7 Tips for Founders When Negotiating Term Sheets with VCs
Founders are always at a disadvantaged when negotiating with Venture Capitalists.
Why?
Simply because Founders only negotiate fundraising a handful of times during the life-time of the company, while VCs negotiate all the time.
In addition, the institutional investors are always very clear about their goals and their math, while Founders most often just get hung up on pre or post money valuation, which is only one of the important deal terms.
So what can Founders do to level up and negotiate to the outcome they want?
1. Get the first term sheet
There is nothing more important in the financing than getting the first term sheet. So how do the Founders get there?
During every interaction with VC ask: Where are we in your process?
You should met the lead partner at least a few times before you get a Term Sheet
You will likely need to present to entire partnership, especially for Series A and later rounds.
Knowing the above should help you figure out how far from the Term Sheet you are
Literally - ask for the Term Seet, ask when can you expect a Term Sheet - remember - if you don’t ask you might not get
Push for the first Term Sheet as it is going to be critical for both closing the round and getting other Term Sheets.
Now here is the really important thing that you as a Founder need to understand.
VCs hate issuing the term sheets that do not get signed.
Let me repeat it again. VCs hate issuing the Term Sheets that do not get signed.
Why? Because VCs hate to lose deals.
Once VC does the work, gets the conviction and issues a term sheet, they want to win the deal. Many firms, especially large, top-tier firms keep track of how many of their term sheets convert. Junior partners can get serious heat for issuing the term sheet and not getting the deal because it is damaging to the firm’s brand.
This is why getting a Term Sheet issued is so critical - it shifts the dynamic in the favor of the founder.
VCs know this too, and thats why before issuing a term sheet, VC is going to try their best to figure out a) What will get the deal done b) More importantly, will you take the term sheet.
What they are going to do is to schedule a call with you, where they will verbally go through the deal, and then will ask you if you will accept this deal?
Now here is a critical negotiating tactic.
Even if you dislike the terms.
Even if you are insulted by the offer.
Even if you think the firm wasted your time.
Even if you aren’t sure you will end up working with this firm
Say one thing and one thing only:
Thank you. We are excited at the prospect of working with you. Please send me the Term Sheet so that I can discuss with my team and my board and then get back to you.
Do not react in any other way, do not negotiate live (More on this below).
Say one thing, and one thing only. The thing I said above.
The reason it works is because there is simply no way to enumerate verbally all the terms that are spelled out in the term sheet. For example, VC can discuss the valuation, the pool, the board composition, but still — while these are major terms — there is going to be more in the actual term sheet.
So your move is simple - ask for the Term Sheet.
By getting the actual Term Sheet into your inbox, you are accomplishing these key things:
You are closer to finishing your round (well, yeah :)
You know the VC actually intends to invest - no one is going just to send you a formal Term Sheet unless they want to do the deal
You have a formal written Term Sheet, which is what you need to negotiate
You are getting leverage
2. Leverage the leverage
Ah the leverage… Amazing when you have it, and sucks when you do not.
Well, once you get a format Term Sheet from a VC you immediately have 2 types of leverage. First with the firm that sent you the term sheet. Second, the leverage over the entire round.
Let’s unpack both now.
First, once the firm issues a Term Sheet, they signal that they want to get the deal done. So even if they are the only option you have (as actually the case in most financings) you still are in a better position to negotiate than you were prior getting the Term Sheet.
More importantly, you now have the leverage to go back to other firms and tell them you have Term Sheet.
Nothing, and I mean literally nothing, makes VCs move faster, than you telling them that you have a Term Sheet from another firm.
And by moving I mean in one of two directions - either passing or finishing their work asap and sending you an alternative Term Sheet.
The FOMO in VC business is real. Term Sheet from a competitor causes FOMO, and causes VCs to act.
Once you get everyone in the process to either pass or to give you a Term Sheet you are now in the position to negotiate with whoever you want to lead your round. The tips below are specific to a single negotiation, but you can use them across several negotiations too.
3. Do not negotiate live
I said this above, and I will say it again here as its own tip.
Founders should not negotiate live with VCs, they should do it in writing
Why?
Again, it is simply that VCs are a lot more skilled in a live negotiation than the founders.
VCs are better at knowing what they want out of these negotiations. Founders get emotional, founders fixate on price. There is always asymmetry in these negotiations as VCs have done more of them, and understand the levers better.
Thats why if you are a founder, you don’t want negotiate live.
4. Do not ask to increase the price
But Alex, you will say, I want a better price. Shouldn’t I just ask for a better price?
Absolutely not. First, because you want to negotiate all at once (more on that below), but more importantly….
No one is going to negotiate against themselves.
What does that mean?
Well, look at this dynamic.
VC sends you a term sheet…
You come back and say, hey I want a better price…
VC thinks, okay well what price should I name? I already named the price I wanted to name…
So you see, the VC already named a number, it is now YOUR TURN.
That is, why would VC keep increasing the price, without knowing what YOU want.
They don’t know what you would accept, so increasing the price simply does not make sense.
5. The best way to negotiate is ALL AT ONCE and in WRITING
Bringing it all together, the Founders are best of negotiating with VCs in writing, and with the help from their mentors and their lawyers.
Once you received a Term Sheet that you want to negotiate, go ahead and apply ALL the changes you want and send the red lined Term Sheet back to the VC.
Why is this better than just negotiating price verbally?
Because you are hitting all the points at once, and the other party understands that there are NO OTHER items you care about.
Go back to the scenario, where you call VC and ask for a better price. Even if they gave you a better price, where is the guarantee that you won’t come back and ask for lower option pool, or different board composition?
By negotiating the WHOLE deal in writing using redlines you are signaling not just one thing thats important to you, you are signaling EVERYTHING thats important to you.
That is the language VCs understand very well - the language of entire negotiation.
You are also signaling that you are respectful of their time, efficient and know how to play the game — so VCs take you seriously and know not to play tricks on you.
6. Say the magic words
Finally, to negotiate effectively, you need to signal the end of the negotiation.
How do you do it? You say the magic words:
This is what we are prepared to accept.
When you say this, VCs take you at the faith value, they know that they can end the negotiation and have a deal.
In most cases, when your ask is reasonable they will just say YES to get the deal done. Without the magic words, VCs don’t know that you are ready to move forward, so saying the words is important.
To sum up, the best response to a VC term sheet is an email with:
Thank you for sending the Term Sheet
A sentence on two saying you are excited at the prospect of working together
Red-lined and revised term sheet from you and your counsel
And the magic words — we are prepared to accept the deal as we red-lined it
7. Handle your emotions
These negotiations are incredibly emotional for the founders, but please, follow the outlines above, contain your emotions and get the best result.
As a founder, you negotiate infrequently. During these negotiations, you are upset, because you may not be getting what you want, because you are selling equity in your business, because you maybe tired, and frustrated.
Contain yourself, and don’t be emotional about this. It is a business negotiation, and you are best of, handling it as such, and not taking it personally.
Negotiating in writing is the best way to not show your emotions.
If you get on a call with VCs, it maybe difficult to conceal your feelings especially in a live negotiation. This is exactly why I think the Founders are better off negotiating through writing, holistically, by red-lining the term sheets and with the help of their mentors and lawyers.
And lastly, everything that we said he applies equally to the VC and M&A conversations, so by mastering these strategies you can get better at both, getting funded and, when the time comes, exiting the business.
