I’ve heard some recent stories of short-fused expiration dates on term sheets for competitive rounds. No, this doesn’t mean we’re in a bubble but it does signal a lot about these investors.
Quick Primer on Term Sheets:
When an investor leads a priced-equity round, he or she formally submits a signed term sheet (or “LOI” — letter of intent) to the startup. (For convertible note financings, generally a note is just drawn up and sent). The term sheet is legally not a commitment to invest, and is conditioned upon completion of due diligence, legal review, and closing docs satisfactory to lead investor.
The term sheet contains the pertinent information about the round, notably:
- Offering terms (how much new money, how much lead investor is taking)
- Securities sold: convertible note, preferred stock, series
- Valuation
- Board makeup
- Closing
- No Shop/Confidentiality
- Expiration
The term of expiration date typically gives the company three days to sign the LOI. If the company does not sign by this date and time, the LOI “explodes” and is no longer valid. Once the term sheet is signed, both parties move in good faith to expeditiously move toward a closing.
Additionally, a summary of key financing terms is included after the key terms which give an overview of terms contemplated within the charter, stock purchase agreement, investor rights agreement, voting agreement, etc. At the end, a proforma cap table is included.
Typically, the only items on an LOI that are binding upon signing are the 30-day no shop and confidentiality terms (company agrees not to disclose terms of LOI to anyone, agrees not to solicit or negotiate with any other parties, etc.).
Crazy LOI Expiration Terms
In hyper-competitive rounds, sometimes the expiration term for LOIs is shorter than three days. Two days, one day — I recently heard a story of a two-hour expiration. These investors are trying to pressure teams into signing and doing the round with their firm with these extremely short time frames.
Never take it. (Did I say never? Yes, good. Never.)
If anyone throws a short-fused expiration date at you other than the standard three-day period, ignore it. Why founders feel that they have to sign something like this in such a short period of time is beyond me. If the investor loved you before the two-hour expiration, they will love you after. And if they don’t love you after, you don’t want them as investors.
You are about to get married to one of the most important people in your company’s history (lead investor, board member) with whom you will ride the startup bus for many years and you are forced to sign the LOI in a matter of hours?
Note I’m not saying that founders have license to string investors out on whatever schedule they see fit. Startups should respect the three-day expiration period. If that is too quick, ask the investor to extend it. We have had founders ask us to extend this period due to special circumstances and we’ve had no problem extending.
The manner in which investors act during the fundraising process highly correlates with their character moving forward. (And founders, the same goes for you). Playing games with terms never gets one anywhere, and it’s incredible the speed at which this information can travel these days.
Step back, take a breath, sleep on it — patience and prudence is something we all need more of these days.
Recipients of this post are not to construe it as investment, legal, or tax advice, and it is not intended to provide the basis for any evaluation of an investment in any fund. Prospective investors should consult with their own legal, investment, tax, accounting, and other advisors to determine the potential benefits, burdens, and risks associated with making an investment in any fund.
