Keep Term Sheets Simple for Quicker Cash to Spend
Remember a term sheet agreement is not a deal until the check clears. Entrepreneurs sometimes assume an initial agreement with an angel is a commitment, so they start spending before any money is received. Due diligence and paperwork take time, and can change everything.
It’s true that angel investors typically do not present entrepreneurs with overly complicated deal structures, especially when compared to venture capitalists. However, there is no set pattern of terms an entrepreneur might be able to anticipate from either. Your best strategy is to bring your own term sheet to the negotiation as a starting point.
When a company is at its earliest seed stage, the terms tend to be the least complex. As the company grows and the second or third group of investors comes in, the terms of each subsequent financing grow in size, scope, and the number of lawyers’ fingerprints on them.
Based on my experience, and the book “Attracting Capital from Angels” by Brian Hill and Dee Powers, here are some key clauses that any investors expect on the first term sheet for the investment you need:
- Set the price. The price is the percent of ownership given to the investor, calculated as “investment/post-money valuation.” The pre-money valuation is company value today, while the post-money valuation is the pre-money valuation plus the investment amount.
- Seat on the board. This does not mean that if you have eight angels in your company, you will have to seat all eight of them on your board. But the lead angel would certainly ask to be given a seat.
- Define equity type. The first capital a young company receives usually takes the form of common stock, the same class of shares the founders hold. Venture capitalists and later round investors like the preferred convertible shares.
- Outline multiple tranches. Investors may provide money in stages or tranches, based on defined milestones, to decrease investment risk. These “IV drip” financings may reduce risk for investors, but put more pressure on founders.
- Anti-dilution protection. This clause attempts to protect the conversion price of stock of angel investors, prior to additional financing, from being reduced to a price equal to the price per share paid in a later “down” round. But some dilution is almost inevitable.
- Right of first refusal. Angels may want the first right to purchase shares held by the other angels in the deal before they are sold to an outside party. This allows a committed angel to consolidate his ownership, rather than see it scattered to the wind.
- Liquidation preference. These are terms which basically say for the investor, “give me the option to get my investment back or my negotiated ownership, whichever is more”. It prevents the entrepreneur from selling early, at a loss to the investor.
Remember that due diligence and negotiation take time. Not allowing enough time is one of the major mistakes made by entrepreneurs. You can end up becoming very frustrated with the investors, or cause the venture to fail if you run out of seed capital before the angel round can be completed.
In a survey for the above book, angels reported that it takes them an average of 67 days to close, while the average closing time for venture capitalists was 80 days. This time does not include finding the right angels, which is the first and longer part of the effort.
You should expect that both parts, when combined, can take three, six, or nine months – or more. .
I don’t think there should be a waiting process – Alan Patricof” href=”http://videos.gust.com/video/I-dont-think-there-should-be-a;search%3Atag%3A%22after-you-pitch%22″>Don’t wait till your last dollar is gone before you start looking for the next one. The check won’t clear in time to save you.
Written by Martin Zwilling
You might also be interested in
When entrepreneurs come to me with that “million dollar idea,” I have to tell them that an idea alone is really worth nothing. It’s all about the execution, and investors invest in the people who can execute, or even better, have a history of successful execution. Execution is making things happen, and for startups it usually means making change happen,
I’ve always wondered who started the urban myth that the best way to start a company is to come up with a great idea, and then find some professional investors to give you a pot of money to build a company. In my experience, that’s actually the worst way to start, for reasons I will outline here,
Steve Jobs was one of those entrepreneurs who seemed universally either loved or hated, but not many will argue with his ability to innovate in the technology product arena over the years. He was instrumental in creating Apple, which has pioneered a dazzling array of new products, and even surpassed Microsoft, to become the
If you are a new entrepreneur, or entering a new business area, it’s always worth your time to assemble an Advisory Board of two or three executives who have travelled that road before. You need them before you need funding, and if you select the wrong people, or use them incorrectly, no
Helpers do what you say, while good help does what you need, without you saying anything. People who can help you the most are actually smarter than you, at least in their domain. Top entrepreneurs spend more time putting the right team in place to accomplish their objectives than they spend on any