Monday, March 29, 2010

Should I Shop This Term Sheet?

You've been working hard. You have a product, it's getting traction. You've been getting some interest from various VCs. And then, voila, you've got a term sheet. Now what?

I know that for many folks in these difficult times the answer is going to be -- where do I sign. Maybe you only have one investor seriously looking at your company. Maybe you could really use the cash. But there are some companies that have the luxury of competing bidders. This comes up time and time again and it is a very tricky area.

On the one hand, you have established conventional wisdom that comes out firmly on the side of "don't ever shop" a VC term sheet. It is considered bad form. You could lose what you've got. It makes the VC feel like they are nothing more than money to you. If you had played the game correctly, you would have already orally agreed to all salient terms, so there should be nothing for the VC to improve upon. Etc.

On the other hand, what if there are some terms that you would like to see improved upon? Or, more important, what if you really clicked with a different VC and would prefer for that VC to be the one that you are going to be married to for the next 7 years? Well now you are in a pickle.

In these types of situations, I have generally counseled folks to follow the following protocols. (And, interestingly, I listened in on a "panel" at SXSW where Justin Fishner-Wolfson a principal at VC shop, the Founders Fund, agreed with this protocol on almost all points. So there is certainly not unanimity among VCs on this issue.)

Shopping term sheets is ok. But only under certain limited circumstances.

First, you should never show an actual term sheet. That really is bad form. Rather, you should orally convey that you've got an actual signed term sheet and let the other firm know one of two things -- either they are your top choice because of personality fit and if they come up with a ball park offer you will go with them, or they are in the ball park but if they can improve on one or two key terms, then you will go with them.

Second, you can only go back once. It cannot have the appearance of an auction or feel like you are playing different investors off against each other for incremental improvements in terms. Remember, VCs talk to each other. A lot. Chances are quite good that they will catch on to you if you are doing multiple round trips.

Third, only ask for things that you really care about. Pick two or three (or one) term(s) that really matter to you and ask for improvement. Don't quibble about silly things like number of demands in a registration rights agreement or number of days notice you need to give on the right of first refusal. Stick to what really matters to you, explain that the competing investor gave better terms in that area and ask for the improvement.

Fourth, if the VC concedes to your request, then you should accept their term sheet. It is NOT ok to then go back to the first VC and ask for further improvement. Etc.

Finally (and most important), never shop an "oral" term sheet. Another word for an oral term sheet is diddly-squat. If you don't have it in writing, it doesn't exist. Just because a VC told you that they "feel really good about getting you a term sheet soon", it does not mean you have a term sheet. Trust me, VCs talk. They will figure it out if you are shopping something you don't really have. And then you really will have nothing.

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Dividends and Preferences by Hank Heyming is licensed under a Creative Commons Attribution 3.0 United States License.