Term Sheets

I'm at the end of negotiating a term sheet for a significant investment in the company by a socially responsible venture firm. It's an exciting time for us; we're posting record sales this month, we've reorganized, and we've got great plans for this year after a 6-week process of re-org and planning. We're thrilled with the firm, which shares passion for enabling nonprofits to do more good better. (that barely sounds like English, but I think it works).

I'm not going to go into the details of this deal, not yet, anyway, if at all. There's a line I'm still figuring out between what should be made public and not, and I think investment is one of the things that should remain private for a bit. But deal terms should be made public in some way, and I think www.thefunded.com is working on it.

But I do have some advice for this, my 4th term sheet of my career (at which our attorney scoffs, having worked on hundreds).

Negotiating term sheets requires organization, concentration, understanding of terms, creativity, good faith, and flexibility. And research. And your attorney. And patience. It's an iterative process, and decisions about changes and proposals can take time. So some tips:

• Get an attorney who has deep startup experience and has seen more than 30 term sheets.
• Get an attorney who has more startup clients than VC clients, and who has an unusual love of underdogs.
• Assign a single point person to negotiate and ask the same of the firm. While your board members might want to speak directly with investors, doing so can create confusion. The board should empower the CEO to handle the negotiations on behalf of all shareholders, and make their comments on terms to him, especially the terms they reject outright.
• Understand the lead partner is negotiating a draft and usually needs to get final buy-in from his/her partners.
• Learn to say "what are you trying to accomplish with this term so I can perhaps suggest another way to get there". Most VCs I know are willing to work with you on terms, because they know that sometimes the way things are phrased can either be too general or have unintended consequences. There are many ways to structure deal terms to serve all or most interests pretty well, if not perfectly.
• Forget perfect. A perfect term sheet is one that's adequate, doesn't trample on previous investors, and gets money in your bank at decent terms so you can build value. So don't sweat the small stuff, don't major on the minors.
• Know what the minors are, know what the majors are, and know when to just accept it and move on. That's why you need a lawyer. I've studied this during each investment and I still need a lawyer to help me.
• Study. You need to know your terms. In fact, it might even be better for your attorney to handle the negotiations (with you on the line, of course). The best sources for understanding term sheets I've found are here:
  
  Venture Hacks (http://venturehacks.com/term-sheet-hacks) by Nivi (Nivi is one of the smartest people blogging in the startup world)
  Term Sheets by Brad Feld (http://www.feld.com/blog/archives/term_sheet/index.html)
  (Brad is a great guy from what I know)
  
• Be honest, open, and show good faith. Most VC firms aren't trying to screw you. They have to protect the interests of their limited partners, which makes them risk-averse in term sheets, and that risk aversion tends to feel oppressive. But with every negotiatoin I have not experienced that in the term sheet.
• Do a gut check. Just before you agree to a venture financing, consider calling your potential acquirers to see if there's interest. Tell the acquirers that you have a deal on the table, and that the investors expect a 10x return, making it a very expensive purchase the day after the deal is signed, so how about an offer? If they are interested at all they will try to get an offer together. Don't be surprised if the offer isn't 10x your post-money valuation, or even 10x your last round valuation. But it's worth considering, given it's going to take you some years before you get to that potential 10x exit.
• Be gracious and thank the firm. These are your new partners, and it's in their interest for you to do well, and it's in your interest to develop a great relationship with them. Be open to their ideas, be open about how you feel about their ideas, and keep them in the loop with regular reports (monthly, detailed sales and marketing reports, dev progress, significant milestones, new hires, etc).
• Once the money is on board, involve them in planning so they aren't freaked out when you run out of money exactly when you expected.
• Don't run out of money. Plan for sustainability, and adjust along the way. You should know your cash flow down to the day at least 3 months out, but shoot for 9 months if you can. If you say on plan it's a lot easier, but everyone understands that plans change given changes in the market.

I hope that helps. Keep in mind I've only run 4 companies, two of which aren't relevant here. So get advice from a number of people and sites. See who links to Brad's blog and Nivi's site, because they'll likely have additional advice. And have fun!