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Term Sheet Negotiations: A Startup Lawyer's Perspective With Nicolai Nuber from Kellerhals Carrard

Spela Prijon
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Receiving an investment, especially the first one, is a major step for a startup. It’s important that the terms attached to the investment are favourable for the founders and their startup. It’s crucial to understand what you’re getting into once you sign the term sheet.

This is where experienced lawyers are an invaluable resource to help you navigate all of the terms before you sign. To answer some crucial term sheet negotiation questions and give some invaluable insight, we spoke to Nicolai Nuber. Nicolai is a member of the Startup Desk at Kellerhals Carrard Zürich. He offers advice to entrepreneurs and investors on financing rounds, general contract law, employment law, and commercial law. Nicolai has extensive experience in fundraising negotiations and he shares what he’s learned here.

Negotiating term sheet provisions

Some less-than-friendly investors can exploit the inexperienced founders and slip unfavourable anti-dilution provisions in the term sheet. For example, there have been some notorious cases where the founders were left with nothing, even in a 10 figure liquidity event, because of terrible liquidation preferences and participation rights.

On the other end, there have also been a lot of instances where startups focus on negotiating provisions that just don’t matter and end up losing a deal because of it. To make sure you’re receiving the best term sheet possible, you should hire an experienced lawyer.

A good lawyer will educate you on the important terms and help you lead the negotiations. Good lawyers will get you a better deal while inexperienced lawyers can sink your deal.

Questions for Nicolai Nuber

1. Who usually pays the legal fees associated with writing up the term sheet?

Generally speaking, each party will bear its own legal fees. However, when it comes to equity financing rounds, the question becomes broader as particularly in series A and later rounds, professional (lead) investors will typically ask for a (capped) compensation to be paid by the company (they invest in) for legal fees associated with the drafting and negotiation of the documentation of the round.

2. A scenario: Two VC firms are considering an investment, one of them asks for details of the other’s term sheet. What should a startup do?

Most of the time, terms sheets are subject to (binding) confidentiality obligations so if you as founder do not feel comfortable sharing such information, this could be explained with reference to such obligation. Absent confidentiality undertakings (or assuming waivers thereof) or if the term sheet is not yet signed and thus no confidentiality obligation is yet existing, from a negotiation point of view, you could strategically use / disclose “good” terms from another term sheet with a view to getting better terms from the other investor. It’s a good thing to have competing term sheets in place. This topic is linked to another clause, an exclusivity undertaking, which from a startup’s perspective is even more important: According to such a clause, an investor would ask for the startup to not negotiate with any other party during a specified time period. This should be avoided from a startup’s perspective. Ultimately, you want to increase your options and have maximum freedom when it comes to finding the best matching investor (at the best terms).

3. What are some reasons why VCs pull term sheets?

The reasons for a VC walking away from term sheet negotiations will be driven by a business rationale. By that I mean, by way of example, if one of the key persons is not willing to fully commit or another key value driver cannot be satisfied (e.g. if key IP is not and cannot, for whatever reason, fully vest with the target company). Another business rationale may be the case where valuation expectations are just too far apart from each other. Inability to agree to “nitty gritty” provisions of the term sheet will typically not be the reason for a VC’s decision to abort a transaction.

4. How can a startup prepare for the due diligence process?

That is an important question. A startup should keep some ground rules when it comes to corporate housekeeping. As such, written records of key documents have to be kept, ideally in a virtual data room which is organized by subject matters. Key documents include: Minutes of shareholders’ and board meetings, any documentation related to share transfers, employment and IP-related agreements, and key commercial contracts. In a due diligence, investors will want to see all such documentation and if no orderly corporate housekeeping is maintained, this does not send good signals to professional investors. Further, it will make the due diligence process much more time-consuming and cumbersome if you have to produce such documents in a short time period. Also, you run the risk that some clean-ups cannot be effected anymore.

5. What are the most absurd terms you’ve seen in a term sheet?

Frankly, professional investors don’t require absurd terms as they have a reputation (that’s easy to lose) and know what’s market standard. What I see from time to time is that startup “support” organizations or other (very) early-stage investors ask for VC-like investment protection (even pre-seed), including representations and warranties, liquidation preference, anti-dilution protection and far-reaching consent/veto rights. This is in nobody’s interest as it does not position the company well for future financing and development.

6. What small mistake in a term sheet turned out to be a disaster later in M&A?

Thankfully, I didn’t have such an experience until this point. Exit-related clauses are among those that are more intensely negotiated (albeit certain standard provisions are existing) and will be carefully drafted in the shareholders’ agreement. From a founders’ perspective, one has to be watchful of clauses where investors can trigger an exit independently of any founder and/or other common shareholder consent. What professional investors will have a close eye on particularly is the drag-along clause and any change of control-related clause, as well as the corresponding majority/consent/veto or other requirements to trigger such transactions.

7. How long does it typically take to negotiate a term sheet?

This depends, among others, on whether you are trying to sign a “short form” or “long form” term sheet. The short form has the advantage that a meeting of the minds occurs faster but the negotiations of the actual agreements will then take longer. I have seen everything from a few days until a few weeks.

8. How do veto rights on future investors play out in real life (the protective provisions a startup gives to a VC in a term sheet)?

Veto rights are certainly a powerful tool as deal protection measure for a VC. In the shareholders’ agreement you will have veto or consent rights on the board level (if the investor is entitled to board representation) and, typically, super-majorities in shareholders’ meetings where preferred shareholders or a certain class thereof will have the right to (jointly, mostly) consent on certain items, failing which the respective decision cannot be taken. The items where veto/consent rights are granted are typically included in an annex to the shareholders’ agreement and are to some extent standardized. From a founder’s perspective, these items should be carefully analyzed so as to be not too dependent on another person’s consent (but of course, a balance between deal protection for a VC and freedom to operate for founders needs to be found).

9. What advice would you give to new founders, when it comes to investment rounds/term sheets?

Start early with the (equity) fundraising process and its planning as it can take longer than expected. Prepare your own term sheet. Talk to many investors and to other founders they invested in to see if they “walk the talk”. If you talk/negotiate with many investors, determine a lead investor. Increase your options and have a plan b.

More on term sheets

In our series of posts on term sheets, we've introduced the basics of term sheet negotiations, asked Creathor Ventures' Cédric Köhler and Andreas Goeldi of b2venture to share their experiences, and followed the exit story of Elohna's Philipp Millar. Check them out for more essential insights.

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