ASK AN INVESTOR: WHAT ARE THE SIGNS OF A BAD TERM SHEET? by Sarah Marion

TL;DR - Founders should be wary of investors who include review periods without having done enough diligence in their term sheets and any term sheet that includes a guarantee of the exit horizon and/or an undiscussed change in management.

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Tags - term sheet, term sheet pitfalls, term sheet advice, term sheet negotiation, venture capital

Questions answered:

  • What are the signs of a bad term sheet?
  • What is a review period?
  • What is a no-shop clause?

Summary:

  • Founders should be wary of investors who include review periods but have not actually done enough diligence (e.g. customer engagement data, the competitive landscape, and market trends) because they likely have not built enough conviction to put down a term sheet.
    • Review periods allow investors to pull the term sheet after it’s been signed.
    • Especially concerning if they are accompanied by a no-shop clause which effectively prevents founders from talking to other potential investors.
  • Any term sheet that includes a guarantee of the exit horizon is a red flag.
    • Expecting payment within a pre-planned timeline is a sign that the investor is focused on mitigating his/her downside.
    • Will lower the founder’s negotiating power in an acquisition scenario as potential buyers will realise that he/she is under pressure to get a deal done; they often check the cap table and term sheets in advance of a transaction.
  • An undiscussed change in management should raise concern.
    • Some term sheets are written after a prior discussion of an advisor/third-party joining as CEO with founders transitioning into a CTO or COO role.
    • However, an undiscussed mention of replaying a current CEO should raise concern as it’s both unnecessary and, frankly, rude.

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