Draft Term Sheets: Expectation Setting

Suzanne Dingwall Williams has a post up about Draft Term Sheets.  Suzanne doesn't appear to like them:

"I don't understand why some VCs believe that providing a draft term sheet is a useful, relationship-building tactic. There are only two ways a draft term sheet can reasonably be interpreted:

1. The investee's valuation expectations are too high and need to be right-sized. (I have never heard a VC say, "Your business is even better than we first thought! We need to increase the pre-money valuation before we close!" )

2. Some of the VC's partners don't support the deal, but he still wants to hedge his bets that things might work out after all."

Hmmmm....

I can't speak for every VC firm, but I'll explain how I use draft term sheets.  For me, a draft term sheet is a document given to the entrepreneur to discuss the actual deal structure points before I sign it.  The debate on valuation is usually a discussion that I have before I ever put a term sheet (draft or otherwise) in front of anybody.  If you are looking for a 50 million dollar pre-money and I think it is a 5 million dollar pre-money valuation, trust me, we won't be discussing or drafting much. 

It is the points like covenants, restrictions, board structure, drags, tags, and other major terms of the deal I put in front of an entrepreneur which are up for discussion. I want two independent board members, you want one. We discuss before we sign a term sheet because we believe a term sheet is the framework of the deal. I don't agree to one independent and then draw up documents that call for two, I honor what we signed in the term sheet; a document I signed after the draft was discussed.

In our firm, we track along a 12 step process (you can read it here) and the term sheet comes after my partners and I are comfortable with the potential deal.

So, with respect to Suzanne, a third way to interpret a term sheet (at least from me) is:

I'm ready to do a deal on the valuation we've discussed, now lets talk about the details of what the transaction would look like and if we agree, let's sign and move to the next step.