Term sheet negotiations are tough.
Even though they're not legally binding, they hold a certain weight.
And if you get this wrong, you could even lose control over your startup.
After reading this guide, you will be well-prepared to avoid the most destructive mistakes.
And make the most out of your term sheet negotiation.
Let's dive right in.
1. Hunt that first term sheet
It’s a significant step when a VC gives you a term sheet:
It means they’re interested enough to have gone to the trouble of creating one for your startup.
Even more, it often puts the VC under pressure to close the deal with you because many VC firms consider closing ratios a marker of success.
If they don’t close the deal with you, their ranking takes a hit.
And since they don’t like that, receiving a term sheet changes the power balance in your favor.
Because it commits the VC to the next move.
Term sheets are something you should be going after with enthusiasm.
2. Get at least 3 term sheets and build your confidence
Never stop reaching out just because you got a term sheet from one investor.
If you were job hunting, you might send your CV to 30 companies and get 3 offers.
Three is better than one because now you get to choose.
With term sheets, it’s the same:
Meet 30 investors to get 3 term sheets. (1 out of 10 is a good ratio.)
And it does more than just allow you to play the VCs against each other.
The ability to choose increases your confidence in conversations and your decision-making.
People feel that. Your outcomes improve.
It makes VCs jump and get to it quickly when they hear you’ve got multiple term sheets from other potential investors.
3. Never sign a term sheet right away!
The moment you sign a term sheet, the power dynamic changes again.
This time, not in your favor.
That’s because term sheets usually include an exclusivity clause, or a no-shop policy, meaning you can’t go “shopping” for other investors for 45 days.
Or 60, or whatever the clause says. (I’ve seen 90, too, but that’s overkill. It smells fishy.)
Once you’ve signed the term sheet, you lose the power to say, “Company ABC’s offer is better.”
Because you’re not even allowed to talk to company ABC anymore.
4. Always negotiate term sheets with your investors
Do you want what’s best for your startup?
Then make a point of always negotiating term sheets.
Because the first offer is never what’s best for you.
And that’s not ill intent – investors aren’t bad people.
Knowing what’s best for everyone is impossible unless you’ve negotiated.
Experienced, legitimate investors know that.
So, never accept a term sheet as it is.
Not only will you not get the best possible deal.
You’ll look like a bloody beginner.
(Or worse: Like you don’t care about your startup.)
5. Prepare to negotiate effectively without flinching
You’re at a disadvantage:
You’re squaring off against an investor representative who has negotiated hundreds of term sheets. Maybe even thousands!
But this is your first rodeo. Or your second.
And you have yet to reach the level of experience that the guy on the other side of the table brings.
This insecurity makes some founders “flinch” – they stop short of making a daring ask, or they accept bad terms for fear of losing the deal.
You may feel like they’ve got a gun to your head, but if you’re cut out for being a startup CEO, you’ll follow Harvey Specter’s advice:
"What are your choices when someone holds a gun to your head? You do what they say, or they shoot you, right? Wrong! You can take the gun, pull out a bigger gun, call a bluff, or do 146 other things."
And you’ve got it a lot easier than this because the truth is:
They don’t have a gun to your head. So don’t flinch.
Know your leverage and use it.
6. Use your leverage
They’ve given you a term sheet, and not closing this deal with you could hurt their ranking.
You’ve got term sheets from 3 investors, not just one. You’ve got choices; they’ve got competition.
You’re the competent, likable, innovative founder of a fantastic startup.
It’s their job to invest in you, and they hate missing out on a great opportunity.
You both want to find a way to make it work.
So, if you remain reasonable and likable throughout, there’s a lot more you can ask for than you may think.
7. Don’t ask for more money
“Great,” you may think. “I’ll ask for more money.”
(After all, you’ve got leverage now, right?)
But that’s the one thing you do not want to do.
You pitched to them, you probably had 2 or 3 meetings, they’re interested, and you’ve already told them how much money you need and how you’ll put it to good use.
So, why would you need more now if you said you needed 475.000 a few days ago?
There’s no logic in that, so never ask to increase the investment sum after you’ve received a term sheet.
(unless the sum is wrong and different from what you discussed in your meetings)
Asking for more money after you’ve received a VC term sheet is a trust breaker.
Don’t do it.
8. If someone’s got a gun to your head, leave the room
There’s either a problem with Harvey Specter’s advice when “someone holds a gun to your head,” or maybe it’s just an option he doesn’t mention (one of his 146 other things).
The option: Leave the room.
Nowadays, most investors will email you your term sheet, but some will hand it to you in a meeting.
If that happens, just let them talk you through it, make no commitments (definitely don’t sign it!), and say, “Thank you.”
Then leave the room.
It’s an easy choice:
If your counterpart is so much more experienced than you, and you can’t overcome the sense of insecurity when you’re negotiating a term sheet live, then just don’t do it.
Get a lawyer or mentor to go through the term sheet details with you, red-line it, mark up all your change requests, and send the edited document by email with a friendly professional text saying, “These are the terms we are willing to accept.”
Negotiation by document isn’t my favorite, but I’ve seen founders pull it off.
It can help inexperienced negotiators side-step the dangers of making bad choices in a live situation.
If that feels like the safest way for you, go that way.
But … how do you know you should leave the room?
9. Never negotiate with an increased pulse rate
Most US city riots result from police brutality, and police brutality is linked to car chases.
So now, there are laws in many US states that prohibit the police officer driving the car in a chase to walk up to the perp and make the arrest (once they’ve pulled him over).
What?!? That can’t be right.
Don’t all the Hollywood movies you’ve seen show the cop jumping out from behind his steering wheel, running over to the perp’s car, and handcuffing him?
Yeah, but those movies can't show you the cop’s pulse rate at that point, and sadly, that’s usually off the charts: 175 bpm or more.
Let’s face it:
Driving a car at 100 km/h through an inner city does that to you. It jacks up your pulse.
And research shows that, at 175 bpm, your prefrontal cortex shuts down completely.
(That’s the part of your brain that allows you to make intelligent decisions.)
Since a cop’s “bad decisions” involve brutality and lead to riots, the new law makes sense:
You don’t get to make the arrest if you drove the car.
Your pulse might not go up to 175 bpm when a VC proposes you sign that term sheet with an offer of 2.5 million (or whatever the sum).
But do not make any decisions if your pulse goes up beyond that “fun excitement” level and into hard-core pumping mode.
Because you cannot judge, at that moment, if they’re good for you or just mindless reflexes.
Just stick to this simple rule: pulse up = postpone important decisions.
(Note that you need to be much better at minding your pulse than a cop because the question isn’t whether at 175 bpm you beat the crap out of the investor and start a riot.
It’s whether at 98.3 bpm, a short distraction makes you miss some small but crucial detail that will ruin your startup’s future.)
10. Don’t skim past innocent-sounding “standard terms” without understanding what they mean!
“Standard terms” sounds innocent – right? But it isn’t.
When you see the words “standard terms” in a term sheet, red-flag that part.
Dig into it until you understand it.
Here’s an example*:
After x years, “upon a redemption request from the holders [ = VC], all Series A Preferred shares shall be redeemed.”
Not always a problem.
But a poorly timed redemption is a great way to go bankrupt.
(e.g., if your share prices drop)
So ask yourself:
Do you want a scenario where a VC can threaten you with bankruptcy?
Or to use that threat as leverage to force your hand on some other decision?
Just because you’re going through a rough patch?
Like: kick ‘em when they’re down…?
I’m not saying they would, but why tempt fate?
Never accept a term that hangs a war hammer over your head by a thin thread.
11. Learn the terminology and don’t get forced into a badly timed IPO
You have to wrap your head around their vocabulary if you want investors to treat you as equals.
From preferred convertible (nothing to do with roofless sports cars) to redemption (nothing to do with morals or religion), learn what it means.
If not, you’re putting the future of your startup on the line.
For example, what does it mean when VCs can request “consummated registrations of their shares”?
(Yeah, that’s another one of those innocent-sounding “standards.”)
After a certain time (e.g., 3 years), they can force you to do an IPO (initial public offering).
But IPOs must be carefully timed.
And what if you disagree with the VCs on the best timing?
You’ll want to be able to negotiate the timing, right?
Good luck if you’ve given them the right to decide without you - on paper, with your signature.
Don’t be the schmuck who is told, “Look, it says here in your contract.”
Be the smart founder who understands the terminology before signing.
12. Don’t underestimate how preferred shares and priority return of capital affect your common shares’ value
Say you did well for 3 years.
Got a $5 million series A investment (for 20% equity), worked hard, turned your company into a business worth 12 million, but then hit a bump.
It's not really a problem, just the cost of growth.
You made some big investments, and cash flow is tricky.
Luckily, you’re approached by a potential buyer, a larger company.
They want to help you out.
You line up the sale.
But now your original investor wants out.
So, give ‘em 20% and be rid of them, right?
The sale will easily finance you through the current growth pains.
Plus, it’ll bring a whole ream of other advantages, including boosted marketing power, access to their client base, and the security of a corporation that’s got your back.
But hold on:
Your original investor holds “preferred shares”, which guarantee a priority return of capital.
The investor receives back what they put in before anyone else gets a piece of the pie.
So, now you have to give them back their "preferred" $5 million.
But you’re valued at 12, so in real terms, they're getting 41.7%, not 20.
And now your buyer is no longer interested.
Because the VC pulling out is like your startup getting shot in the heart and bleeding out. (And your common stock’s value has taken a nose-dive off a cliff.)
Do not underestimate the effect of preferred stock.
You will need to give it (it's "common to give preferred," the joke goes).
But give it sparingly, and when you do: Know what that means.
13. Look at terms from your investor's perspective
Preferred stock, forced IPOs, redemption “standards” – all these conditions can make it seem like early investors are sharks.
Sure, some are.
But most are just really good at risk management.
Many of the “standard terms” serve to protect investors by minimizing the VC-side risk.
They only affect you negatively when your startup is not doing well.
Think of it from the potential investor's perspective:
9 out of 10 startups fail, so every investment is risky for a VC.
It’s reasonable that they want to reduce that risk.
By any method possible.
Don't hold that against them.
Instead, do this:
- Ask, “Which risk management tools in this term sheet are the most important to you?”
- Get the VC to prioritize them.
- Ask them why they prioritize them that way.
That’ll give you a super valuable understanding of their way of thinking.
It’ll also make them appreciate you as a pro.
Someone they can talk to at eye level.
14. Watch out for investors who accept your high valuation but slip in tough risk management tools that could hurt you
Your valuation is high. Very high.
You’ve defended it rigorously, and the VCs have accepted it.
Which means they’re accepting a smaller piece of ownership than they expected.
In return, they’re just asking for a bit of risk management:
- double-dip preferred shares,
- cumulative dividends, and
- participating preferred liquidation.
Now, here’s your dilemma:
On the one hand, the better your pre-money valuation, the less equity you’re giving away.
(That’s important. You don’t want to sell equity below value.)
On the other hand, you don’t want to compromise your long-term success for short-term gain.
But how can you tell if that’s a risk you’re taking?
The higher your valuation, the greater the risk of a down round.
(next investment round at a lower share price)
In effect, a down round means that your high valuation wasn’t fit for the long term.
For both you and the investor, down rounds cause losses.
The investors will try to manage that risk by adding the above provisions.
That leaves you to take the hit.
In essence, the investor is saying:
"I don't fully trust your valuation, and I'll protect myself from down-round losses. If you want to keep this higher valuation, it's on you."
Now you've got 2 options:
Either you gamble on success, or if you don’t want to be stuck with the downsides, you carefully calibrate the risk against a slightly lower valuation.
Especially in early rounds, don’t accept
- double-dip preferred shares,
- cumulative dividends, or
- a participating preferred liquidation.
Such terms are not a sign of trust in your future success, and you need an investor who trusts you.
So, rather than accepting these distrusting provisions, learn better ways to keep your valuation high.
15. Don’t let them hit you hard with anti-dilution
They will hit you with anti-dilution protection, and you have to take it (usually), but the question is:
How hard will they hit you?
Anti-dilution protection is a form of down-round risk mitigation for investors.
It limits how much their share value gets diluted if a future additional investment round values shares at a lower price.
Luckily, all you need to know is the 3 main types of anti-dilution provisions:
- full ratchet
- weighted average, narrow-based
- weighted average, broad-based
Never allow full ratchet.
Instead, try to negotiate a broad-based weighted average.
That’s the best scenario because it will cost you the least in a down-round.
16. Avoid aggressive protective provisions
Protective provisions come in the form of approval and veto rights, penalties, and preferential treatment.
We’ve already covered many preferential treatment clauses, like anti-dilution.
Approval and veto rights you should pay attention to are:
- board appointments (who gets to appoint how many directors and who can block those appointments if they don’t like them)
- future investment rounds and share issuances
- spending (esp. veto rights on large expenditures)
- hiring and firing of C-level executives
If you give investors too many rights, you won’t run your company anymore.
Carefully read the protective provisions in the term sheet and negotiate to get what you consider appropriate.
17. Never accept due diligence periods of 90+ days
VC term sheets include an exclusivity clause, which locks you into the potential deal (without a finalized contract!) for 30 to 90 days.
A long period is a great disadvantage to you.
The investor claims that this is the time they need to do their due diligence.
But that’s only one reason.
What if they’re unsure how you’ll perform, how well they think you run your business?
A long due diligence period allows them to observe, test, and evaluate you and your co-founders.
So, usually, a lengthy due diligence period is a sign of missing confidence.
That can make the next 3 months tough on you – but you have a business to run.
A confident investor will accept a 30 to 45-day due diligence / exclusivity clause, and that is what you should go for.
Maybe 60 if there are plausible reasons.
18. Make them commit to specific value-adds on paper!
Let’s say your investor promised introductions to advisors, consultants, potential clients, etc.
Or they may have access to tech or labs you need for product development.
Whatever they promise, always make it part of the term sheet.
And clearly define the actions and expected results with time frames and deadlines.
Why? Isn’t that part just a gentlemen’s agreement?
(Or a ladies’ agreement, for that matter)
Most investors use the value-add they offer as a bargaining chip.
And if it’s part of the negotiation process, it should be part of the term sheet.
Clearly agreed on and written down.
And you shouldn’t feel awkward about asking, either.
(If an investor tries to make you feel awkward about that, something’s fishy.)
19. Ask for advice
Here’s who you can and should ask for advice about your term sheet:
- your co-founders (sounds obvious, but I’ve seen startups delegate this topic to one founder – don’t do that, get everyone on board)
- mentors, trainers, or coaches you know and trust
- friendly founders of other startups you know (unless they’re the competition)
- other startups in the investor’s portfolio (a trustworthy investor will bring this up – if they’re good, their founders are their greatest advocates, so they’ll introduce you)
- your lawyer (and if you don’t have one yet, make it a point to find one)
You’ll have a lot of conversations, get contradictory advice (for sure), and then learn to make up your mind.
The main thing is:
Discussing the pros and cons of specific terms and clauses with other people deepens your understanding and makes you think of long-term impacts you might have missed otherwise.
So, use these people.
Take the time.
It’s worth it.
20. Do your due diligence on the investor
Investors spend an excessive amount of time doing due diligence on you.
They ask your friends, colleagues and even (sometimes) family about you.
They read your references and contact former employers.
They test your business plan, look into the industry sector (often, they’re experts in that sector, esp. from series A upwards), test your hypotheses about market trends, your market entry strategy, and so on.
They have accountants pour over your financials.
And honestly, you should do the same!
- How many startups have they invested in?
- What sums, on average?
- What sum, in total?
- How many of their startups succeed?
- How many fail?
- How many grow 5x, 10x, or more?
- In which industries are they experts?
- What do other industry players say about them?
- How does their performance compare to that of other investors in this industry?
- Who says what about them – what’s their reputation?
- Reflect on how you perceive them during meetings – quick-witted, kind, excited about your startup, happy to explain things, patient, or domineering?
- How do they react under pressure – calm, easy to anger?
You’ll be interacting a lot with this person, so you need to see if that will be fun, bearable, or aggravating.
Last but not least, talk to people who know them.
Some founders they’ve worked with (and introduced you to). Ask these founders directly:
- “What would you say I should pay attention to in meetings with [name]?”
- “What’s one thing that impressed you when making your first deal with [name]?”
- “What puts him/her on edge?”
… and the like. Contact me if you want some more ideas about what to ask.
21. Prep your meetings like a pro
Are you ready for negotiating a term sheet?
One thing’s clear:
If you’ve read this article, you’ve got a head start on most founders who go in blind.
If you want to learn more, you should study the details of term sheet clauses.
It helps if you’re clear on your expectations about
- option pools,
- cap tables,
- your valuation,
- control provisions,
- board make-up,
- directors’ rights,
- post-money valuation,
The point is:
A successful term sheet negotiation depends on more than just smarts.
There are too many moving parts and terminology you can’t possibly understand unless you’ve specifically learned it, and investors who are honest, trustworthy and helpful, and those who aren’t.
So don’t get manipulated.
And get the best deal you can!