Entrepreneurs seeking financing more often than not turn to venture capital firms. These firms usually provide capital and apart from that they also provide strategic assistance and help with the introductions to potential customers, employees, and partners.
Venture capital financing, however, is not easy to get or to close. It is, for this reason, all entrepreneurs must prepare them well by knowing the process, understanding the terms and conditions of the anticipated deal and realize the potential issues that may arise.
To understand the process of securing venture capital financing it is important that you know that typically all venture capitalists will focus their investment efforts by using one or more of the following factors:
- Specific industry sectors such as software, mobile devices, digital media, SaaS, semiconductor, biotech and others
- Stage of the company such early-stage seed, Series A rounds, or later stage with companies that have attained meaningful profits and traction and
- Geography or location of the company.
You must know whether the focus of the venture capitalist aligns with that of your company and its various stages of development before approaching.
Next up, you must understand that the venture capitalist may get inundated with different investment opportunities through unsolicited emails and in most cases all these mails get ignored. Therefore, the best way to grab the attention of a venture capitalist to have yourself introduced through a trusted colleague, another entrepreneur, or through a lawyer who is friendly to the VC.
You must have a strong “elevator pitch” and also a solid investor pitch deck. This will help you to attract the interest of the VC more easily.
You must also know that the entire venture process can be very time consuming and even meeting the principal of the venture capitalist firm may take a few weeks. After that it will be followed up with:
- More meetings
- More conversations
- Presentation to all of the partners of the venture capital fund
- The issuance and negotiation of the term sheet and
- Continued due diligence.
Finally, the process will be concluded by the negotiation and drafting by lawyers from both sides for a large number of legal documents to evidence the final investment.
Know the venture capital term sheet
Just like any other loan that you may take from a bank or NBFCs such as liberty lending USA you will need to read the terms and conditions of the loan contract to avoid unexpected surprises, you must also know everything about the venture capital term sheet.
- This is the initial document of most venture capital financing.
- This is prepared by the VC firm and presented to you.
- This important document signals that the VC is serious about the investment and
- It indicates that the VC wants to proceed to finalize the due diligence and prepare the definitive legal investment documents.
Ideally, most VC firms will have obtained the approval for the investment from their investment committee before the term sheets are issued. However, you must know that these terms sheets are not a guarantee that the deal will be consummated through most of these result in completed financing.
The term sheet will cover all of the important aspects of financing such as:
- The economic issues such as the valuation provided to the company as higher valuation equals less dilution to the entrepreneur
- The control issues such as set up of the Board of Directors, sorts of approval, veto rights and others and
- The post-closing rights of the investors including the right to get periodic financial info and the right to participate in future financing.
Apart from that, the term sheet will also mention the fact that it is non-binding excluding a few specific provisions such as no shop or exclusivity or confidentiality. This is the most important document to negotiate with your investors despite it being not binding. This is because almost all major issues will be covered in the term sheet only leaving the smaller ones that will be resolved in the financing documents that will follow.
Give a lot of attention
As an entrepreneur, you must give the term sheet a lot of attention and importance as ideally, it is the blueprint for the relationship with you and your investor.
Ideally, there are varying philosophies and a lot of recent developments made in the venture capital term sheet regarding its use and extent. One such approach is to have an abbreviated form term sheet. You will have only the most important points in the deal included and covered in it. However, it is argued that the principals may focus on only the major issues and leave the other minor ones to the lawyers to decide during negotiation process of the conclusive financing documents.
The drawback of this short form approach is that there are high chances that a lot of minor issues may be left unresolved while drafting the definitive document. If these are not resolved in this stage then you will have to spend extra time and legal cost. However, if you want to reach to a ‘handshake’ deal faster, a short form approach is ideal.Even VCs prefer this approach as they feel it will be more appealing to an entrepreneur.
Another specific approach to term sheets is to follow the long form approach. In this method, virtually all issues in the deal that are needed to be negotiated are included and raised. This makes the drafting and negotiating the process of the decisive legal documents a lot quicker and easier.
It is, therefore, recommended that you have a long form comprehensive term sheet as that will mitigate all future problems during the definitive document drafting stage. This will ensure that your interest as an entrepreneur as well as the expectation of your investors will be well protected and safeguarded. You will find it easier to convince any investor to trust your business. A long form term sheet will ensure that you convey the message that you are organized and sincere to your business facilitating a trusted investment.
| About the Guest Author:
Isabella Rossellini is a marketing and communication expert. She also serves as content developer with many years of experience. She has previously covered an extensive range of topics in her posts, including business and start-ups.