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“Standard term sheet” suggestions

TheFunded has published what it believes should be a standard termsheet in venture financings. Their argument is that the following balances the rights and incentives of investors and founders well, and the negotiation should be limited to valuation and amount being raised. Interesting point of view.

FFI Plain Preferred Term Sheet

Chris Dixon has earlier proposed his (similar) “standard” termsheet here.

These are all commendable efforts and in my view, in the right direction. The issue arises when certain provisions are more valuable to one party than other (due to differential view on the business, different degrees of experience etc) – so in some cases, founders may be optimistic to not care about participation, but may want higher valuation. Or, the VCs may perceive certain additional risks and may want protection against those. Such deal-specific characteristics encourage “trade-offs” amongst terms – a la “if I have to offer a higher valuation to be competitive in the deal, let me add more participation”. A negotiation process in the end is about trading off what is less valuable to oneself for something that might be less valuable to others.

Would love to get thoughts from the readers on where they tend to fall on this debate.

  • http://www.canaan.com Alok Mittal

    Niranjan – in my experience, there is fair degree of negotiation that happens on the term sheet. For a couple of reasons – one, competing term sheets are not uncommon, and that allows the entrepreneur leverage. Two, many entrepreneurs I have come across in India always carry the option of not raising capital, so non-usage is competition. Third, the VC who gets far along to issue a term sheet is fairly excited about getting the deal done and moving on asap, so if the requests are reasonable (in their perspective), they are often incorporated.

  • http://magicrooms.in Niranjan Gupta

    Do you have any statistics of how many deals fall through because the terms of the TERM SHEET was not accepted by the startup. Typical startup cannot afford to skip the offer and hope to get the deal from other. It is not that VC are standing in line. Given that situation, it finally boils down to what terms VC offer and the startup accepting it. Unless one has more than one TERM SHEET on hand, there is not much room to play with.

  • Karthik

    Alok, could you post something which is more relevant to the Indian marketplace? Maybe a sample VC termsheet after taking out all confidential information.

  • http://blog.investraction.com Deepak Shenoy

    Good points. I thought a term sheet was given before due diligence – perhaps I’m wrong there.

    One thing to note: In India, a company can’t make a deal to buy back shares from a shareholder just like that. Buyback regulations require you to offer shares to all shareholders equally. Plus, once you do a buyback you can no longer sell shares for another two years. So that clause – that if employee X leaves we will buy the shares back – isn’t quite valid.

    What’s more common is an escrow of current shareholding that is released over a period – the remaining escrowed shares are transferred to the other party (usually the VC, or an ESOP trust) if the founder leaves before the period is over.

    On a first right of refusal: this bit has to be handled with care. The VCs can lowball you if they kick you out, because you have no other recourse. Ensure that the clause says they have the right of refusal at the same price that the shares are offered to any other party.

    The legal term for something like this in India (once executed finally) will be an MoU (Memorandum of Understanding). It’s best to get a lawyer to oversee it anyhow – lawyers in India on an average charge a lot lesser than the US (5K to 10K per hour AFAIK).

    There will be other things that could complicate matters (i.e. tag alongs, drag alongs, ESOP pool expansion, staggered funding etc.) Best to keep it simple, but that’s hardly in one’s control…

  • http://www.slipstreamlabs.com Anil Jain

    There is a lot of value in having a basic framework to start from, but I think it is very important for entrepreneurs to recognize that the various terms of a financing are meant to enable company founders/management and investors to balance their particular interests and address their risks.

    Entrepreneurs should strive to understand their investors prior to presenting a term sheet. What are key issues the investors are concerned about and how will management address those issues? What is the investors “investment thesis” (i.e. what types of deals do they want to do, what return are they expecting, what is their risk tolerance, how much of their available capital are they putting into this deal, what does the rest of their portfolio look like) and what are their expectations relative to this venture?

    Entrepreneurs should also take the time to assess themselves and to identify the key concerns and interests they have. To what degree will we be willing to empower these investors to influence key business decisions (i.e. hiring, partnerships, financing, etc.)? Will these investors deserve preferences over founders in terms of what the company achieves liquidity (e.g. a liquidation preference)?

    The term sheet is the document that distills all of the various questions and answers into a simple articulation of how both parties will inter-relate. Different financing structures (e.g. convertible debt), preferences, information/disclosure privileges, governance and control rights, etc.) should all be factored into the crafting of a deal and hence, the term sheet.

    The last thing I would add is that while bootstrapping and cash conservation are key, it is always important to use a good corporate lawyer that understands securities laws and has worked with startups. They are worth their weight in gold — this is sometimes only realized further down the road.

    To ensure I’m not misunderstood, let me clarify that I am not an attorney (nor do I play one on TV). I run a venture development business where we work closely with entrepreneurs, management teams and investors to build a grow promising ventures. We are advocates for innovation and entrepreneurship and have a few companies of our own.

  • First-time entrepreneur

    Given this has the blessings of serial entrepreneurs like Chris Dixon and has also received a positive nod from Fred Wilson (a forward looking founder-friendly VC IMO), this is great for first-time entrepreneurs.

    If VCs adopt such templates, this can greatly help in expediting fund raising and thus, minimize entrepreneurs’ downtime. Also, reduces legal fees.

    @ Himanshu: Standardization increases volumes, quite likely improves scalability, and increases efficiency.

    It would be good to standardize things that rather be standard.

    Let innovation in technology / product / business model be the only non-standard thing.

  • http://www.kmonyb.wordpress.com Krish

    I think it’s a near-perfect Alpha with built-in flexibilities for customization. If both Founders and VC folks don’t act up, the PITA breed of lawyers can be kept out of the loop and a fortune saved in fees.

  • Himanshu Nautiyal

    Standardization encourages volume and reduces “margins”.

    Of the VCs and founders, who wants funding to be a volume game? Makes little sense for traditional VCs (they do say 10 deals a year) but makes even less sense for founders (1 deal in 2 years).

    This can benefit only folks like Y-combinator (they do have std sheets) or matchmaking agents.