How do I handle multiple term sheets?

What does a term sheet bind me to?

A term sheet is mostly a statement of intent. The price, the investor's commitment to invest and the economic terms are usually non-binding until the definitive documents are signed. A few clauses are binding as soon as you sign. The no-shop (or exclusivity) clause stops you from soliciting or negotiating with other investors for a set period, commonly 30 to 60 days. A confidentiality clause stops you from sharing the terms, which limits your ability to show the term sheet to another investor. An expense clause often makes the company pay the lead's legal fees, sometimes even if the deal doesn't close. Read these three clauses before you sign anything; see Who Pays the Legal Fees in a Startup Funding Round?

The investor is not bound to close. It can walk away during confirmatory diligence, though reputable firms rarely do unless they find something material.

What do I do with an exploding offer?

An exploding offer is a term sheet that expires quickly, sometimes within 24 to 72 hours, to stop you from getting competing bids. Don't panic, and don't sign just because the clock is running. Thank the investor, say you take the offer seriously, and propose a specific, short extension tied to a reason: "We have two partner meetings this week and will give you an answer by Friday." Most investors who want the deal will agree. If one refuses a reasonable request for a few days, treat that as information about how it will behave on the board.

How do I compare offers beyond the valuation?

Put the term sheets side by side and work through each term.

The option pool. Most term sheets require the company to expand its option pool to a target percentage of the post-money capitalization, and to do it inside the pre-money valuation. That means the new pool dilutes only the existing holders. A bigger pool target lowers your effective valuation. See Negotiating an Option Pool.

The liquidation preference. A 1x non-participating preference is standard at seed and Series A: investors get their money back or convert to common, whichever is worth more. A participating preference lets them take their money back and also share in what's left. Multiples above 1x are a red flag in a normal market. See Liquidation Preference.

Board seats. A seed or Series A board of two founders and one investor keeps the common in control. A term sheet that gives investors a majority, or adds an independent director the investor effectively picks, changes who runs the company.

Protective provisions. Standard veto rights cover changes to the preferred's rights, new senior securities, a sale and similar matters. Watch for extra vetoes over budgets, hiring, debt or ordinary operations. See Protective Provisions.

Pro rata and other rights. Pro rata rights for major investors are normal. Super pro rata rights, which let an investor buy more than its share of future rounds, can crowd out the next lead. See Pro Rata Rights.

The documents. A term sheet based on standard forms, such as the NVCA model documents or the shorter Series Seed documents, means fewer surprises and lower legal fees. See Series Seed vs NVCA Docs.

The lead. Ask how the firm behaves when things go badly, whether it reserves money for follow-on investments and usually uses it, how much partner time you will get, and how fast it can close.

How can a higher valuation net me less?

Example. Two founders own 9,000,000 shares of common stock, and the company has a 1,000,000-share option pool with no grants yet, so there are 10,000,000 fully diluted shares. Two firms offer to invest $5,000,000.

Term Sheet A offers a $20,000,000 pre-money valuation, a $25,000,000 post-money. The option pool must be 20% of the post-money, created in the pre-money, and the preferred gets a 1x participating preference. The investor buys 20% of the company ($5,000,000 ÷ $25,000,000), the pool is 20%, and the founders keep 60%. The post-money fully diluted count is 15,000,000 shares (9,000,000 ÷ 60%), so the price is about $1.67 per share, the investor gets 3,000,000 shares and the pool grows from 1,000,000 to 3,000,000 shares.

Term Sheet B offers a $15,000,000 pre-money valuation, a $20,000,000 post-money, with a 10% pool and a 1x non-participating preference. The investor buys 25%, the pool is 10%, and the founders keep 65%. The post-money fully diluted count is about 13,846,154 shares, the price is about $1.44 per share, the investor gets about 3,461,538 shares and the pool grows to about 1,384,615 shares.

At the round price, the founders' stake is worth $15,000,000 under A (60% of $25,000,000) and $13,000,000 under B (65% of $20,000,000), so A looks better. Now sell the company. Under A, the investor takes its $5,000,000 first and then 20% of the rest, and the founders get 60% of what is left after the $5,000,000. Under B, the investor either takes $5,000,000 or converts to its 25%; above a $20,000,000 sale it converts, and the founders get 65% of the whole price. The table assumes every pool share has been granted and ignores option exercise prices and taxes.

Term Sheet B pays the founders more at every sale price in the table, by $4,500,000 at $30,000,000 and $8,000,000 at $100,000,000. The extra 10 points of pool in A more than offset its higher valuation, leaving the founders with 60% instead of 65%. The participating preference then cost them a further $3,000,000 in each of these sales, their 60% share of the $5,000,000 the investor takes off the top before converting. Before you choose, also consider that the bigger pool in A gives you more room to hire without topping it up at the next round, so the right comparison uses the pool you actually need.

How do I use competition without burning the lead?

Be truthful. Tell each firm that you have other interest, and when you have another term sheet, say so. You can describe the terms in general (a higher valuation, a smaller pool, a non-participating preference) if the confidentiality clause in the other term sheet allows it, and many do not allow you to share the document itself. Never invent an offer or inflate one. Investors talk to each other constantly, and a founder caught bluffing loses credibility with every firm in the round.

Set one deadline for final offers and apply it to everyone. Tell your preferred lead what it would take to win, often a single change such as a smaller pool or a non-participating preference, rather than running a series of auctions. Once you've decided, call the firms you're turning down yourself and thank them. You will likely meet them again at the next round.

What happens once I sign?

The no-shop means stop. Don't take new investor meetings about the round, don't respond to other term sheets and don't use the signed term sheet to get a better offer elsewhere. Shopping a signed term sheet breaches the no-shop, gives the lead a reason to walk away and is the fastest way to damage your reputation with investors. You can tell other investors that you have signed and may have room for them in the round with the lead's agreement. Then move quickly through diligence and documents, because the no-shop has an end date and so does your runway.

How do I reference-check the lead?

The investor has spent weeks checking you, so check it. Ask the partner for founder references, then find others yourself, especially founders whose companies failed or went through a down round, a layoff or a CEO change. Ask whether the partner was helpful when things went wrong, whether the firm supported the next round, how it acted on contentious board votes and how much time the partner really spent. The partner who takes your board seat matters more than the firm's brand.

To go deeper, read our Founder Guide: Seed Funding and Founder Guide: Series A.

For more, see Negotiating an Option Pool, Liquidation Preference, Protective Provisions and How Do I Find the Right Angel Investors?

If you have more than one term sheet on the table, contact us before you sign any of them.