Term Sheets vs. Intent

I've said this many times before but it's worth repeating: Nothing is worse than having a term sheet pulled during the process. It is awful for you and it is actually awful for the VC who pulls it from many perspectives not the least of which is reputation.

My view has always been that you should get a term sheet as late in the process as you can stomach which should be inversely proportionate to the likelihood of the deal closing.  The farther down the road, the more likely it goes the distance.  These term sheets that get flung out to companies so there can be a lock up while the VC does the sniff test is just not a cool business practice.

From the entrepreneur's perspective, they want to know what the VC is thinking in terms of value, structure, etc, etc.  It's fair and, in my view, reasonable to want this data so you can make a decision on spending time with a particular VC, Angel, etc.

I've found over the last few deals and interactions on potential deals that a letter/document which spells out what is being contemplated goes a long way toward setting expectations and getting people on the same page with respect to process.

If I am working on an opportunity and I believe it has a shot at making it through the due diligence process, I will almost always give the entrepreneur the following information in an email and/or a letter:

• An intro paragraph that says deals like yours will typically fall into the following zone for a structure. This is not a term sheet rather a document designed to give you an idea of where my head is at with respect to what I'd be willing to do assuming all the stars line up.  Yeah, I say it that clearly with that language; the lawyers have a serious Maalox moment.
• The share structure (i.e. Preferred, 1x liquidation, etc)
• The best case pre-money value.  I don't do a range rather I say, assuming this opportunity is a 10 out of 10 (or better), this is the value I will subscribe to it.  I do it this way because I want the entrepreneur to know, up front, her best case.  It seems fair and we all know what we are shooting for.  Naturally, this has high risk of people getting seriously annoyed if the value is lower. It can look like a bait -n- switch but I honestly believe people should know that if this is better than sliced bread, this is where I would end up.  I've had entrepreneurs say thanks but no thanks.  The value, in the best case, isn't what they want, so we part friends right there.
• The timing with respect to when a term sheet comes in our process.

By structure, mentioned above, I am referring to things like board seat(s), protective provisions, matters requiring special approval, etc.  Any decent VC can spend 90 minutes with an entrepreneur and get a good feel for what they are likely to want from a structure perspective assuming they are interested. We, for example, always have board representation. Always, no exception. So telling you this immediately seems to be a smart thing to do because if you are not giving up any board seats, your call but not with my coin. 

The upside of this process is we both save time, part friends, and don't go down an expensive path (time and/or money) only to find ourselves at an impasse that could have been avoided with a simple 'here's what I'm generally thinking' memo to the company. 

I wish more VCs would do this.

Comments

[Paul Marshall]

Rick,

While I have not (yet) had the good fortune to work with you I am an avid reader of your blog and one of the things I really enjoy is the no-nonsense, matter of fact and common sense approach you take with most issues.

In business relationships I am a firm believer that gamesmanship and positioning is a poor long term strategy, as in time everything comes out in the wash. Communicating openly and honestly with Business Partners as soon as it is reasonable to do so allows you to collectively address issues and assess action plans to remedy issues or capitalize on opportunities.

There are times early on in a the evolution/creation of a relationship that it is prudent to tread slowly (as your 3 questions post points out) but in my experience there is no benefit to avoiding the elephant in the room.

[Saul Lieberman]

Once you send your "intent email" and you and the entrepreneur are on the same page, what are your expectations regarding the entrepreneur continuing to negotiate with other investors?

[Joe Wheeler]

This concept makes so much sense for both sides of the deal. A simple letter letting the entrepreneur know what your intentions and expectations are is the best way to create immediate trust with me as an entrepreneur. The upside has to be huge.

This should be the basis for early VC communication with startups across the board.

Would you consider sharing a "dummy-data" version of a letter? It would be great for me to be able to understand the contents better.

Great post.

[Jason Starr]

I agree that this "letter" is a great approach, really in the best interest of both parties. I would also add that the later stage the company and round of funding, the more standard this practice is. It is fairly common on growth equity deals, and pretty much standard on acquisitions, for interested parties to submit a non-binding "indication of interest" letter that includes the following sections:

- Valuation (often stated as a range, but people just view the high end as the same "best case" number anyway)
- Structure (key points that will go into the term sheet)
- Financing (when debt is applicable to the deal)
- Key Due Diligence Items
- Timing and Approval Process

Of course, a lot of times these letters are required because of a more formal process being run to raise money (i.e. investment bankers)...but it has the same positive effect as what is outlined above. It's a good way to get a base of expectations on the table and be judicious with everyone's time...not to set terms in stone, but if two parties are simply way off in terms of thinking, best to not waste everyone's time, or at least focus the conversation on some key "make or break" points.

Nice post!