October 11, 2022

Term sheets: 3 practical tips for founders

By Babbage

If you’re reading this blog, then you presumably already know what a term sheet is. But just in case you need a reminder, let me offer a brief definition (and yes – I do have my computer open to the Wikipedia entry. Why reinvent?). Here goes:

“Within the context of venture capital financing, a term sheet typically includes conditions for a startup company. The key offering terms in such a term sheet include (a) amount raised, (b) price per share, (c) pre-money valuation, (d) liquidation preference, (e) voting rights, (f) anti-dilution provisions, and (g) registration rights.”

So there – that should clear things up for you 100%. Just make sure to cover these seven simple areas with your attorney, and of course, things will be super swell with any terms sheets that you might be handed by a venture capital team such as ours. Yes – just review the terms and there should not be any real risk to you. Everything will be as you expect. No sweat.

Uh… not.

The truth is that you could spend a lifetime working on term sheets – and for some of us, it seems like we’ve been doing just that – and still not feel like you are an expert in this fine art of startup financing. Term sheets are complex, and they can lead to massive surprises, and the only reasonable approach for startups is to mitigate the risk as best they can. This is the truth.

That said, we can offer some useful tips on term sheets from our perspective – three tips, specifically, that we hope will help you navigate the term-sheet waters as you seek financing for your company. These tips presume that you are a founder of your company and that you are in the midst of an early or mid-series round of financing. Here they are:

Tip 1: Getting a term sheet does not mean that your startup success is now confirmed.

As a venture capital team, not to mention as career entrepreneurs who’ve worked the term sheet process from both sides of the table, we cannot emphasize enough the importance of damping down the celebrating when a term sheet comes your way.

Too many founding teams, especially ones who are new to the startup funding process, receive their first term sheet and then assume that their success is guaranteed. This is not the right mindset in our opinion and, given the incredible challenges of steering a startup to real success, we believe that a solid mindset is essential.

Perhaps a more suitable approach is to view a term sheet as the first step in a massively long and arduous journey – one that will leave many people behind, that will create all sorts of unforeseen challenges, and that will result in a company that often only marginally resembles the one you’d intended when you got started.

Of course, you should be pleased if you are looking at that first term sheet – and you should use it to help get additional ones for review. But also understand that terms sheets are non-binding and that, even if a financing deal is negotiated, the work just grows in intensity from there. 

Tip 2: Make sure you have experts in your corner who can help you understand and negotiate.

We cannot emphasize enough the importance of making certain that you have a good team to review and analyze the details of a term sheet. Our team at Ballistic Ventures, for example, agrees that the best deals are the ones where everyone seems to be on the same page. And this can only happen when the startup team is well-informed.

Some founders try to use YouTube videos, internet articles, or other free resources to inform their judgment on term sheets. While this is advised for background learning, we’d suggest that you get what you pay for. Instead, work your local network, starting with your legal team, to ensure that the right people are in your corner helping you interpret every aspect of the term sheet.

Without proper due diligence and review, it’s easy for startup founders to miss the details of minimum money to be raised, pre-money valuations, dilution issues, and all sorts of other specifics. This is not an area in which to skimp if you’re a founder. Get the right people working for you – and with you – to ensure clarity in all aspects of the deal being reviewed.

Tip 3: Try to work with reputable VC firms with track records you can review.

Okay, you can start by assuming that we believe we are a reputable venture capital firm – and that our track record as investors and founders speaks for itself. So, if you are dealing with us, you can skip this third tip.

For everyone else, and for any interactions you might be having with other VC firms, be advised that quite a bit of money is being raised and invested in cybersecurity ventures. By some estimates, this number passed $30B in 2021. This implies that there is a strong possibility that a less experienced firm might become involved in your financing.

Before you view this as good news – and yes, it will increase the chances of you getting funded – it also increases the chances that your term sheet might include provisions that are not in your best interest. The only way to address this, to the degree possible, is to stick with reputable firms. And if you are finding yourself in discussions with venture capital firms with a more dubious track record – see tip #2.

Let us know your thoughts on these three tips and on your own experiences with term sheets from VC firms. We hope to hear from you.