the transaction can be daunting. Lean on your lawyer to help you know what to expect and you may also find this primer on VC deal docs helpful.
L.S: Getting the Terms you Want
Optimize for the overall package; don’t try to optimize on each individual term. Remember that there are multiple ways to do an equivalently good deal. Discovering the other side’s high-level interests and priorities before nailing down the specific terms will help both sides create value through understanding differences in priorities between parties. This will create more leverage, because it allows each side to discover wise trade-offs in terms of what one side values more than the other.
Similarity is the enemy of value creation. This may appear counterintuitive―but differences are the levers of exchange. The more ways you can differ (e.g., in interests, in priorities, in risk appetite, in confidence assessment, in time horizon), the more ways you can discover wise trade-offs. This applies both to founder-to-investor negotiations and cofounder-to-cofounder negotiations. Example: you and your cofounder are discussing how to divide company equity between you. If you have a high appetite for risk but your cofounder is more risk-averse, you might suggest allocating more equity to you in exchange for higher salary to your cofounder.
Don’t give anything away for free. Sell it for something else. Say you and your lead investor differ in your company’s valuation, and after multiple conversations it appears they are fixed on this specific issue. You might be willing to agree to their valuation―but for a price. What can you ask for in return for your agreement? A shorter vesting schedule, an earlier cliff, a more expansive ‘good leaver’ clause, etc.? Take the opportunity when ‘conceding’ to a term to exchange it for something else.
M.D: Managing the Transaction
Avoid a term sheet until you are synced on terms. This might sound counterintuitive, as most founders are laser-focused on getting that term sheet wrapped up yesterday. But in our experience, it is more effective for investors and entrepreneurs to sync up on a bullet-point list of high-level terms before writing a first draft. Once there is an agreement in principle, it is much easier to quickly get to an executed term sheet―without confusing redlines and without incurring excessive legal fees. Below is an example of what a precursor to a Series A term sheet might look like.
Inject humor & authenticity. Once the word negotiation gets introduced into a room (or Zoom), everyone gets uptight and formal―which makes it harder to reach an agreement. Being intentional about creating a relaxed, open, and authentic atmosphere ultimately makes it easier to find common ground and build excitement towards working together. It’s a good idea to keep negotiation conversations as small in size as possible. Large group calls can create awkwardness―or worse, lead to posturing and a greater sense of “us versus them”. None of this is helpful. Where possible, negotiate 1-to-1 or pull in just one lawyer representing each side.
Pay attention to the exhibits. The pro forma cap table for the transaction is usually included as Exhibit A in the term sheet. If this is left blank and sent by separate email, the pro forma and term sheet can get out of sync, leading to miscommunication. Make sure that the pro forma is updated to reflect any changes to the economics of the deal and pasted into the execution copy of the term sheet. This ensures that everyone is on the same page about ownership post-transaction.
A final note on the win-win
Business schools emphasize the textbook importance of the win-win, but sadly it is rarely prioritized in the real world. Sometimes, the compulsion to win-at-all-costs overwhelms the course of a negotiation. In venture, this is bad news. Early stage VCs invest in people with big ideas and the ability to drive them forward. If early in the relationship, Founders start off feeling disgruntled (or, worse, demotivated), it can be difficult to recover their trust and goodwill. Likewise, venture investors are fiduciaries: they have a responsibility to act in the best interest of their LPs when making deals. Finding terms that are fair to both sides is hard but necessary work — and worth the investment of time, energy, and intentionality.
About the Authors
Lisa Shu is Executive Director of Newton Venture Program and Negotiations Professor at London Business School. Helen Adeosun is Founder and CEO of Care Academy, a provider of mobile-first online training for senior care professionals. Michelle Dervan is a Partner at Rethink Education, a venture capital firm focused on early stage investments in education technology companies.
Disclaimer. The information expressed herein is subject to change based on market and other conditions. The views presented are for general informational purposes only and are not intended as investment advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation, or sponsorship of any company, security, advisory service, or fund nor do they purport to address the financial objectives or specific investment needs of any individual reader, investor, or organization. This information should not be used as the sole basis for investment decisions. All content is presented by the date(s) published or indicated only, and may be superseded by subsequent market events or for other reasons.
Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal and fluctuation of value. Hypothetical information presented is for illustrative purposes only, is not real and has many inherent limitations. It does not reflect the results or risks associated with investing or the actual performance of any company and has been prepared with the benefit of hindsight. Therefore, there is no guarantee that an actual company would have achieved the results shown. In fact, there will be differences between hypothetical and actual results. No investor should assume that future performance will be profitable, or equal to the results shown. Hypothetical results do not reflect the deduction of fees and other expenses incurred in the management of a fund portfolio. All content is presented as of the date published or indicated only, and may be superseded by subsequent market events or for other reasons.
