Negotiate deal terms to minimize dilution.

Most negotiation in a deal occurs at the “term sheet” phase - it is a short, non-binding document designed to facilitate and provide a framework for negotiations before signing an actual share purchase agreement.

The more commitments (or terms sheets) you get, the more leverage you have and the faster you can move the round to a close.

In a seed round, the Angel investor or VC will typically be the one providing the term sheet to indicate the terms under which they are willing to invest.

However, when there are multiple investors in later and larger rounds, or if your company is a “hot startup”, you may create your own term sheets for the investors to review.

Common items in a term sheet include:

• Type of security being offered

• Pre-money & post-money valuation

• Shares issued and price

• Voting rights

• Board seats

• Conversion options

• Anti-dilution provisions

• Rights to information

• Rights to future investment

• What happens on liquidation or IPO

• Protection provisions

• Founders obligations

• Who will pay legal expenses

• Non-disclosure requirements

Getting to a term sheet is a key milestone in the capital raising process. Although not all term sheets result in a transaction, the term sheet shows that both parties are legitimately interested in executing a transaction. It is then up to the investor and the startup to agree upon the details.

Term Sheet Template

Download a sample term sheet here

How to negotiate terms

Which terms end up in the final term sheet is a matter of negotiation, and there are different formulations that are more favorable to the business founders or to the investors.

In order to get the best possible terms, you need to promote competition between investors. Your goal is to get multiple deals on the table, in a short period of time.

Never tell who else you are talking to until a term sheet is signed. VCs and angels talk to one another. You want all the funds to be competing against one another to drive up your price and to secure better terms.

Once you’ve reached an agreement and have a signed term sheet with a lead investor, you then fill the round with other investors.

Navigate through due diligence.

Once an investor has expressed interest in investing in a company, the deal will enter into a due diligence process - to confirm all material facts are correct.

Some investors conduct due diligence prior to issuing a term sheet. However, most investors, especially when participating in more competitive deals, will issue a term sheet and then do due diligence.

As due diligence is fairly standardized, a startup can actually preempt 95% of the questions it will get during due diligence.

Business Due Diligence

During business due diligence investors are looking to confirm details about a company’s financial health, sales data, market, and team. Some of the things asked for in a business due diligence checklist are:

• Organizational charts

• Past financials and projections

• Management reports

• Shareholder communications

• Customer and supplier agreements

• Credit agreements and loan obligations

• Partnership or joint venture agreements

Legal Due Diligence

During legal due diligence, on the other hand, investors are looking into the structure of the company, its legal obligations, and its right over intellectual property. Some of the things asked for in a legal due diligence checklist are:

• A capitalization table

• Articles of incorporation

• Shareholder arrangements

• IP-related agreements

• Government licenses / approvals

These standard documents should be easy for you to gather and place in your data room.

How due diligence is conducted

The process often begins with the investor providing a checklist to the startup.

Download Capital2u Due Diligence / Dataroom Checklist here.

Due diligence process:

1. Document Verification: Reviewing and confirming the accuracy of the information presented in the company's pitch materials.

2. Stakeholder Engagement: Requesting discussions with various stakeholders, such as customers, vendors, past investors, employees, and other key individuals associated with the business.

3. Red Flag Identification: Actively looking for any discrepancies, missing information, or inconsistencies that might raise concerns.

4. Legal Assessment: Verifying the company's legal rights to its products, trademarks, and other intellectual property.

5. Open Communication: If red flags are identified, engaging with the company to address concerns. This may involve negotiation or, in extreme cases, reconsideration of the deal.

How to Streamline the Due Diligence Process

A few things you could do to help make the due diligence process goes as smoothly as possible include:

• Create a virtual data room: It’s a good idea to keep a data room in google drive or a file sharing service so investors can access and return to documents in an organized way.

• Be proactive: Follow up with the prospective investors and anticipate what they’ll need. Proactively send the required information to them.

• Maintain your own tracking system: Keep a checklist of what has been sent, to whom, and when, so you can move the overall process forward as fast as possible.

When a company is prepared, with its due diligence folder ready, due diligence is much faster and smoother than if a company only starts gathering information when asked.

Get your investment contracts signed and close the deal.

When all of the terms have been negotiated and you have passed the due diligence process, it’s time to close the deal.

The closing will involve legal documents prepared and reviewed by attorneys for both parties. It generally includes a share purchase agreement, and an investor rights agreement or shareholders’ agreement.

The initial draft will be created based on the terms set out in the term sheet. This draft will then go back and forth between both parties until everyone is satisfied with the agreement.

Once the documents have been signed, investors generally wire their portion of the investment to the startup’s bank account. It is at this point, when all docs are signed and all money has been transferred, that the round is officially closed.

Closing the Deal Is Not the End of the Deal

Once the deal is closed, your journey is just getting started—and your investors are now partners in growing your business. You are now running a venture-backed company, and it’s time to start executing on your first orders of business.

Assemble your first board meetings, run strategy sessions, and begin executing on the plan set out in your fundraise. If you haven’t already, share your hiring plan with your board and investors and begin bringing on new team members.

Stay engaged with your investors. Monthly updates are advisable, though quarterly may be acceptable; either way, be sure to make your investor group aware of the frequency with which they can expect updates.

When updating investors, you should include:

• Any issues that have presented themselves

• New organizational changes that are being made

• Answering any queries that investors have raised recently

• Press coverage

• New business development deals and partnerships

• Milestones achieved

• Milestones for the next quarter

• Growth in terms of users and revenues

• Potential new hurdles and challenges down the line

• Details of any financial changes including running costs

• Requests and asks that you would like to make from the investor