What’s the most important item in a term sheet? “The name of the investor at the top,” as a venture capitalist friend of mine once said.
Despite the legal debates about this term versus that term and all the hand wringing and contention that goes on about valuation, ultimately the most important elements contributing to a company’s and an investment’s success are the people and their relationships. Term sheets and financing documents don’t make the relationship, they just codify it and represent it. So, negotiating a term sheet begins way before you get one….it starts with whom approach to finance your company.
First, think about your investment partners like you do any other strategic relationship. Venture capital firms, angel groups and even individual angels are engaged in a business activity. They have their own strategies, their own goals, their own capacities, and their own measures of success. If you were a software company getting cosy with IBM, you’d think about their decision making processes, their interests, and their agenda. Consider the same issues with your investors. Second, review the investment terms with your investor’s strategy in mind. Words mean different things to different organizations. For example, there are very different economic effects if the term sheet has an 8% accruing dividend with a large investor that is putting $10M into the company than with a small investor who is putting only $1M The absolute amount of cash that will build up in interest, and hence not be in the founder’s or management’s pocket on an exit is different by an order of magnitude.
You still should understand what each term means. Just view them in the context of your strategic relationship with that investor. Financings are usually, and should be, rare events for companies. They are monthly and sometimes weekly ones for investors. So, as an entrepreneur, if you are nervous about venture capital terms, you should be. Investors know them cold; it’s a foreign language to you.
These days there are many resources available to entrepreneurs to understand this black art. Click here to see an annotated sample term sheet provided by the MIT Enterprise Forum. We hope it is useful to you and helps you in building your business.
