Mayank Khanduja from SAIF Partners has an excellent post up at NextBigWhat on an unusual but important situation — where a VC moves quicker than is sensible to offering a termsheet.
“We all know of instances where funds move quickly to extend a term sheet, only to see it fall through at later stage, as some part of the due-diligence on areas like market, competition etc. was completed only later. While one cannot entirely fault the VC from backing out, it is definitely unfair on their part to extend a term sheet before completing these elements of the business due diligence.”
Just to add a couple of points on this, this isn’t always a case of simple over-exuberance. A term sheet typically contains a 30-60 day no-shop clause where you aren’t allowed to talk to other investors, which can be abused by the more dastardly variety of VCs/ angels. Getting a term sheet out can be convenient way of securing an option on a hot deal and then doing their evaluation at their leisure during the no-shop period.
Going off the market for a month or more can be disastrous, no matter how hot you are. All the momentum you’ve built is gone. All the other interested parties are somewhat pissed. And they’re asking questions — “What did they find that made them pull the plug?”
- Resist the temptation to get something signed quickly. Term sheets are non binding. It may feel like you’re finally done and can get back to work, but you’re not.
- Ask what they intend to examine in their post-termsheet due diligence. Ideally the only items should be legal and accounting related. For business related items (competitive review, customer interviews etc), just let them know you’re happy to wait to sign a term sheet until they’ve gathered all the information they need. This is probably the most important thing. Do not take yourself off the market while they’re still figuring out how they feel about you.
- This should go without saying, but try to time it so you get more than one term sheet around the same time. It’ll help keep things moving along and help negotiate a quick closing.
- Communicate with your alternatives before you sign. It’s more than acceptable to let other investors know that it was a tough decision and you do still love them, and they’ll absolutely be on your shortlist to call back if something unforeseen happens in closing. Having reasonable confidence that you have alternatives gives you leverage if things start going south post-signing.
- Finally, get your legal and accounting shit together. There’s no excuse for having your deal fall through because you were sloppy with your books. Ideally, everything is spotless and you get through post termsheet due diligence in a couple of weeks, minimizing the window for them to get cold feet.
Like I said, this is rare. Most VCs don’t offer a term sheet unless they intend to close. But if you do come across one who’s rushing to get one signed while you have interest from others, slowing down and taking stock is generally a good idea.