Coming to Terms with Term Sheets

One of the most important documents you’ll read through as you grow your startup is the term sheet laying out potential financing. While not a huge document, a term sheet by a VC will lay out the financial terms of their investment, how much your startup will be worth, who has control over the startup, and how profit will be handled if/when the company goes public or gets sold. It’s a short, but sweet, document spelling out the basics of your engagement with a VC investor. 

Some people compare a term sheet to a letter of intent. Once signed, the more detailed process of negotiation between founders and a VC will result in an involved legal agreement. The term sheet acts as a high-level roadmap to help lay out their intent. These don’t necessarily promise an investment, and many term sheets may never turn into investments. 

Hire Counsel

Any party involved in the investment relationship should have someone help them look through any language from a legal perspective. Most founders are not attorneys themselves, so it’s important that you understand the wording and language in a term sheet, and are comfortable with it. Also, since a more involved legal agreement comes next, it’s important to have your attorney on board from the start so that they can walk with you from start to finish in the negotiation phase.

Look Beyond the Valuation

Look, we’re not saying valuation doesn’t matter, because it does. However, one big rookie mistake founders often make is obsessing over the valuation number. By doing so, they often gloss over the other details around other financial terms, sales or going public details, ownership decisions, and more. Yes, you can care about what a VC firm sets your valuation at. You should ask questions around how and why they got to that valuation, but if you fixate on that alone, you run the risk of missing out on other valuable points like liquidation preferences, participation rights, and more within the investing interaction.  

Think Long Term

At this phase, you’re thinking largely about the immediate needs of your fledgling company and that means dollars and valuation are on the forefront of your brain. However, there are critical pieces around liquidation, option pools, board structures, and more that can affect the future of what your company looks like years down the road. Many of these things may not matter much now, but based on how you grow and scale, could be a major issue in a short period of time. Bad terms in this round can impact subsequent rounds of financing as well as potential acquisitions. It’s best to consider these possibilities early on. This is where a good attorney can be gold. Finding business mentors is a great step as well so you have a pool of people to turn to with questions and to think through possible scenarios. 

Relationships Matter

One of the most important things on a term sheet is not related to specific numbers or processes but in the name of who is writing the term sheet. The relationship is what really counts, and that’s often an intangible gut feeling based on reputation, experience, and rapport you have with those leading your VC fund. Do your research and get to know your VC firm and its leadership. What do they value? Why do they invest or not invest? What drives their investment? What do they bring to the table beyond just mere funds? All of these questions will help you evaluate if the VC firm on the term sheet is a good fit for you. Even if the numbers are all showing one thing, but your impression and gut reaction are saying another, you will know it may not be a fit. 

At Sentiero, we’re not looking for just another good investment (though we love it when we find a good one too!). We’re also focused on finding the right fit for our portfolio. When we put together a term sheet, we’re not just looking for an investment that makes numerical sense, but also an investment that has a good fit for what we bring to the table – and we like to think we bring more to the table than just money. We’re in it for the relationships, the business advice, and the impact of moving technology forward in so many facets that impact daily life. When we find a company that not only fits our approach and philosophy but also makes a great investment from a numbers standpoint, it’s a really thrilling thing for us!