From the VC’s corner (13): Are all the terms in an early-stage financing term sheet that important?

You’re early-stage and now meeting VCs; and here’s Mr. Nice Guy VC (or the bully one, or the skeptical one… there are more types.) It would be great to have a constructive relationship with the VC right from the beginning. Assuming all ok, you’ll end up with a term sheet; obviously, better getting more, to have some leverage in negotiations.

As term sheets land on your desk, there are some terms that matter a whole lot and others that don’t (well, all terms matter, especially within a down situation, but for some don’t spend ridiculous long time; these days, there are plenty of free, online resources/term sheets which you can download at a glance and get some knowledge.) By the way, there’s no such term as “market” term.

If you’re new to the early-stage financing scene, the t/s will be riddled with “mysterious” language that it would seem only the lawyers or experienced deal makers can decipher. Never fear, it can be a straightforward process as soon you understand/learn the important terms (revert in other post on these,) and realize that a common business sense should govern the discussions. Everything that seems out of “fairness” raises questions vis-a-vis the VC’s seriousness, intentions and even professionalism.

Now is the time to bash on lawyers. Avoid the lawyers who are mediocre at best and hire the experienced one(s); and never let them lead the discussion. Negotiation is not about lawyers’ ego wars, but about you, as founders, and the VCs. Know the investors/persons, understand her/him/them, discuss and exchange emails on the main points (economics and control,) and then let the lawyers know what you’ve agreed upon. And when you agree on something, it’s like done. I repeat, don’t let the lawyers drag the discussion to the path of no return. I’ve seen many cases where more preparation on the part of the entrepreneurs could have turned the negotiation into a successful funding outcome. I’ve also seen cases where the parties have agreed, but under the “precious advice” of the lawyers there wasn’t a good understanding from the entrepreneurs on the important terms, and they chickened out.

One of biggest, common mistake entrepreneurs do is trying to negotiate term by term, line by line. For the VCs, the economics and control terms matter most. For the other terms, just spot whatever is out of fairness and say it out loud. And not to forget, don’t ever lie; credibility is all you have. If you fight too much about all the other terms, then this sends a wrong signal.

Just to briefly recap some terms that are pretty standard these days (and have been fiercely negotiated years ago): the protective provisions (if somebody asks for more you should ask yourself why do they do that — light negotiation works here); drag-alongs (since it’s about what’s best for the company, not necessarily you — executives and founders); conversion (has to do with the liquidation preferences); dividends (noncumulative may work in some cases, but most VCs don’t do); redemption rights (for the early stage deals, it’s a vestige of the past); conditions precedent to financing (a VC can walk away at any time before signing, no matter what; if it’s a long list, then the VC/investor is probably not that serious; talk about it openly, or may even push back if you have alternatives); assigning shares (VCs have different legal entities); information rights (it’s normal to have access to info, unless the investor is pretty small/not really material); registration rights (if you go public or in a secondary sale); right of first refusal (aka pro-rata right; make sure it doesn’t have a multiple on it or isn’t linked to a specific percentage, which scares away other potential investors); voting rights (how the preferred and common stock interact in terms of voting); restrictions on sales; intellectual property (have agreements in place!); co-sale agreement; founders activities; IPO shares purchase; no-shop agreement; and indemnification agreement (if something goes wrong, the company is going to back VCs up.)

So, don’t get mesmerized and pay attention to the main terms; for some other terms, it’s not worth pushing the envelope but read them. You might be surprised what comes out of a smooth negotiation with an investor who cares and can really help.

To get more insight on the (term sheet’s) terms, I would highly recommend you to audit or actively participate in the Kauffman Fellows and Techstars’ Venture Deals online course, taught by VCs Brad Feld and Jason Mendelson, partners at the Foundry Group and also authors of “Venture Deals — Be smarter than your lawyer and venture capitalist” (sort of a Bible for the startup’s founders.)

My today’s preferred: Miro — the #1 visual collaboration platform to create, collaborate, and centralize communication across your company; enables you to engage all your collocated, distributed, or remote teams across formats, tools, channels, and time zones, without the constraints of physical location, meeting space, and whiteboards. Great short video presentation!