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Updated September 15, 2023You’re reading an excerpt of The Holloway Guide to Raising Venture Capital, a book by Andy Sparks and over 55 other contributors. A current and comprehensive resource for entrepreneurs, with technical detail, practical knowledge, real-world scenarios, and pitfalls to avoid. Purchase the book to support the author and the ad-free Holloway reading experience. You get instant digital access, over 770 links and references, commentary and future updates, and a high-quality PDF download.
Founders should consider two things with regard to corporate counsel when negotiating a term sheet: (1) leveraging their experience doing deals with many different investors to put yourself in the strongest negotiating position and (2) managing the process with diligence, as the legal bill for the paperwork related to a priced round—from term sheets to final docs—can often approach or even exceed $100K if you don’t.
Even if this is your third time raising money, the investors you’re negotiating a term sheet with have probably done this 20+ times. This puts you on the ugly end of a drastic information asymmetry. Great attorneys who know venture capital terms will have many years of experience across hundreds of deals done with many investors. Choosing the right lawyer can be as important as choosing the right investor. You want someone who understands how to support startups and work with venture capital investors. Even if someone is from a nationally ranked firm and an expert in real estate, public finance, or bankruptcy, that does not mean they will be a great startup lawyer. Great startup lawyers aren’t just good with deal terms, they also can help read the dynamics between negotiators, have a strong sense of what’s market for a deal, and give solid practical advice appropriate for the stage your company is at. Aside from being helpful when creating a target list of investors, your lawyer can help to even the playing field when you’re negotiating with seasoned investors.
When you receive a term sheet, you should share it with your counsel. Then walk through each term line by line with them. Many founders see this as a costly exercise, but to skip this step is penny-wise and pound-foolish. If you are the founder responsible for negotiating the investment, it is your responsibility to understand what you’re negotiating. Even if you have terrific counsel whom you trust (hopefully you do!), you’ll only be able to determine what’s worth fighting for in a negotiation if you understand the substance of each term.
Finally, founders should be sure to recognize that corporate counsel is legally obligated to represent the interests of the company. While the interests of the company and its founders can often overlap, that is not always the case. When making decisions that have a personal impact, founders should consider hiring their own lawyers to represent their personal interests. When we refer to lawyers or counsel in this guide, you can assume we are referring to corporate counsel that represents the interests of the company, unless we explicitly state otherwise.
caution In addition to paying your own fees for counsel, founders are typically expected to pay legal fees for the investment firm. This is usually negotiated as part of the term sheet, so we’ll discuss it later on.
Term sheets, and the final legal documents that follow them, are the result of a decades- long tug-of-war between investors and founders. Each clause can be used either defensively or offensively by either party. This is why term sheets are so complicated. In the business of company-building, the incentives for one party to find a loophole to keep or take more ownership are high. The contracts that term sheets set the stage for are the mechanisms both sides use to keep the other party from taking unfair advantage of them.
Term sheets can contain more than 20 specific conditions, each of which is highly nuanced and evolving. Founders don’t need to memorize every term, but they are responsible for negotiating term sheets and getting their company a good deal. Some founders only care about the pre-money valuation and amount raised and then rely on their counsel to tell them what to do with the rest of the term sheet. Every founder with a term sheet in front of them wants it signed yesterday, so they can finish this fundraising round and get back to their company! This temptation is understandable, but you should be cautious about giving even a great lawyer complete decision-making power.
caution Unfortunately, the temptation to just get the thing signed is exacerbated by the fact that term sheets often have an expiration date or an exploding deadline. While there are many firms that do not put an expiration date on term sheets, those that do, use it as a pressure tactic to discourage founders from shopping a term sheet around for better terms. Many founders panic when they see the exploding deadline and then fail to take the necessary time to understand the terms they’re negotiating.