Credit: Rob Moffat, Partner at Balderton Capital as published on sifted

It is 10pm on Wednesday, Feb 21.

You are a founder raising funding. You have got to know VCs over the last few years and had increasingly intense conversations with them over the past few weeks. They have asked you lots of due diligence questions and met most of your team. They have emphasised their focus on long-term partnership; how the average VC investment is longer than the average marriage; why you should choose your VC carefully based on their value-add rather than just valuation.

Finally, after an expensive dinner, the promised term sheet arrives. But with the dreaded sentence:

“This offer expires at 5 pm on February 23”

Sorry, what?

You have been given 43 hours to decide on whether to allow this investor to take a significant ownership position in your company.  An investor who you may well be working with on your board for over a decade.  An investor with their own particular circumstances, strengths and weaknesses which you can only find out from careful referencing.  Does this seem reasonable?

It is bad form to go around other VCs saying exactly who you have an offer from and at what price.

It is obvious why VCs issue these “exploding” term sheets. They are worried that given more time you will either find another VC you would prefer to work with, or a higher offer.

Enforcing a tight deadline forces you to decide whether to take the bird in hand or drop it for the two in the bush. Crossover investors who were ‘fast and loose’ in 2021 became renowned for the 24-hour deadlines on their term sheets, trying to stop founders from going through the process with other firms.

It is much less obvious how founders should react to an exploding term sheet.  A few points to note:

• The deadlines in exploding term sheets are very rarely enforced.  If the investor wants to invest in you this week they will want to invest in you next week.  Only very occasionally their ego might get in the way or another shinier investment might come along.
• Once you have a good term sheet from a good investor you can let other potential investors know.  Not who the firm is or the valuation, but you can tell them that you have a good offer and they need to hurry up and reach a conclusion.  You can set your own reasonable deadline for this if you like.
• Obviously, no one loves fundraising and you want to get back to running the business. But taking an extra week or two to make the right decision on your long-term funding partner is a decent use of your time.
• Term sheets are a moral and reputational commitment but they are not legally binding. So, even if you do sign up before the deadline, you are not rewarded with 100% certainty of outcome.
• Term sheets are not standard and there are a number of terms beyond price. You want your lawyer and existing investors to have time to review the terms.

Various articles have been penned in the past defending the practice of exploding term sheets.  Some of the arguments they give, and why I don’t buy them:

It drives a quicker decision process so the founder can get back to running the business.

That’s great. In our view, the founder should be able to decide on a time limit themselves. In practice, once a founder has a good term sheet they will want to wrap up the fundraise quickly and get on with building.

The dynamics of the business might change while the offer is open.

The VC is investing in the long-term potential of your company.  A few weeks more of performance data shouldn’t affect that decision.

Every Friday

Public tech stocks might crash, but this has little relevance for an early-stage investment in a company which will probably remain private for a decade. In the last crash, we saw good VCs honouring their offers.

The best VCs are fed up with their term sheets getting ‘shopped’* and put tight timelines on term sheets to avoid this.  FOMO investing is annoying and the best VCs want to squeeze it out.

Often it is not clear to the founders who the best VC would be for them. Forcing a tight time limit on this can lead to the wrong decision.

From a founder’s perspective, you want to choose the best investor and should take the time to do so. If after your research you decide you want to work with a top VC but their offer is lower, go back to them saying you have a higher offer.

They might move on valuation, they might not. They aren’t going to walk away unless you handle the situation clumsily and raise questions in their mind on your integrity.

It is bad form to go around other VCs saying exactly who you have an offer from and at what price. VCs don’t want to participate in an open auction. It is enough to say you have a good offer from a good VC and so need their best offer quickly.

In summary, don’t expect VCs to stop issuing exploding term sheets, but do take them for what they are: a negotiating tactic. Once you have a good offer, you are in control and can set the timing of the fundraise on your terms.

*Example of ‘getting shopped’: TopVC offers you $10M for 20%. You tell less good VC. They react by saying “If TopVC wants to invest I’ll double their valuation”.

Don’t expect VCs to stop issuing exploding term sheets, but do take them for what they are: a negotiating tactic.

Credit: Rob Moffat, Partner at Balderton Capital as published on sifted