The term sheet is the most important document a founder may sign to raise capital that’s required by the business to achieve its future potential. When it finally arrives, it does build excitement, however, there are always finer details that require attention before one signs up on the dotted lines.
There can be catches that can make you lose control in several future scenarios or clauses that may not be favourable in the long term. Here are my three suggestions on how a founder can successfully negotiate with investors for a term sheet that’s a win-win for both parties.
Prepare the basics diligently
As a tech founder, you should kick off your next fundraising round by defining the amount you aim to raise and the valuation you want to achieve. While it is important to define a clear goal internally, you should not openly communicate it to the outside world just yet.
You should also think about the characteristics of an ideal partner. Some startups might optimise for valuation when choosing their investors, while others seek particular industry expertise, reputation or other kinds of support like recruiting or debt access from their investor.
Regularly engage with your preferred investors in informal conversations, ideally, even before the actual fundraiser. This makes them feel more comfortable because they already know the team and its plans which in turn increases the chances of investment.
Also, define a rough timeline during which you want to have first calls, provide data room access, facilitate deep due diligence, aim to receive first term sheets and finalise the fundraising. If you receive term sheets within a similar range of time, you have a better negotiation position.
Next, develop a strong storyline. A good story typically covers the team’s strengths, milestones and achievements, and a grand vision with a roadmap to success. When the content is finalised, it is time to work on the format.
Consider working with a freelancer or design agency to make the pitch deck look appealing. When the deck is close to ready, you should do a test pitch with your existing investors or business angels to get feedback and finetune the pitch.
Before going out into the market, it is essential that you arrange the data room to have all relevant information accessible to investors. You can set up the data room with a certified data room provider, or by using a normal cloud solution.
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The data room should include the deck/memo, financial model, traction data (revenue growth, retention, customer pipeline, CAC, etc.), cohort data, and cap table. And, if applicable, you can also add the recorded product demo (e.g. via Loom), customer testimonials and your P&L.
Build an investor pipeline that won’t dry up
Based on the relevance and the reputation of the investors, you can now assign priorities as to whom you want to speak to first. This is always a trade-off between AAA funds and those who are willing to put a term sheet quickly.
With the help of an investor track sheet that your investor can provide, keep on top of the people you have already spoken to. Generally, it makes sense to initially focus on funds that are able to lead your round.
If your business model is in line with the hypothesis of a VC, it is naturally a good fit. Overall, you have to manage a balance between the efficiency of the raise and optimising for the probability of success when deciding how many investors to approach.
Once you have a good overview of all the VCs you want to talk to, ensure to get as many friendly introductions as possible. For this, prepare an outreach template and a teaser deck and share it with your existing investors as well as other notable people from your network, such as unicorn founders, to tease your financing round with the investors on your list.
Now you are ready to kick off the actual fundraising and go out into the field.
In many cases, it makes sense to entertain competitive dynamics in the fundraising process. The earlier you receive a term sheet, the more competitive it gets, and the hotter the deal, the higher the valuation you will be able to achieve.
Start your outreach with 40–50 investors as a first batch, be in active conversation with 20+ VCs, and in close conversations with at least ten of the latter. If these numbers drop during the process, restack the panel as quickly as possible. Make sure that you schedule and cluster the outreach to investors appropriately and that your pipeline never dries out.
Navigate your fundraising conversations
When you start these conversations, always communicate a clear timeline. The amount of capital you want to raise should be communicated as a range rather than a precise number.
In this context, share that the valuation will be in the typical dilution range, don’t be too specific in the beginning. This results in a wider range for the valuation expectation, leaving sufficient flexibility later on. You will provide certain valuation signals anyway, such as the size of the raising, the valuation of the last round, and the total amount of capital raised.
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When the conversations with VCs advance, they will request additional information to assess the investment opportunity, this is where your data room comes into play.
Make sure to only share data with investors who are actually interested in partnering with you. You can also share the data one step at a time as opposed to all at once.
However, bear in mind that there are also several risks associated with not sharing enough information up front. One is that investors are not able to perform their diligence and do not feel comfortable enough to offer a term sheet in the first place.
Another risk is that the investor may change their mind after signing and receiving all information. Post-term sheet, only confirmatory diligence should be necessary. Overall, share information wisely and trust investors, but always use common sense, too.
For the whole fundraising process, timing is key. Once the first term sheet is on the table, time is running against you as term sheets typically have deadlines and you don’t want to risk losing one without having a strong alternative.
If you are in the position of having received several term sheets, you can decide with which to go. Before signing, do not forget to also take a closer look at your investors, as you will partner with them for the long term. Leverage your network to learn about experiences other founders had working with the VC and request introductions to portfolio founders of the VC to get first-hand references.
So, continue the closing process and start term sheet negotiations with all investors who put up a term sheet and seem like a good fit. It is crucial that the term sheets cover all important clauses and leave no critical points open.
This is of grave importance as most term sheets are subject to an exclusivity clause that, as soon as signed, restricts you from further communication with other investors.
If not all critical terms are agreed on pre-signing, the negotiation post-term sheet can get very difficult and may even lead to a situation in which at least one of the parties backs out. If this happens, it also complicates re-engaging with investors who offered other term sheets prior.
Once you have agreed to all terms and decided on the perfect partner to go with, you can sign the term sheet and close the deal. Be prepared for post-term sheet due diligence, which can take several weeks.
Also, make sure to prepare all legal documents in time. If you have many small investors or business angels on the cap table, it is critical to start collecting the power of attorney well ahead of the planned notary date.
When the deal is formally closed, it is time to celebrate, and, more importantly, to fully focus on your business again.
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