An Insider's Guide to Venture Capital Term Sheets

Tuesday, September 2, 2003

Jeff Tarter, Soft*Letter, http://www.softletter.com

Better Business Management & Planning Practices

How do venture capital firms cope with the downturn in lucrative IPOs? Many have started to nickle-and-dime their portfolio companies, squeezing out cash through interest payments, directors fees, and liquidation ˇ°preferences.ˇ± All too often, founders and early-stage investors have learned the hard way that fine print in a VC term sheet has left them on the wrong side of a seriously lopsided financial relationship.
But finally one venture capitalist has exposed the secret paths through the VC minefield.
Alex Wilmerding, a principal at Boston Capital Ventures, recently published a small
book called Term Sheets and Valuations that we think every entrepreneur should read
cover to cover, preferably before talking to a single outside investor. Wilmerding's
book isn't filled with sexy success stories; rather, he carefully dissects paragraph after
paragraph of legal language, showing who wins and who loses. The information is
often esoteric, but understanding these details will certainly give you a significant
edge in negotiating million-dollar venture deals.

A few excerpts:

On milestones:
For some entrepreneurs any milestone set by an investor in a term
sheet is a red flag. Investors typically milestone a deal by writing into a term sheet the commitment to fund, but only in allotments and based upon specific financial performance prior to subsequent rounds... Not surprisingly, management will want to have the flexibility to change course as necessary, rather than find out that in two or three months, should the company not be meeting their plan for unanticipated and understandable reasons, an investor can basically take over the company, boot management, and bring in new management.

On forensic audits:
The most complete and 'investor favorable' information rights are typically referred to by the term forensic audit, an investor requires that he be able to examine almost any document, audited or unaudited, financial or otherwise, that may exist in a company's files or accounting software... Whether this transpires or not is another issue. It may be that unless the investor suspects fraud or other questionable activities, specific types of [forensic] information will never actually be requested.

On term sheets that keep changing:
Some firms will float a term sheet before much of the due diligence work on the deal is done by the firm and submit a term sheet with the intention of getting the entrepreneur to commit to a relationship before seriously researching the opportunity... The risk is that the nature of the relationship
will not be really clear until after the negotiation has transpired, and that disagreements
may result in irreconcilable differences.

On East Coast vs. West Coast terms:
There are a few areas where East Coast and
West Coast rules vary significantly. One area is dividends. West Coast firms may encourage clients to consider cumulative dividends where East Coast firms may be comfortable with non-cumulative dividends. Another area is the way in which antidilution
clauses are calculated. The California standard could effect a 6%-7% higher value for existing shareholders in the event of dilution.

Term Sheets and Valuations
$14.95
by Alex Wilmerding, principal
Boston Capital Ventures
45 School Street
Boston, Mass. 02108
617/227-6550
awilmerding@bcv.com

Return to Library of Business Information