The Future of Term Sheets
The predictable pendulum swing of harsher terms during a buyer’s market lead to a lively online discussion on the future of the term sheet. A dialogue between influential bloggers — entrepreneurs and venture capitalists alike — including Chris Dixon, Fred Wilson, and the eponymous Brad Feld extol the benefits of a simple, standardized, Series A term sheet (see posts by Chris, Fred 1, Fred 2, and Brad). A couple of law firms all have their own versions, as do one or two incubators and, perhaps smelling controversy, even The Funded got into the act. With legal fees for a Series A investment running around $40,000 – $50,000, plus the considerable time spent in negotiations and impact on investor and management goodwill, the benefits for a standard term sheet are numerous.
Most prominent is the suggestion – endorsed by nearly everyone — that most Series A terms should be standard (liquidation preference, type of security, pro rata rights, founder vesting, etc), leaving only two terms left to haggle: investment size and valuation.
Personally I think a standard term sheet would make the venture market more efficient, but I’m doubtful of wide adoption. The most important metric to a VC – what ensures their continued survival and prosperity – is their rate of return. Sadly, the more initial deal terms favor the VCs, the higher their potential return. If your business model is based partly on selling high, it sure helps to buy low. Some VCs will hopefully follow the standardized term sheet model, but summer romances usually fade, and the overall industry benefits are unlikely to overcome simple agency conflict, particularly as the VC industry contracts.
And while on the subject, two different analyses of Q2 venture term sheets battle for the last weekend of beach reading. Although there are some notable difference between them (one from Cooley Godward, and one from Fenwick), both saw signs of increased confidence in venture funding. Even with different data sets (Cooley looked at 75 financings nationally; Fenwick 89 financings in just Silicon Valley) the studies agreed that down rounds are still prevalent, but also noted that a number of the most aggressive terms – that skyrocketed after the credit crises — are slowly falling back to earth.