How 2 Read a Term Sheet: The Connection
The following post is from Yushan Lou ’18, a Butler Venture Accelerator team member.
We were so lucky to have Professor Santinelli host a #How2Tuesday on how to read a term sheet. He described the relationship between Venture Capitalists and Startups as dating. Before VCs decide to invest in a Startup (before you get married), the process is the deal (your dating experience is what make you decide whether or not to marry a person).
Here are the steps of the dating process between VCs and Startups that you can apply towards your fundraising strategy:
Phase 1: Getting a warm introduction
There is an effort that lots of entrepreneurs forget about. Entrepreneurs are always happy that people do due diligent on them, however, it is more important to do due diligent on potential investors. Seeking a potential investor is just like picking a date. You always need to ask yourself: why do you think we can make good match? Therefore, having a background research on the potential investor is necessary. Who are they? What is they interested at? What did they invest in? Who have they invested in? For example, if an investor has invested in renewable energy for three times and lost lots of money, the chance of them investing in this field again is almost impossible.
Phase 2: Know where you are in the relationship
At the early stage of dating, you are observing your partner. Venture Capitalists will always ask questions like: Is this date adding values to me? Is this date going to add more value to me than the date from last night? Are we aligned with goals (strategies)? The relationship can end at any point between you and VCs once they don’t see a future of marrying you.
Phase 3: You’ve been presented with a prenuptial agreement (term sheet)
When you’ve been presented with a term sheet to review, you have to keep in mind that the term sheet is not a legally binding document, but a one-side prenuptial agreement that helps VCs to recruit as much money as they can in the future. VCs will try to keep high control rights for their dollars. As an entrepreneur, the more people who want to date you (potential investors), the more power you can leverage your control on the company. You want to choose the VC that gives you simple terms, convertible preferred stock, and the VC that gives you more rights. This includes voting rights, board representation and information rights. Avoid complicated or open terms that require further negotiation, as well as the restrictive terms.
See you on Tuesdays at 5pm in the Blank Center for our next #How2Tuesday!
What are #How2Tuesdays?:
Want to learn something really practical to get your startup moving in the right direction? #How2Tuesdays are short, workshop style sessions meant to bring you very specific, user friendly instruction on some of the most important things you need to know how to do for your venture. Every Tuesday at 5pm in the Blank Center!