In the previous blog post, we introduced some basics of term sheet negotiations and focused on showing you the most important parts you should always pay attention to. While term sheet negotiation can be one of the most exciting steps of fundraising, it is certainly not the first. As a follow-up, we compiled a list of other steps that startups, investors, and lawyers need to follow before and after term sheet negotiations. Then, we asked one of our investors - Cedric - to answer some interesting questions about the whole process.
Getting an investment isn’t just about wiring the funds from an investor to a startup. The process of getting to know an investor, talking more seriously, and then actually closing an investment often lasts up to several months. The reason the process is so long is that there are precautionary steps followed by both sides:
- Finding the investor/startup via referrals or cold emails. Startups usually attach an executive summary and later send a longer presentation.
- Founders and investors getting to know each other as possible partners—talking to previous collaborators, investors, etc.
- The startup provides fundraising materials for the investor (presentations, projections, competitive analysis, team profile, customer personas, development plan, etc.)
- Signing term sheet, followed by investors initiating the due diligence process, which requires additional materials (cap table, contracts, employment contracts, board meeting notes, etc.)
- Drafting the final agreements—the lawyers are doing most of the work here.
- Signing the documents and finally, within a few days, wiring the money to the startup’s bank account.
One reason for the lengthy process can rise from founders who are unprepared, and have to create the requested documents at the time of the request. On the other hand some VCs will ask startups to provide a lot of unnecessary material — for example, a 10-year detailed financial projection when raising a pre-seed round.
We decided to ask experienced investors, lawyers and entrepreneurs to give their perspective and answer questions founders rarely get the opportunity to ask. We mostly asked questions about the actual startup-investor dynamic, to shed some light on the expectations of the fundraising world.
In this blog post, we’re introducing our investor Cédric Köhler, who was just named one of the Digital Shapers of 2019. Cédric is a managing partner at Creathor Ventures who has been investing at the frontier of technology and science for over 30 years.
Question 1: How long does it typically take to negotiate a term sheet?
Cédric: Hopefully not longer than a week. If both parties want to work together the terms should be plus-minus market standard. If it is not a growth round both parties should keep in mind that the negotiated terms are valid until the next financing round.
Question 2: How can a startup prepare for the due diligence process?
Cédric: Have all legal paperwork (contracts, license agreements, all reports etc.) ready to be sent within a click. Long delays when delivering requested information might result in a pull of the term sheet from the VC.
Question 3: Who usually pays the legal fees associated with writing up the term sheet?
Cédric: Usually, there are no legal fees occurring in early stages. If this happens, mostly the startup needs to pay it. But this is rather unusual and/or included in the costs of the legal fees from the investor which the startup needs to pay until a capped amount.
Question 4: 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?
Cédric: My advice: If there is a clear lead investor and the terms are negotiated, the startup might hand over the term sheet details to the following investor – after cross-checking with the lead investor. To avoid scenarios where the following investor tries to renegotiate final terms I suggest the startup to ask the second investor to hand in their own terms first. A VC should always invest based on their own investment thesis and terms. If the delta is not too big the startup can then bring the two parties together.
Question 5: What can be reasons for which VCs pull term sheets?
Cédric: Strong delays in legal negotiations, where the founder shows e.g. strong weaknesses in negotiation or lacking social skills. Unexpected developments during the phase between TS (term sheet) and contract signing.
Question 6: What are the most absurd terms you’ve seen in a term sheet?
Cédric: Growth investors who come from the private equity world want to put in terms like signing fees, % of legal fees paid by the startup, due diligence fees and whatsoever-fees which in other words are just nice mechanisms to direct parts of the investment amount into the personal pockets of the investor. Might work in PE (private equity) but is luckily not standard in the VC world.
Question 7: What small mistake in a term sheet turned out to be a disaster later in M&A?
Cédric: Unspecific definition of a change of control for ESOPs. (Luckily not a huge disaster)
Question 8: How do veto rights on future investors play out in real life (the protective provisions a VC gives to a startup in a term sheet)?
Cédric: Veto rights are important to protect all shareholders. If these are being used frequently, the beginning of the end of the company has already started. But especially for blocking absurd budgets with multiplying costs these veto rights are helpful.