TERM SHEETS ARE NOT CONTRACTS: Beware and plan wisely

Did you know the term sheet is not a contract?

It is simply a letter of intent. So beware! Your desperately needed cash is not in the bank until the cash is in the bank. The VCs (or you) can stop at any moment for any reason.

VCs will present the term sheet like a contract with God. But it is not. It is simply a letter of intent about what you and they are going to negotiate in detail and agree on, if you and the VCs still want to do the deal after doing all their checking (called "due diligence"). If they find a surprise they do not like, or if another VC invites them into another deal instead of yours, they can and will quickly stop and pull out of your deal. There is no legal action you can take because the term sheet is not a legal contract.

This can act in your favor. For instance, if a world-class VC pops up and offers you a much better deal, you can stop working on the first term sheet, without penalty. That has happened to many startup CEOs. It is common because you will have contacted several VCs and they are often following up your first meetings and may have become more eager since the first meeting. Yes, the term sheet you signed said you would agree to no longer solicit new investors, but you are wise to listen to incoming phone calls from investors.

In an ideal world, you want to make a decision to do a deal with your favorite venture person. Then you will ignore other investors. That is the spirit of the term sheet. If you are not so sure about the investor, then beware of quickly signing a term sheet. It would be better to finish your first round of contacts with a half dozen VCs and think about which you would like to do a deal with.

BOTTOM LINE: Think of a term sheet as a serious handshake. Both parties want to come to an agreement. But both are not obligated to do so. The term sheet is a sketch of a plan to create a contract. When that new contract is signed, cash goes into your bank account. As I wrote in yesterday's blog, be prepared for a much longer time to money than you believe possible. The money is not in the bank until it is in the bank. Meanwhile, keep advancing your company. And answer emails and phone calls from any investor. You are in the driver's seat. It is your company. Investors want to put money into it. Allowing that is your decision. When you understand this, you'll be well on your way to building an unfair competitive advantage.

Comments

[John Nesheim]

A. nonymous, you are wise about keeping a set of "backup" VCs. Like a sage General, you need reserves. Serial entrepreneurs always have VCs working their deal, regardless of the term sheet approaching the closing date. I aim to keep 6 lead VCs going until the deal is done. I hope your second wave works well for you. I wish you the best!

[A. nonymous.]

This could NOT be MORE TRUE. I negotiated through AND executed a term sheet with a well-known VC in Silicon Valley. LITERALLY 5 DAYS before signing the long-form (which was generated and delivered to the VC,) they called me to inform me the associate who was managing my deal had taken another job. Now that he was leaving the firm did not believe they had the internal expertise or "bandwidth" to manage the start-up phase of the deal. So, up in smoke my deal went only a few days before we were set to finalize the deal. I feel this is unethical, as the partners of the firm had represented our deal was "DONE" and they "WE'RE IN!" - but, it is not the case. Bottom line, the fat lady sings when the cash hits the bank. Until then, the VC can screw you over up to the last minute. Luckily, we haven't made the rounds and the first VC we went to was interested, so, now it is back to the phone to set meetings with more (hopefully BETTER!) VC's. But, WHAT A LET DOWN!

[John Nesheim]

Jen, your comment is very wise. I never cease to be amazed at how "sneaky" humans can be, especially when under stress. Then it becomes a test of character and you'll know who you are really negotiating with.

[jen_chan, writer MemberSpeed.com]

I've always thought that they are more or less the same. And while I've always been taught to be careful of anything that requires my signature. After all, I'm of legal age now. While I'd like to say, "Ooh how sneaky of them," it can also work to my advantage. I guess this just warns everyone to be careful no matter what.