4 Things to Do After You Get Your First Term Sheet

I’ve recently been involved in helping a couple companies with their first major round of VC financing.  It’s actually been pretty interesting for me because I have histroically been on the other side of the table.  In addition to generating several stories worthy of “The Funded” and getting a better appreciation of the trials and tribulations that entrepreneurs must go through when trying to raise money, I also gained a better appreciation for just how important it is to properly manage the “end game” of a VC financing.

What is the “end game”?  The End Game generally takes place after you have gotten a term sheet, but before you actually sign it.  How well you manage this process can make a big difference in the actual terms and pricing you ultimately get, so it pays to approach this process as thoughtfully and diligently as you do any other part of fundraising.

With that in mind I present 4 things that you should definitely do after getting your 1^st term sheet:

1. Get a second term sheet:  It may sound flip, but this is the single most important thing you should do upon getting your 1^st term sheet.  Nothing loosens up a VC’s purse strings or makes them more flexible on a particular term than the threat of competition.  Without competition (real or perceived) you have very little leverage against a VC.   Now getting one term sheet, let alone two, is tough enough, but getting two must be your goal and you must not waiver in pursuit of that goal even you after you get the 1^st one.  The biggest problem most entrepreneurs have executing on this strategy is that they have mismanaged the sequencing of their fundraising.  Many entrepreneurs make the mistake of pursuing an “in order” fundraising process whereby they take one meeting, run that process to its logical conclusion and if that doesn’t work out try to get a meeting with another VC.  VC fundraising must be pursued concurrently!  You must put as many irons in the fire in as short a time as possible so that all the firms start the process at roughly the same time. As firms progress through the process, you should do your best to try and “herd” them along by trying to slow down the ones pushing ahead and speed up the ones lagging behind.  The ultimate goal is to ensure that when you receive your first term sheet you have several other firms that are very close (within a week or so) to potentially issuing their own term sheets.  Proper sequencing ensures that you are not forced to take an inferior “bird in hand”.
2. Ignore term sheet “expiration dates”:  Most VCs put “expiration dates” in their term sheets (usually at the end).  In almost all cases these are artifices that are inserted into the term sheet in order to put pressure on the entrepreneur and to try and prevent them from “shopping the sheet”.  The reality is that as long as you are negotiating in good faith with a VC they are not going to pull a term sheet.  That’s not to say that VCs won’t pull a term sheet if they feel like you are being dishonest with them or have no real interest in taking their money, they will, but as long as you deal with them professionally and explain to them why you need more time to consider their offer, they will extend their phantom “deadline”.
3. Do some due diligence of your own:  One of the more unfair aspects of VC fundraising process is that VCs are allowed to take months probing every orifice of your company, but entrepreneurs are expected to make one of the most important decisions of their life in a week or two and often with little or no information.  There’s no good reason for this and all entrepreneurs would be well served by taking some time to do some basic due diligence on any investor who has offered them a term sheet.  I suggest, at a minimum, talking to at least two entrepreneurs that the VC has funded and then talking through with the VC A) all the deals they have done and what happened to them B) the current status of their fund and partnership.  Doing your own due diligence has 4 main benefits 1) it may help you avoid making a bad decision  2) it will create the perception of a competitive process 3)  it will make you appear more savvy and diligent to the VC  4) it can come in handy when you are trying to stall while you get your second term sheet.  Don’t go overboard and act like a VC by asking lots of annoying questions and drilling to the center of the earth on irrelevant/tangential questions; just ask for a few reasonable pieces of information and be very gracious about it.
4. Negotiate:  By the end of the fundraising process most entrepreneurs are so fatigued and shell shocked that when they finally get a term sheet they are loath to do anything that might upset the apple cart.  This situation generally leads to some pretty one sided “negotiating” sessions in which the entrepreneur meekly asks to eliminate the triple participating preferred, the VC says “NO!”, and the entrepreneur quickly retreats.   The reality is that VCs expect some negotiating and their first offer is never their best.  That means you should, within reason, feel free to push back on their initial offer.  Of course, if you have a second or even a third term sheet you can push back even harder, but even if you only have one term sheet you should still push back.  As they say, it never hurts to shake the tree.

If you follow these four pieces of advice you will put yourself in position to get the best possible outcome.  The most important thing to remember is that once you get a term sheet, the whole dynamic of the fundraising process changes and the ball is now in your court.  How you “return serve” can make a big difference in the outcome as I've seen VCs increase their initial offers anywhere from 25–50% when these principals are applied.  Your mileage may very, but its definitely worth a shot.