Negotiating 'Time Bomb' Term Sheets

Fred Wilson of Union Square Ventures, the best VC blogger in my opinion, recently referred to a blog post on negotiating job offers and said, "Replace the words 'job offer' with 'term sheet' in @spolsky's post and the advice is still spot on." What Fred is referring to here is the "exploding term sheet," a commonly followed practice in which a VC issues a term sheet with a really short validity period – sometimes less than 24 hours. VCs use this tactic to lock in deals and prevent entrepreneurs from shopping around for other offers. The intent may also be to prevent entrepreneurs from fully understanding implications of certain clauses, not giving them enough time to negotiate. While this tactic invariably pisses off entrepreneurs, they succumb to it many a time because they do not want to risk losing out on the offer.

I actually believe this tactic can be detrimental to VCs who want to invest in the best entrepreneurs. Let me illustrate with an anecdote. One of our clients was in advanced discussions with three funds for their first round of funding – let us call them funds A, B and C. Fund A was the first to move to term sheet stage and sent us a draft copy of their standard term sheet without any numbers and specifics. We received this at around 3 pm in the afternoon and we were told by the fund that if we were fine with the broad terms, they would send us a copy with the numbers filled in by 6 pm or 7 pm during the same evening. However, the term sheet would expire by midnight on the same day and if we were interested, we needed to sign and send it across before that. We requested for a couple of days' time to properly review the term sheet and negotiate terms. The fund declined and said that they did not like to have their term sheet floating around after they made an offer. We had to sign on the same day or the offer would fall off. The entrepreneur politely declined the offer and walked away from the deal. To the entrepreneur, this was a clear indication of how his relationship with the fund would pan out and he did not want investors on his board who would hold a gun to his head and force decisions on him.

A few days after this, Fund B made an offer and sent us their term sheet, with all numbers filled in. Over the next couple of days, we negotiated various terms and arrived at a consensus on most of them. By this time, Fund C was also very close to making an offer and we naturally wanted to compare offers and make an informed decision. We decided to be completely transparent with Fund B and told them that we were expecting another offer and requested for a few days to make a decision. Fund B's response to this was that they wanted the entrepreneur to make a decision based on what was best for him and did not believe in forcing him into a decision. They were happy to wait for us, but requested that we would not leave this hanging indefinitely. We promised to give them our decision within two weeks. The offer we received from Fund C in a few days was marginally better than the offer from Fund B. However, the entrepreneur was so impressed with the way Fund B handled the negotiations that he was convinced they were the right people to be on his board and help him build a great company. We accepted the offer from Fund B with hardly any re-negotiation and closed the deal within a month.

Looking at this from a fund's perspective, I understand why VCs try and push the "exploding term sheet." However, I think they stand a much better chance of winning the deal by making the entrepreneur comfortable enough to be open and transparent with them. Most entrepreneurs don't just decide on the basis of valuation or a few other terms. As long as the terms are fair, it is the comfort level with the fund partners that usually sways the decision. I agree that a term sheet cannot be open indefinitely, but the timelines need to be reasonable and fair to both sides.

My final piece of advice to entrepreneurs: Funds are not going to go back on an offer if you take an extra week or two to decide. Once a fund decides to make an offer, they want the deal as badly as you do. So do not succumb to pressure tactics and sign a term sheet unless you are fully convinced about it. Being open and transparent would work best (as with most situations in life). At the same time, be fair to the fund and respect their time too. The VC community is a small, closely knit group and if you try and play one fund against the other, you will do your reputation more harm than good.