So you’ve made it past all the VC grilling and received a term sheet. Congratulations! But don’t celebrate just yet. Term sheets are non-binding, and even though they should signify a VC has conviction in investing in you and is ready to move towards closing, they fall through more often than most founders may expect.
Here are the three most common reasons why receiving a term sheet may not result in an investment by a VC and what you can do about it.
The Rushed Term Sheet
Ideally, before offering term sheets, VCs should already have examined the business side of intended investments from all angles. For example, at LionBird, we review opportunities before moving to term sheet stage, and post-term sheet due diligence is limited to confirming nothing foul has been overlooked.
Unfortunately, sometimes fundraising processes are rushed due to multiple investors vying for a deal. As a result, some VCs may push their usual pre-term sheet due diligence to after your term sheet is signed in order to speed things up, and if this is the case, the chances of them backing out post-termsheet are much higher.
For example, I’ve seen startups receive term sheets by investors who had only just met them but smelled a competitive deal. If a VC that is not deeply familiar with your industry and team offers a term sheet before they know who your competition is and what your plans are, this should raise red flags. They may be clueless or driven by FOMO, either of which may signal a fickle investor.
The Term Sheet Draft
Sometimes, a VC is interested in investing in a company in order to get a “good deal” before a company goes out to officially fundraise. So they lob a rough outline of a term sheet with little commitment, and if they get too much push back, they move on. When I see boilerplate term sheets that demonstrate lack of knowledge of a company’s current capital structure, for example failing to address open convertible notes or other share classes, I take this as no more than an indicator of interest.
If you’re on the receiving end of a term sheet draft, even if the round doesn’t go through, you can still use this outside interest to your favor. In cases where extra runway is desired, you can leverage the social signaling this term sheet represents to raise a quick internal extension round from your existing investor base, positioning this as a chance for them to invest more at a lower valuation before other term sheets come in.
The Honeymoon Term Sheet
VCs often (and should) fall in love with the startups they offer to fund. However, after the pre-term sheet honeymoon phase, when they begin taking a deeper look into the minutiae of your business, they may discover red flags that significantly change their perception of the deal.
In extreme cases, for example where there are serious legal, ethical or character concerns that weren’t previously addressed, they may even decide to walk away from the deal. If this happens, they should be willing to explain the rationale so that you can address this, or at least prevent this from happening next time around by being proactive in dealing with potential show stoppers.
Make Sure Your VC Is Term Sheet Ready
When a VC provides you with a term sheet, don’t assume the fundraising process is over. Make sure it represents real investor conviction and that it is based on true and full understanding of your business, or else it may represent a huge waste of time and resources for all involved.
Always have a plan B, and save your celebration for when the money is in the bank.